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Module-3 Role Players

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Board of Directors are the driving force of every organization. Therefore, a strong governance framework needs to be established, and should serve the following objectives:1. Clarify the roles, responsibilities and accountabilities of the board members and management team; 2. Enable the board to provide strategic guidance and effective oversight of the management; and 3. Ensure that no one single individual has too much power or influence on the organization. Further to the above, the board’s main role is to protect the interests of the shareholders and other relevant stakeholders. At the same time, they have to ensure that the company is able to compete in the market. The directors are also expected to be able to have a firm grip on the company’s internal controls processes, to ensure operational and financial risks are identified, addressed and managed. In a general context, the effectiveness of a board within an organization depends on a few factors, namely, size and composition, competencies, activeness and leadership qualities. These factors are non-exhaustive and non-conclusive whereby every organization should include relevant gauge wherever necessary.

Size and Composition
There is no such thing as the optimal size for the board, but the Companies Act 1965 determines the minimum number of directors and the Articles of Association normally specifies the maximum. However, instead of arriving at the absolute number, an organization should look into certain factors to gauge the optimum size of the board. Some of these factors include:• •

Size of the organization, scope of business and geographical diversity; There should be a balance between executive and non-executive directors as well as the independent elements of those non-executive directors. This is mainly to achieve the check and balance whereby no single individual has the ultimate control over the board; Whether the board has representation diversity in terms of professional experience, race, gender and technical know-how of the industry.

Competency
There should be a mixture of core competencies among the directors in the board to cover most aspects of the organization. Certain directors need to have relevant industry specific knowledge

e. The bylaws commonly also specify the number of members of the board. the board is also expected to monitor the management’s decisions and actions. In addition to playing the strategic role within the organization. and responsibilities delegated to it or conferred on it by an authority outside itself.and experience whereas others are professionals having focused expertise in areas such as finance.g.. Whilst the board of directors plays a very big part in corporate governance. they should question the management based on factual knowledge." A board's activities are determined by the powers. Furthermore. and if there are inconsistencies found. accounting. These matters are typically detailed in the organization's bylaws. They have to be able to evaluate strategic decisions. the board is the supreme governing body of the institution. and when they are to meet. Role of Board of Directors: A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. the board is also expected to ensure that the management conducts their tasks ethically and comply to all financial reporting and regulatory requirements. or executive board. the board must should leadership qualities such as having ability to inspire talents and provide strategic direction and vision of the organization. the board is expected to be vigilant in ensuring the management is implementing the direction of the board. Leadership Qualities Being the driver of the organization. In a stock corporation.. duties. internal and external audits too affect the framework of corporate governance. which usually chooses the members of the board. Activeness The board is required to play an active role in directing the organization. In an organization with voting members. a university. and is subordinate to. board of managers. how they are to be chosen. a professional society.[1] Typical duties of boards of directors include . The body sometimes has a different name. e. conceptualizing ideas and innovation to continually pressing for growth and address future challenges.g. the organization's full assembly. the board acts on behalf of. Although they may not be playing an active role in the daily operational issues. the board is elected by the stockholders and is the highest authority in the management of the corporation. In a nonstock corporation with no general voting membership. certain other factors like risk management. such as board of trustees. It is often simply referred to as "the board. risk management etc. board of governors.

