Clause 49 – Listing Agreement

CORPORATE WORLD Cla utilization 49 of point in timeisation balance on Corporate administration Dilip Kumar Sen SEBI has rescriptd Cla white plague 49 of the Listing Agreement pertaining to corporate giving medication vide circular dated October 29, 2004, which supersedes tot completelyy other preliminary circulars issued by SEBI on this subject. The article highlights important changes in the corporate government activity norms. C lause 49 of the Listing Agreement, which deals with Corporate Governance norms that a listed entity should follow, was low gear introduced in the financial grade 2000-01 based on passports of Kumar Mangalam Birla direction. aft(prenominal) these recommendations were in quad for about both years, SEBI, in order to evaluate the adequacy of the alert practices and to further improve the actual practices set up a commission under the Chairmanship of Mr Narayana Murthy during 2002-03. The Murthy committee, after keeping three collisions, ha d submitted the draft recommendations on corporate governance norms. After deliberations, SEBI accepted the recommendations in August 2003 and asked the Stock Exchanges to revise Clause 49 of the Listing recommendations and the same was put up on SEBI website on 15th December 2003 for public comments.It was only on twenty-ninth October 2004 that SEBI finally announced revise Clause 49, which go international brook to be implemented by the end of financial year 2004-05. These rewrite recommendations rush in addition aimably diluted the original Murthy deputation recommendations. Areas where major changes were make include ? Independence of handlers ? Whistle Blower policy ? Per conventionance valuation of nonexecutive managers ? Mandatory training of non-executive managers, etc. The changes in corporate governance norm as inflict in the revise Clause 49 atomic arrive 18 as follows A. Composition of get on withThe revised clause prescribes six tests, which a non-exe cutive conductor indispensablenesss to pass to qualify as an Independent Director. The existing exigency is that to qualify as an Independent Director, the director should non subscribe to, apart from receiving directors remuneration, any other visible pecuniary relationship or transactions with the club, its promoters, its trouble or its subsidiaries, which in the judgment of the plug-in may affect independence of judgment of the director. This need finds place in the revised clause also Agreement based on Murthy committee recommendations.This conduct to widespread protests and representations from the Industry thereby forcing the Murthy committee to meet again to consider the objections. The committee, thereafter, considerably revised the earlier The author is Vice prexy, Tata Tea Ltd. He force out be reached at dilip. emailprotected co. in THE hire controller 806 declination 2004 CORPORATE WORLD except that the relationship pull up stakes promptly distort t o its caution, its holding society and its associates in addition to the existing list. Further the shape up is no wideer required to judge the independence status of a director as at present.Five red-hot clauses have been added to determine independence of a director. These are (i) He is non cerebrate to to promoters or persons occupying centering positions at the jump on take or at one level below the board (ii) He has non been an executive of the come with in the preceding three financial years (iii) He is not a partner or an executive or was not partner or an executive during the preceding three years of (a) the statutory audited account unfaltering or the internal audit firm that is associated with the company and (b) the legal and consulting firms that have a temporal association with the company. iv) He is not a material supplier, service provider or customer or a lessor or lessee of the company, and (v) He is not a substantial shareholder of the company ownin g two percent or more of the block of select shares. The stark naked tests of independence, the readers would recall, were intimatelyly included in the Companies (Amendment) Bill, 2003. The important and practical change that has now been made is addition of the rallying cry material in power point (iv) above. Without use of the word material, technically even a single run or purchase by the director to or from the company would have taken away independence status if he/she was otherwise eligible.However, the word material has not been defined. Nominee directors of Institutions are now to be considered as Independent Director. man on the subject of Independent Director one must re share that no one is invited to join a board to act as a nonexecutive director unless he/she is hygienic known to the Promoters or the Chairman or the Managing Director. All non-executive directors, whether or not strong-minded, need support of Promoter Group for their reelection. If the purpose or objective of having a specified number of independent directors on the boards of listed companies is to ensure that boards are notTwothird of the members of canvas committee shall be independent directors as against the present requirement of legal age being independent. packed with yes-men or to ensure constructive reproach one needs to ponder how many independent directors sewer