Professional Documents
Culture Documents
1
Section I
The Need for Corporate Governance
Responsibility to Stakeholders
Predictability
Transparency
Accountability
Easier access to capital (FII, VCF)
2
Section II
Conceptualizing Corporate Governance
Narrow Definition
- A set of relationships between the company and
shareholders, directors and management.
Broad Definition
- Going beyond and looking to the implicit and explicit
relationships of the company with employees, creditors,
consumers, distributors, local communities.
3
Conceptualizing Corporate Governance
(Contd.)
OECD Definition
– System by which corporations are directed and controlled.
– Spells out the rules / procedures for making decisions on corporate
affairs.
– Provide the structure through which the company objectives are set, and
the means of attaining those objectives and monitoring performance
– Specifies the distribution of rights and responsibilities among different
participants in the corporation, such as, the board, managers,
shareholders and other stakeholders
4
Conceptualizing Corporate Governance
(Contd.)
What constitutes shareholders’ interest? sustainable
profitability versus profitability
Need for external regulation
– FOR:
» Conflict of interest b/w Management/Promoters and other
constituencies
» To protect small investors
» To account for Externalities
– AGAINST:
» Risk of excessive policing (time & cost of compliance)
» Increase costs
» Check the box approach
5
Section III
Evolution of Systems of Accountability:
Indian Initiatives
In December 1995, CII set up a task force to design a voluntary code
of corporate governance
In April 1998, the Desirable Corporate Governance: A Code, was
released
SEBI set up the Kumar Mangalam Birla Committee in 1999 to design
a mandatory-cum-recommendatory code for listed companies ( Clause
49)
DCA set up the Naresh Chandra Committee Report in 2002. The key
recommendation related to financial and non-financial disclosures and
independent auditing and board oversight of management (Draft
Companies Bill)
The Narayana Murthy Committee was set up by SEBI in 2002 to
review clause 49 and suggest measures to improve corporate
governance standards (Proposed Clause 49)
6
Developments in the U.S
ENRON
– Bankruptcy filing in 2001 (largest in US history)
– Accounting techniques involving unconsolidated partnerships and
“special purpose entities” to hide losses from financial statements
& conceal indebtedness.
– Issues regarding independence of auditors, provision of non audit
services & conflict of interest
– Independence of directors
7
SOX
Applicable to:
– Companies listed or traded in the U.S (including non U.S
Companies)
– Subsidiaries of U.S Companies in India (provided they
have a business connection in the U.S)
– Foreign accounting firms that prepare or furnish audit
report for an issuer
– Sometimes compliance expected by U.S Companies
from business partners in India (implications for BPO
sector)
8
SOX-Brief Overview
CEO & CFO certification in SEC Reports (Ss 302 & 906)
– Compliance with Securities Exchange Act, 1934
– Financial statements represent the true financial condition of the
Company operations
– Financial results contain no untrue statement /omission of
material fact
– Company has complied with Disclosure norms
– Management have disclosed significant deficiencies, changes,
fraud to auditors & audit committee
Ban on loans to executive officers and directors
Accelerated filings of periodic reports
Filing of change of beneficial ownership within 2 days
9
SOX-Brief Overview (Contd.)
12
Major Areas of Debate
Directors
Independent Directors
Audit Committees
Auditors
13
Section IV
Director: The Fiduciary
“If directors act within their powers, if they
act with such care as is reasonably to be
expected from them, having regard to their
knowledge and experience, and if they act
honestly for the benefit of the company they
represent, they discharge both their
equitable as well as their legal duty to the
company”
14
WHO DO DIRECTORS OWE A DUTY
TO?
SHAREHOLDERS
COMPANY
EMPLOYEES
PUBLIC
CREDITORS
15
General Duties of Directors
16
Duty of Care and Skill
17
Duty of Care and Skill (Contd.)
Courts in UK and USA have held that directors in banks
and financial institutions owe a higher degree of care
– The banking industry is involved in regular receipt of public cash
and property and is thus more vulnerable than other businesses and
therefore a greater care is required;
– A director of a company (a bank) that has a large amount of liquid
assets carries with him higher risks and temptation to which such
assets give rise;
– There are more legislative and regulatory monitoring and liability
provisions pertaining to banking companies than any other
company and such provisions may also extend to the director of
the bank or financial institution.
18
Duty of Care and Skill (Contd.)
19
Duty of Loyalty & Disclosure
Section 299, Companies Act, 1956
principal is based on the rudiments of law that the same
person cannot act for himself/herself and at the same time,
with respect to the same matter, act with another whose
interests are conflicting
Effect of disclosure
Disclosure to whom
How extensive should the disclosure be
20
Duty in Relation to Corporate Opportunity
21
Corporate Opportunity
Any profit made by a Director through holding the office
of such director must be accounted for. Therefore, a
Director would be held accountable for personal profits
made from:
– The sale of goods, materials or services earlier dealt with by
Company for its business
– Forestalling the company’s business opportunity unless the
company has rejected such opportunity
– Requesting the customer to place orders for goods, materials and
services with another company in which he has some interest
– Receiving Commission from another company, which has sold
goods to the company
22
Liabilities of Directors
Derivative Action
Statutory Liability
Contractual Liability
Tortuous Liability
23
Derivative Action
24
Statutory Liability
25
Director:Legal Provisions
26
Director: Legal Provisions (Contd.)