while restricting themselves to their term of reference. They will not be required. International Audit Standards maintain that an auditor's mandate may require him to take cognizance and report matters that come to his knowledge in performing his audit duties which relate to: >Compliance with legislative or regulatory requirements.• • • • • governing the organization by establishing broad policies and objectives. it prohibits in explicit terms any such excesses on the part of the auditors. pertaining to economic actions and events. and projects. AUDITING — ROLE OF AUDITORS IN GOOD GOVERNANCE: Auditing is defined as obtaining and evaluating evidences regarding assertions about economic actions and events to ascertain the extent to which they correspond with the established criteria. >Adequacy of accounting and control systems. attestation process. "to design procedure for the specific purpose of identifying matters of governance interest". Thus. or. Lately. The only alternative then is to make the auditors feel more conscientious. while the later is the outcome of a wide range of managerial functions. IAS 260 categorically requires the auditors to communicate with the officials charged with the governance of an entity the matters arising from the audit of financial statements. Should this mean to expect them to cross the established borders of genuine audit functions. and to communicating the result to the interested users. more dutiful. alternatively. Rather. appointing. ensuring the availability of adequate financial resources. Two variant situations emerge when the functions of auditors and the requirements of good governance are placed face to face. it would be stretching the string too far. approving annual budgets. the IAS continues. and with the jurisdiction within which it operates. >Viability of economic activities. Typically the board chooses one of its members to be the chairman. The question then arises whether the auditors should cross their operational limits in order to bring about the desired level of improvement in the quality of governance. and therefore to be more effective. which are directly related to the audit of financial statements. they should operate more effectively so as to help improve the quality of governance. programmes. and the reporting process. The legal responsibilities of boards and board members vary with the nature of the organization. without gaining any thing positive and substantial. Even the Code of Good Corporate Governance envisaged by the SECP subscribes to this phenomenon. while restricting themselves to their term of reference. The former is confined to 'econonuc actions and events. a view has emerged that auditors should play a more vital and direct role in establishing good governance. International Auditing Standards (IAS) also recognize that the matters that may be relevant to the governance of any business entity may be broader than those that form the subject matter of IAS. accounting to the stakeholders for the organization's performance. For public corporations. supporting and reviewing the performance of the chief executive. selecting. these responsibilities are typically much more rigorous and complex than for those of other types. it encompasses investigation process. Paragraph xl under the heading 'External Auditors' reads: "No listed company shall appoint its auditors to provide services in addition to audit except in accordance with the regulations and shall require the auditors to observe applicable IFAC (International Federation of Accountants) guidelines in this regard and shall ensure that the auditors do not perform management .

auditors of BCCI. be from within their range or sphere of activity. Heller and Partners Ltd. about a set of circumstances depend upon: (i) his view point. it is established that auditors are not required to traverse their area of operation. An answer to this very pertinent question can be traced back in what Denning LJ observed in Candler v. losses which. Three blind men were led to an elephant and asked to state by touching it what it was. to the best of their knowledge. and the opinion that he forms. therefore. they believe. could have been prevented had the auditors been more vigilant. The 'care' again is a relative term. No doubt the vast majority of the profession do behave with integrity but auditors can and do some times fail to exercise their duty to as high a standard as is expected of them. The third gentleman who came in contact with the trunk claimed that it was a hose-pipe. needs to be ameliorated to match the requisites of good governance. In other words. Crane Christmas & Co. " Thus. it is the quality of their performance that will make all the difference. This becomes all the more important in view of the fact that the law has not defined the expression 'true and fair'. Interestingly enough. This is largely the result of wide publicity being given world over to considerable sums sought by plaintiffs in compensation for losses they have suffered.functions or make management decisions. the statutory auditors and internal auditors. (1951). therefore. The other who groped around the tail announced that it was a rope. All the three. the overriding requirement is to have a "true and fair view". remained in the news for quite some time during the last decade of the preceding century for their reportedly inapt behaviour leading to the collapse of the Bank. sufficient and credible. Moreover.10 As the audit committee acts as the bridge between the board. Once it is settled that it is the quality of audit that is aimed at. were 'true and fair' but none of them was right. responsibility for which remains with the Board of directors and management of the listed company. They have also duty to use care in their work which results in their reports". (1963)]. To quote a lively example. whose opinion was later upheld in famous Hedley Byrne case [Hedley Byrne & Co. . The famous Elephant Story will help explain this riddle. the question arises what is the desirable quality. the whole process of auditing requires much imagination and careful thought from beginning to end. v. and (ii) the information made available to him. The first who touched the animal from the side and felt hard and broad span of the skin said it was a wall. the Committee recommends that its role should include the following • Oversight of the company’s financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct. Birla Committee Report on Audit Committee: Functions of the Audit Committee 9. " Their [the auditors'] duty is not merely a duty to use care in their reports. However. It is highly demanding and is often described as a very onerous responsibility. The degree of care required may also vary from situation to situation. Whatever they are expected to contribute towards good governance shall. and which reads. what is 'true and fair' is not necessarily the 'truth'. m/s Pricewater House. which. and how can it be measured? The question has gained great momentum in recent years when considerable attention has been focused on the auditor's responsibility for negligence. This leads to the conclusion that the perception and belief a person may have.