freely raise questions at board meetings. Is it right that a vast majority of them invariably support every proposal of management? Only a few persons who are eminent in their own fields may ask right questions, even if they look inconvenient, at board meetings solely the majority may not muster enough courage to do so.It may therefore appear that no amount of regulation can ensure how an independent director should behave at board meetings. After all independence is a matter of attitude and a director who is conscious about his responsibilities, will always raise right questions at board meetings, whether or not he holds the independent status. The original recommendation of the Murthy Committee for mandatory training and updating of know guidege of directors has now been shifted to non-mandatory requirement, most probably in the face of strong opposition from industry.This indeed is dark as a vast majority of directors are in need of training in the business model of the company and for updating of knowledge. I do THE CHARTERED ACCOUNTANT 807 DECEMBER 2004 CORPORATE WORLD imagine that a beginning in this regard was immediately necessary. It may not be out of place to mention here that under the Listing requirements of UK all directors are mandatory required to regularly update and brush up their skills and knowledge. From the point of view of listed companies, a declaration should be obtained one-yearly from all independent directors confirming compliance with all six conditions of independence.The chief executive policeman/chief financial officer credentials is a ne w requirement and is based on Sarbanes Oxley set of USA. Five new distributor points have been added under nonmandatory requirements and the existing item on postal ballot has been deleted. (ii) A code of Conduct for visiting card members and senior management has to be laid down by the Board which should be posted on the website of the company. All Board members and senior management should affirm compliance with the code on annual basis and the annual get over shall contain a declaration to this effect signed by the CEO. B.Non-Executive Directors compensation & disclosures A new requirement has been provided for obtaining prior thanksgiving of shareholders for salary of fees/compensation to non-executive directors. If there is stock option, the limit for the maximum number that can be granted to non-executive directors in any financial year and in aggregate should be disclosed. According to the Companies Act, 1956 fees paid to directors do not form part of Managerial remun eration and hence no approval of shareholders for pay of fees to directors is required.Listed companies will now need to obtain prior approval of shareholders for remuneration of sitting fees to directors. Unless the Government is contemplating to change the law and bring sitting fees at heart the ambit of Managerial remuneration this contradiction should have been avoided. (v) Role of the study committee has been enlarged to include (a) matters required to be included in Directors Responsibility education (b) to brush up the functioning of Whistle Blower instrument if the same is existing and (iii) review of performance of statutory and internal auditors. vi)The size up committee will also mandatorily review (a) Management sermon and Analysis of Financial condition and results of operations (b) statement of solid related party transactions (c) Management letters/letters of internal authority weaknesses issued by t h e D. scrutinize Committee sideline are the changes wit h regard to visit Committee (i) Two-third of the members of Audit committee shall be independent directors as against the present requirement of majority being independent (ii) Earlier, only non-executive directors could be members of Audit committee. The revised clause has omitted this requirement. iii) All members of the Audit committee shall be financially literate (as defined in the revised clause) as against the existing requirement of at least one member having financial and accounting knowledge. (iv) Minimum number of Audit committee meetings in a year increased to 4 from 3. C. Other provisions relating to Board (i) Gap between two meetings has been reduced to three months from four months rule at present. statutory auditors (d) Internal audit pieces relating to internal control weaknesses, and (v) To review the appointment, removal and terms of remuneration of the Chief Internal Auditor.The Audit committee will no longer be required to review the companys financial and ri sk management policies. Risk judicial decision and minimization procedures will now be reviewed by the Board. Listed companies should now THE CHARTERED ACCOUNTANT 808 DECEMBER 2004 CORPORATE WORLD ascertain from their single Audit committees the absolute frequency of reporting related party transactions, frequency of discussing Management letters issued by the statutory auditors etc. drawn to the following (a) Material non-listed Indian supplemental has been mentioned only for Board representation.In respect of review of financial statements of ex-directory underling by the audit committee of holding company and placing of minutes and significant transactions entered into by subsidiary, it is significant that the words material and Indian