Disclosure of interest by directors (s. 299)
– Default ground for vacation under s. 283.
Interested directors not to participate or vote in board proceedings (s. 300)
– Applicable only to public companies
Maintenance of records of contracts, companies, firms in which directors are
interested (s. 301)
– to be signed by all the directors present in the next board meeting
– kept at registered office and available for inspection
Restriction on directors from holding office of profit (s. 314)
– Company can give consent by special resolution
– Does not apply to managing directors
27
Issues for Consideration
28
Independent Directors
No mention in the Companies Act
Clause 49
- Optimum combination of executive and non-executive directors
- Not less that fifty per cent being non-executive
- If non executive chairman, at least one third of the board should comprise of
independent directors
- If executive chairman, at least half of the board should comprise of
independent directors
Clause 63, Draft Companies Bill
– Every public company of prescribed paid up capital or turnover to have at least
seven directors of which at least three or fifty percent, whichever is higher, to
be independent directors
» Would include unlisted public companies also
29
Who is an Independent Director?
Independence of judgement
No material relationship
No pecuniary relationship
30
What is Independence?
The Cadbury Report defines independence as:
Apart from their directors’ fees and shareholdings, they
should be independent of management and free from any
business or other relationship which could materially
interfere with the exercise of their independent judgement.
Clause 49
‘Independent’ defined as those directors who, apart from
receiving director’s remuneration do not have any other
material pecuniary relationship or transactions with the
company, its promoters, management or subsidiaries,
which in the view of the board may affect independence of
judgment
31
What is Independence? (Contd.)
Clause 2(45), Draft Companies Bill
32
Independent Directors
External expert
33
Audit Committee
34
Audit Committee (Contd.)
Section 292A, Companies Act
– public companies
– minimum three directors
– two thirds other than managing or whole time directors
» no other qualifications prescribed
– recommendations relating to financial management binding
» reasons for not accepting any recommendation
– Auditors required to attend the meetings
35
Audit Committee (Contd.)
36
Audit Committee (Contd.)
Audit committees- Efficacy?
37
Section V
Auditors: The Watchful Eye
38
Section V
Auditors: The Watchful Eye
Duties of Auditor
– Duty of Care (Re Kingston Cotton Mills Co.)
» Reasonable care and skill
– Auditor is the servant of the shareholder and
whose duty is to examine the affairs of the
company on their behalf at the end of a year
and to report to them what he has found.
– The auditor is like a trustee for shareholders.
– Watchdog and not a bloodhound
39
Auditor’s Liability
Basis of Liability
– Contractual and Fiduciary
» Company
» Shareholders as a body
– Tortuous
» “Holding out”
40
Auditor’s Liability (Contd.)
Stage I (Upto 1963)
– Candler v. Crane
» Privity doctrine: a third party not in privity with the auditor cannot recover
damages for negligence
» Justice Denning gave a dissenting judgment
it must be known to the advise41r that the advice would be communicated to the
plaintiff in order to induce him to adopt a particular course of action
the advice must be relied upon for the purpose of the particular transaction for
which it was known to the advisers that the advice was required.
Stage II (1964-1990)
– Hedley Byrne & Co. v. Heller & Partners
» Liability for a negligent misstatement made by one person to another, even
in the absence of any contractual or fiduciary relationship causing financial
loss
41
Caparo Industries Plc v. Dickman
Stage III (Post 1990)
– Watered down in Caparo Industries case
» The three criteria for the imposition of a duty of care are
foreseeability of damage
proximity of relationship
the reasonableness or otherwise of imposing a duty
43
Issues for Consideration
Should statute set out the liability?
– Should ‘breach of care’ be extended to any other
group?
44
Similarities between US position & Indian
Proposals
SOX Narayana Murthy Committee
CEO/CFO Certification CEO/CFO Certification
misstatement misstatement
Restriction on loan to
Ban on loans to directors
directors
Written/Public Code of
Code of Conduct/Ethics Conduct
Independent Board/ Independent Board of
Committee Directors
More limited disclosures-but
Disclosure of Off Balance
left open for consideration
Sheet/transactions that may
have future impact
45
Comparison between US & Indian Position
46
Proposed Amendments
Proposed amendments to clause 49 and Draft
Companies Bill address major issues
– Appointment of a Chief Accounting Officer by a
Company
– Definition of related party transactions expanded and
specific approval requirements introduced
– Disclosure of all contingent liabilities
– Timely communication of Risk Management activities
– CEO/ CFO certification requirements
47
Section VI
Reinventing Corporate Governance in
India
Super regulator v. Multiple regulators?