share holders (in case of non-payment of declared dividends) and creditors. o Significant adjustments arising out of audit. This is evident from the continuous updation of guidelines. Reviewing the company’s financial and risk management policies. Discussion with internal auditors of any significant findings and follow-up thereon. the SEBI had specified principles of Corporate Governance and introduced a new clause 49 in the Listing agreement of the Stock Exchanges in the year 2000. o Qualifications in draft audit report.” Based on the recommendations of the Committee. SEBI had constituted a Committee on Corporate Governance under the Chairmanship of Shri Kumar Mangalam Birla. It is the muscle that moves a viable and accessible financial reporting structure. Looking into the reasons for substantial defaults in the payments to the depositors. These principles of Corporate Governance were made applicable in a phased manner and all . Reviewing the adequacy of internal audit function. with promoters or the management. of the nature and scope of audit. The Committee in its report observed that “the strong Corporate Governance is indispensable to resilient and vibrant capital markets and is an important instrument of investor protection. o Major accounting entries based on exercise of judgement by management. transactions of the company of material nature. the adequacy of internal control systems. Reviewing with management the annual financial statements before submission to the board. staffing and seniority of the official heading the department. debenture holders. Discussion with external auditors before the audit commences.• • • • • • • • • Recommending the appointment and removal of external auditor. SEBI and Governance: Good Governance in capital market has always been high on the agenda of SEBI. Corporate Governance is looked upon as a distinctive brand and benchmark in the profile of Corporate Excellence. o Any related party transactions i. focussing primarily on: o Any changes in accounting policies and practices. It is the blood that fills the veins of transparent corporate disclosure and high quality accounting practices. o Compliance with accounting standards o Compliance with stock exchange and legal requirements concerning financial statements. their subsidiaries or relatives etc. o The going concern assumption.e. that may have potential conflict with the interests of company at large. Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board. reporting structure. including the structure of the internal audit department. rules and regulations by SEBI for ensuring transparency and accountability. external and internal auditors. Also post-audit discussion to ascertain any area of concern. fixation of audit fee and also approval for payment for any other services. Reviewing with the management. In the process. coverage and frequency of internal audit.

2004. It clarified that some of the sub-clauses of the revised clause 49 shall be suitably modified or new clauses shall be added following the amendments to the Companies Act 1956 by the Companies (Amendment) Bill/Act 2003. system of Corporate Governance need to be continually evolved. 1992 read with section 10 of the Securities Contracts (Regulation) Act 1956. The companies which are required to comply with the requirements of the revised clause 49 have been put under an obligation to submit a quarterly compliance report to the stock exchanges as per sub clause (IX) (ii). nor can any system of Corporate Governance be static. Views expressed are personal views of the author and do not reflect those of the Institute. The report is required to be submitted either by the Compliance Officer or the Chief Executive Officer of the company after obtaining due approvals. within 15 days from the quarter ending 31st March. Schedule of Implementation The circular specifies following schedule of implementation of the revised clause 49 : (i) All entities seeking listing for the first time.the listed companies with the paid up capital of Rs 3 crores and above or net worth of Rs 25 crores or more at any time in the history of the company. so that the relevant provisions of the clauses on Corporate Governance in the Listing Agreement and the Companies Act remain harmonious with one another. as part of its endeavour to improve the standards of corporate governance in line with the needs of a dynamic market. constituted another Committee on Corporate Governance under the Chairmanship of Shri N. revised the existing clause 49 of the Listing agreement vide its circular SEBI/MRD/SE/31/2003/26/08 dated August 26. * Secretary. In a dynamic environment. R. The companies are required to comply with the requirements of the clause on or before March 31. SEBI. The Committee in its Report observed that “the effectiveness of a system of Corporate Governance cannot be legislated by law. 2003. Application of Revised Clause 49 . were covered as of March 31. The ICSI. SEBI on the basis of recommendations of the Committee and public comments received on the report and in exercise of powers conferred by Section 11(1) of the Securities and Exchange Board of India Act. of the revised clause 49.” With a view to promote and raise the standards of Corporate Governance. Narayana Murthy to review the performance of Corporate Governance and to determine the role of companies in responding to rumour and other price sensitive information circulating in the market in order to enhance the transparency and integrity of the market. 2003. at the time of listing. 2004. (ii) All listed entities having a paid up share capital of Rs 3 crores and above or net worth of Rs 25 crores or more at any time in the history of the company.