solidated upset or net expenditure respectively of the listed company and its subsidiaries. This definition is plausibly to exclude most of the unlisted subsidiaries as they are not liable(predicate) to meet the turnover or net worth tes t. (c) Significant transaction or arrangement shall blind drunk any soul transaction that exceeds 10% of the total revenues/expenses/assets/liabilities of the subsidiary.It is difficult to understand the logic of excluding subsidiaries corporate abroad from the opinion of representation on the board by an independent director. E. Subsidiary Companies These are new requirements, which provide for the following (i) At least one indepen- T th he o m e ri in an M gin ha g o dat ur t al r m s f or hy ec pr an now kno y tr C om op ob dat b w ain o me in po ab or een led in mm nd de s ly y g g i a ed itio in re cha e o an tte tio qu n f d e n is n th g o sa fro e ire ed dir up fo f d. m fac me as ec da r i n e n t a n t o r tdu o f , o s st st mo nry ro s . T n t hi g s F.Disclosures adjacent new disclosure requirements have been specified in the revised clause 49 (i) line of reasoning on transactions with related parties in the ordinary course of business shall be placed beforehand the Audit committee periodically (ii) Details of material individual transactions with related parties which are not in the normal course of business shall be placed before the Audit committee and (iii) Details of material individual transactions with related parties or others, which are not on builds length basis should be placed before Audit committee together with managements justification for the same.Here also, the word material has not been defined. Listed companies should ascertain dent director on the Board of the holding company shall be a director on the board of a material non-listed Indian subsidiary company (ii) The audit committee of the holding company shall review the financial statements, in particular, the investments made by the unlisted subsidiary company (iii) The minutes of board meetings of the unlisted subsidiary company shall be placed at the board meeting of the holding company.The management should periodically bring to the attention of the holding comp any a statement of all significant transactions and arrangements entered into by the unlisted subsidiary company. management of the readers is have not been used. It can therefore be interpreted that board meeting minutes, financial statements and significant transactions of all unlisted subsidiaries whether incorporated in India or abroad are to be placed before the board of the holding company or to be reviewed by the audit committee of the holding company.Is this the intention? (b) Material non-listed Indian subsidiary shall mean an unlisted subsidiary, incorporated in India, whose turnover or net worth exceeds 20% of the con- THE CHARTERED ACCOUNTANT 809 DECEMBER 2004 CORPORATE WORLD from their respective audit committees the frequency of reporting such transactions. (iv) Financial statements should disclose together with managements explanation any accounting treatment antithetical from that prescribed in Accounting Standard. v)The company will lay down procedures to inform b oard members about the risk assessment and minimization procedures which shall be periodically reviewed by the Board. (vi) The company shall disclose to the Audit committee on a quarterly basis the use of funds raised by public/ rights/preferential issues. Annually a statement showing use of funds for purposes other than those stated in Offer document/ course catalogue should be placed before the Audit committee. Such statement should be certified by the statutory auditors. vii) Under Remuneration of Directors new disclosure requirements have been prescribed, which include criteria of making payments to nonexecutive directors, shares and convertible instruments held by non-executive directors and shareholding (both own and held on beneficial basis) of nonexecutive directors to be disclosed in the notice of general meeting called for approving appointment of such director. 2002-03. The revised Clause only requires CEO and CFO to certify to the Board the annual financial statements i n the prescribed format.While this certification will certainly provide comfort to the non-executive directors and will indeed act as the basis for the Board to make Directors Responsibility Statement in terms of section 217(2AA) of the Companies Act, 1956, it is not clear why SEBI did not require the listed companies to include such certification in the Annual constitution. While the new corporate governance norms are more stringent than the existing requirements it must be appreciated that while regulations in these areas are necessary, regulations per se cannot and will not ensure good corporate governance.H. Compliance storey The format of quarterly report to be submitted to the Stock Exchanges has been revised and the new format follows the revised requirements of Clause 49. The CEO or the Compliance officer can now sign the compliance report. The annual corporate governance report should disclose adoption or non-adoption of non-mandatory requirements. G. CEO/CFO Certificatio n This is a new requirement and is based on the Sarbanes Oxley Act of USA. This had also been recommended by