- Efficiency
- Cost of Compliance
48
Reinventing Corporate Governance in
India (Contd.)
49
Reinventing Corporate Governance in
India (Contd.)
50
Conclusion
52
Internal Audit
• CARO Requirement
Requirement of CARO – Auditor’s comment on
internal audit
• Clause 49 of Listing Agreement
- Applicable to listed companies in Indian Stock
Exchange.
• SAS 70 Report
- Use of Service Organizations like payroll - Hewitt,
MF accounting – Syntel Outsourcing, etc
53
Internal Audit
Sarbanes Oxley Act, 2002
• Applies to all companies listed in SEC
• US based company and its subsidiaries, foreign
companies like Patni, TATA Motors ADR
listed in NYSC.
• Sec 404 – Internal control on Financial
Reporting
• Certification by CEO/CFO on quarterly basis.
54
Internal Audit
Sarbanes Oxley Act, 2002
Senator Paul Sarbanes
Mike Oxley
55
End in Mind…
a statement acknowledging your responsibility for establishing and maintaining
adequate “internal control over financial reporting“
a statement identifying the internal control framework you used to conduct your
evaluation of the effectiveness of internal control over financial reporting
an assessment of the effectiveness of your company's internal control over financial
reporting as of the end of your most recent fiscal year.
– Assertion: a statement as to whether or not your company's internal control over
financial reporting is effective
disclosure of any “material weaknesses“ in your company's internal control over
financial reporting.
– If there are any disclosed material weaknesses, then you are not permitted to
conclude that your internal control over financial reporting is effective
a statement that your independent auditors have issued a report on your assessment of
internal control over financial reporting
56
How to be there..,
Financial Controls must be suitably designed using established criteria
(COSO)
· Control objectives and related financial controls are appropriately
documented
· Documentation is auditable
· Key financial controls are identified (Assertions)
· Management perform the own tests of:
• the design of controls over financial reporting
• the effectiveness based on key financial controls
· Deficiencies are documented, disclosed and addressed.
57
Applying the COSO
Framework Information &
Communication
Monitoring
Assessment of a control Pertinent information
system’s performance identified, captured
over time. and communicated
Combination of ongoing in a timely manner.
and separate evaluation.
Access to internal and
Management and externally generated
supervisory activities. information.
Internal audit activities. Flow of information that
allows for successful control
actions from instructions on
responsibilities to summary
Control Activities of findings for management
Policies/procedures that action.
ensure management Control Environment
directives are carried out. Sets tone of organization-
Range of activities including influencing control Risk Assessment
approvals, authorizations, consciousness of its people. Risk assessment is the
verifications, Factors include integrity, identification and analysis of
recommendations, ethical values, competence, relevant risks to achieving the
performance reviews, asset authority, responsibility. entity’s objectives – forming
security and segregation Foundation for all other the basis for determining
of duties. components of control. control activities.
58
Controls
Preventative and Detective Controls
Completeness
– All financial transactions are included for reporting (Purchases)
Valuation or Allocation
– All amounts represented at appropriate amount (Accounts receivable)
61
Documentation standards
Management must document the design of controls related to all relevant
assertions for all significant financial statement accounts
Documentation must encompass the entire process of:
– initiating
– authorising
– recording
– processing
– reporting individual transactions
The required documentation might take various forms: flowcharts, policy
manuals, accounting manuals, narrative memoranda, decision tables,
procedural write-ups or completed questionnaires
Flowcharts, supplemented by narrative descriptions, are frequently the
most effective form of control documentation
62
Objectives of a walkthrough
Confirms that the documentation prepared by the company
reflects its actual processes
Confirm that controls described in the documentation are
actually those applied “in the field”
Confirm that, at least, all key controls have been
documented appropriately (completeness of the process
documented)
63
Gaps in Controls
Processes not adequately documented (scope and quality)
Non-existence of policies
64
Scope
Process identified for documentation
65
Purchase
Purchase of
of Materials
Materials and
and Accounts
Accounts
Payable
Payable
66
Production
Production Accounting
Accounting
Material Issues
Production accounting – back flashing
Costing and standard updation
67
Stock
Stock Accounting
Accounting
Physical Verification
Stock valuation
3P Management
68
Sales
Sales Accounting
Accounting to
to Receivables
Receivables
Master maintenance
Receiving and accepting sales orders
Dispatching
Accounting sales and debtors
Provision for debtors
69
Treasury
Treasury and
and banking
banking transactions
transactions
70
General
General Accounting
Accounting
IUT’s
Cut offs and period end/ consolidation
Journal entries
Restructuring provisions
71
Fixed
Fixed Assets
Assets
72
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