the revised clause will apply to the extent that it does not violate their respective statutes. For this purpose. but body corporates (e. HIGHLIGHTS OF THE NEW AMENDMENTS 1. The stock exchanges have been empowered to grant a reasonable time to comply with these conditions if they are satisfied that genuine legal issues exists which will delay such compliance. Widening the Definition of Independent Director Under the revised clause 49. the stock exchanges are required to obtain a suitable undertaking from the company. shareholders/ investors grievances committee. its subsidiaries and associated companies. However. its promoters. (b) is not related to promoters or management at the board level or at one level below the board. does not have any material pecuniary relationships or transactions with the company. and to obtain the quarterly compliance report from the companies which are required to comply with the requirements of Corporate Governance. The revised clause is not applicable to the Mutual Fund Schemes. and has not been a partner or an executive of .g. its senior management or its holding company.) incorporated under other statutes. and guidelines or directives issued by the relevant regulatory authorities. In case of the company failing to comply with this requirement without any genuine reason. (c) has not been an executive of the company in the immediately preceding three financial years. Obligations on Stock Exchanges The Stock Exchanges are put under obligation to ensure that all the provisions of Corporate Governance have been complied with by the company seeking listing for the first time. before granting any new listing. in accordance with the schedule of implementation given above. In such cases while granting listing. for other listed entities. financial institutions. (d) is not a partner or an executive of the statutory audit firm or the internal audit firm that is associated with the company.The revised clause 49 is applicable to the listed companies. insurance companies etc. The stock exchanges are required to submit a consolidated compliance report to SEBI within 30 days of the end of each quarter. The expression ‘independent director’ mean non-executive director of the company who — (a) apart from receiving director’s remuneration. the definition of the expression ‘independent director’ has been expanded. it would be satisfactory compliance if these companies set up the Boards and constitute committees such as Audit Committee. which are not companies. the application money shall be kept in an escrow account till the conditions are complied with. private and public sector banks. The Stock Exchanges have also been required to set up a separate monitoring cell with identified personnel to monitor the compliance with the provisions of the Corporate Governance. before seeking listing. etc.

the compensation to be paid to non-executive directors was fixed by the Board of Directors.e. 4. owning two percent or more of the block of voting shares.any such firm for the last three years. It has been clarified that the Institutional Directors on the boards of companies are independent directors whether the institution is an investing institution or a lending institution. whereas the revised clause requires all compensation paid to non-executive directors to be fixed by the Board of Directors and to be approved by shareholders in general meeting. Compensation to Non Executive Directors and Disclosure thereof As per earlier clause 49. 2. The revised clause also requires non-executive directors to disclose prior to their appointment their stock holding (both own or held by / for other persons on a beneficial basis) in the listed company in which they are proposed to be appointed as directors. service provider or customer of the company. the revised clause provides that the considerations as regards compensation paid to an independent director shall be the same as those applied to a non-executive director. The revised clause specifies that no defence shall be permitted that the independent director was unaware of this responsibility in case of any proceedings against him in connection with the affairs of the company. The company is also required to disclose on an annual basis. (e) is not a supplier. These details are required to be accompanied with their notice of appointment. this may be put up on the company’s website and a reference thereto in the annual report. 3. i. Code of Conduct . and (f) is not a substantial shareholder of the company. The stock options granted to the nonexecutive directors to be vested after a period of at least one year from the date of retirement of such non-executive directors. The companies have been put under an obligation to publish their compensation philosophy and statement of entitled compensation in respect of non-executive directors in its annual report. including on an “if-converted” basis. Alternatively. There is also provision for setting up of limits for the maximum number of stock options that can be granted to non-executive directors in any financial year and in aggregate.. details of shares held by non-executive directors. Placing the independent directors and non-executive directors on equal footing. This should include lessor-lessee type relationships also. Periodical Review by Independent Director The revised clause 49 requires the Independent Director to periodically review legal compliance reports prepared by the company and any steps taken by the company to cure any taint. This will also apply to legal firm(s) and consulting firm(s) that have a material association with the entity.