the Naresh Chandra Committee set up by the Centre in I. Non-mandatory requirementsFive new items have been added under non-mandatory require- ments and the existing item on Postal ballot has been deleted. The first new item states that Independent directors may not have tenure not exceeding in the aggregate a period of nine years on the Board of the company. The next item relates to companies moving towards a regime of unqualified audit report. The third item deals with training of board members in the business model of the company as well as risk profile of the business parameters of the company and responsibilities of directors and how better(p) to discharge it.The fourth item deals with performance evaluation of non-executive directors by a peer group comprising the entire Board. The fifth item relates to setting up of a whistle blower policy in the company. While the new corporate governance norms are more stringent than the existing requirements it must be appreciated that while regulations in these areas are necessary, regulations per se cannot and will not ensure good corporate governance. Attention of readers is drawn towards the Report on Observance of Standards and Codes carried out under a joint programmed of realness Bank and IMF.This report benchmarks the observance of corporate governance in India against the benchmark Principles of Corporate THE CHARTERED ACCOUNTANT 810 DECEMBER 2004 CORPORATE WORLD Governance laid down by the Organization for Economic Cooperation and Development (OECD). The assessment team had extensively interviewed issuers, institutional investors, financial institutions, market analysts, lawyers, accountants and auditors. The report was also discussed by Government of India and cleared by the DEA for publication in June 2004. Following are the areas identified for reform in the World Bank report a.Sanctions and enf orcements Sanctions and enforcements should be credible deterrents to help align business practices with the legal and regulatory framework, in particular with regard to related party transactions and insider trading. b. The afoot(predicate) framework places the oversight of listed companies partly with DCA, partly with SEBI and partly with Stock exchanges. This break structure gives rise to regulatory arbitrage and weakens enforcement. c. If boards are to move away from simply rubber stamping the decisions of management or promoters they must have a clear understanding of what is expected from them.They should know their duties of care and loyalty to the company and all shareholders. They should know their responsibilities and should be familiar with the changes in this regard arising from changes in laws and regulations. A tonality missing ingredient is a strong centralize on overlordism of directors. Director training institutes can play a key capacity building role and expa nd the pool of competent candidates. d. institutional investors acting in a fiduciary capacity should be encourage to form a comprehensive corporate governance policy including voting and board representation.It will be observed that the World Bank report has stressed the need of training and updating of knowledge of directors. Unfortunately the recommendation of Murthy Committee in this regard has now been shifted as nonmandatory requirement. The rule of industrys objection to mandatory training, etc. of directors is not quick understandable. Hopefully, when the governance norms are reviewed next the training and knowledge updating would be made mandatory requirement. A new requirement has been provided for obtaining prior approval of shareholders for payment of fees/compensation to nonexecutive directors.If there is stock option, the limit for the maximum number that can be granted to nonexecutive directors in any financial year and in aggregate should be disclosed. Leading li ght of CA world, SN Desai passes away ne of the highly revered rent Accountants and a ahead(p) light of the affair, ICAIs former-president Shri Shantanu Nanubhai Desai passed away on 10th November 2004 in Mumbai. natural on 26th January 1925, he became a member of our Institute in 1949 and rose to become one of the pillars of the profession.Having become President of ICAI in 1961-62 at a young age of 35, he had served as a profound Council member for decades. He was actively associated with Indian Merchants Chamber as its Managing Committee member for a long period of 32 years. He became its President in 1976. He had held several distinguished positions in his illustrious professional life, including as Member of the High Powered Sachar Committee on companionship Law & MRTP Reforms, as Chairman/ Director of several reputed public companies too as a member of ASSOCHAM. Mr.Desai was also the founder member of the Bombay Chartered Accountants Society. A Rotarian of repute and a veteran of several Committees, Mr. Desai was a free, wiener and modest personality a thorough gentleman who endeared one and all with his qualities of both head and heart. Mr. Desais services to the cause of our profession and his long career of more than 50 years as one of our professions most distinguished ambassadors will long be remembered and will continue to inspire new generation of Chartered Accountants. O THE CHARTERED ACCOUNTANT 811 DECEMBER 2004