It has been clarified that the term senior management will include personnel of the company who are members of its management / operating council (i. 8. removal and terms of remuneration of the Chief Internal Auditor shall be subject to review by the Audit Committee. the management of such company shall justify why they believe such .e. Chief Financial Officer(CFO). 7. Review of information by Audit Committee The Audit Committee is required to mandatorily review financial statements and draft audit report. balance sheet.e. 5. or requisite professional certification in accounting. all Board members and senior management personnel have been put under an obligation to affirm compliance with the code on an annual basis and a declaration to this effect signed by the CEO and COO is to be given in the Annual Report of the Company. running continuously. or other senior officer with financial oversight responsibilities. Audit Committee Two explanations have been added in the revised clause 49. core management team excluding Board of Directors). management letters/ letters of internal control weaknesses issued by statutory / internal auditors. and statement of cash flows. including being or having been a Chief Executive Officer(CEO). It has also been clarified that a member is considered to have accounting or related financial management expertise if he or she possesses experience in finance or accounting. The appointment. reports relating to compliance with laws and to risk management. including quarterly / half-yearly financial information. Disclosure of Accounting Treatment The revised clause 49 requires that in case a company has followed a treatment different from that prescribed in an Accounting Standards. and records of related party transactions. this would comprise all members of management one level below the executive directors.The revised clause 49 requires the Board of a company to lay down the code of conduct for all Board members and senior management of a company and the same to be posted on the website of the company. or any other comparable experience or background which results in the individual’s financial sophistication. management discussion and analysis of financial condition and results of operations. Accordingly. profit and loss account. The first explanation defines the term “financially literate” to mean the ability to read and understand basic financial statements i. Non–Executive Directors – Not to hold office for more than Nine Years Revised clause 49 limits the term of the office of the non-executive director and provides that a person shall be eligible for the office of nonexecutive director so long as the term of office does not exceed nine years in three terms of three years each. Normally. 6.

The clause further requires that at least one independent director on the Board of Directors of the holding company should be a director on the Board of Directors of the subsidiary company. 11. Management is also required to clearly explain the alternative accounting treatment in the footnote of financial statements. Personnel who observe any unethical or improper practice (not necessarily a violation of law) can approach the Audit Committee without necessarily informing their supervisors. which shall be accompanied by the auditor’s clearly worded comments on the management’s view. Companies have also been required to affirm that it has not denied any personnel access to the Audit Committee of the company (in respect of matters involving alleged misconduct) and that it has provided protection to “whistle blowers” from unfair termination and other unfair or prejudicial employment practices.alternative treatment is more representative of the underlined business transactions. etc. as well as. Such affirmation should form part of the Board’s report on Corporate Governance that is required to be prepared and submitted together with the annual report. Disclosure of contingent liabilities The revised clause 49 requires the management to provide a clear description in plain English of each material contingent liability and its risks. This section is required to be highlighted in the significant accounting policies and notes on accounts. 12. Whistle Blower Policy Companies have been required to formulate an Internal Policy on access to Audit Committees. Subsidiary Companies The revised clause 49 provides that the provisions relating to the composition of the Board of Directors of the holding company are also applicable to the composition of the Board of Directors of subsidiary companies. Additional Disclosures . 9. The Audit Committee of the holding company has been empowered to review the financial statements. The employment and other personnel policies of the company should also contain provisions protecting “whistle blowers” from unfair termination and other unfair or prejudicial employment practices. It is further required that the Board’s report of the holding company should state that they have reviewed the affairs of the subsidiary company also. 10. in the auditor’s report. where necessary. Companies are also required to take measures to ensure that this right of access is communicated to all employees through means of internal circulars. in particular the investments made by the subsidiary company and the minutes of the Board meetings of the subsidiary company to be placed for review at the Board meeting of the holding company.

Further they are required to certify that these statements together present a true and fair view of the company. to evaluate the effectiveness of internal . the cash flow statements as well as the Directors’ Report and these statements do not contain any materially untrue statement. Further. it shall disclose to the Audit Committee. The Audit Committee shall make appropriate recommendations to the Board to take up steps in this matter. sales and marketing. the uses / applications of funds by major category (capital expenditure. (C) Proceeds from Initial Public Offerings (IPOs) When money is raised through an Initial Public Offering (IPO). on a quarterly basis as a part of their quarterly declaration of financial results. the company shall prepare a statement of funds utilized for purposes other than those stated in the offer document/prospectus. measures to address and minimize such risks. If any transaction is not on an arm’s length basis. Management shall place a quarterly report certified by the compliance officer of the company. Certification by CEO/CFO CEO (either the Executive Chairman or the Managing Director) and the CFO (Whole-Time Finance Director or other person discharging this function) of the company has been put under an obligation to certify that. management is required to justify the same to the Audit Committee. working capital. omits any material fact or do they contain statements that might be misleading. to the best of their knowledge and belief. These procedures shall be periodically reviewed to ensure that executive management controls risk through means of a properly defined framework. etc). and are in compliance with the existing accounting standards and/or applicable laws/regulations. This statement shall be certified by the independent auditors of the company. This document shall be formally approved by the Board. on an annual basis. and any limitations to the risk taking capacity of the corporation. 13. before the entire Board of Directors documenting the business risks faced by the company. they have reviewed the balance sheet and profit and loss account and all its schedules and notes on accounts.The revised Clause 49 of the Listing Agreement requires the following additional disclosures: (A) Basis of related party transactions A statement of all transactions with related parties shall be placed before the Audit Committee for formal approval/ratification. The revised clause requires them to be responsible for establishing and maintaining internal controls. (B) Board Disclosures –Risk management The Board members should be informed about the risk assessment and minimization procedures.

They are also required to disclose to the auditors as well as the Audit Committee. if different. Report on Corporate Governance The companies have been required to submit a quarterly compliance report in the prescribed format to the stock exchanges within 15 days from the close of the quarter. The report has to be submitted either by the Compliance Officer or the Chief Executive Officer of the company after obtaining due approvals. (i) Disclosure of accounting treatment. if any. (ii) Whistle Blower policy and affirmation that no personnel has been denied access to the audit committee. their responsibilities as directors. which is sent annually to all the shareholders of the company. if any. The same certificate is also required to be sent to the Stock Exchanges along with the annual returns filed by the company. The revised clause requires the company to obtain a certificate from either the auditors or practicing company secretaries regarding compliance of conditions of corporate governance and annex the certificate with the directors’ report. instances of significant fraud. and the best ways to discharge them. 14. that involves management or employees having a significant role in the company’s internal control systems. 17. Additional disclosure in the Report on Corporate Governance The following additional items are required to be disclosed in the suggested list of Items to be included In the Report on Corporate Governance in the Annual Report of Companies. and to disclose to the auditors and the Audit Committee. (ii) Training of Board Members Company shall train its Board members in the business model of the company as well as the risk profile of the business parameters of the company.control systems of the company. deficiencies in the design or operation of internal controls. Additional Disclosures under Non-Mandatory Requirements The following additional disclosures are required to be made under the non-mandatory requirements : (i) Audit qualifications Company may move towards a regime of unqualified financial statements. 15. . Company Secretary in Practice to Issue Certificate of Compliance This is a landmark amendment authorizing Company Secretaries in Practice among other professionals to issue certificate of compliance of clause 49. whether or not there were significant changes in internal control and / or of accounting policies during the year. 16. from that prescribed in Accounting Standards with explanation.

the United States enacted Sarbans Oxley Act. It is hoped that the revised clause 49 would go a long way in providing corporates good governance framework . most timely and provides much needed disclosure requirements. The revised clause 49 of the Listing Agreement is. the need for strengthened norms for Corporate Governance is also felt. quarterly compliance report in the prescribed format and issue of certificate of compliance. 2002 bringing out fundamental changes in every dimension of Corporate Governance. and Peer Group evaluation should be the mechanism to determine whether to extend / continue the terms of appointment of non-executive directors. Conclusion The recent events worldwide. excluding the director being evaluated. particularly in the United States have renewed the emphasis on Corporate Governance the worldover. periodical review by independent director. therefore. Reacting swiftly and spontaneously.(iii) Mechanism for evaluating Non-Executive Board Members The performance evaluation of non-executive directors should be done by a peer group comprising the entire Board of Directors. widened definition of independent director. whistle blower policy. Back home in India. These events have highlighted the need for ethical governance and require management to look beyond their systems and procedures.