Fore or!

For over a decade, the Confederation of Indian Industry (CII) has been at the forefront of the corporate governance movement in India. In April 199 , it released a !as" Force report entitled # Desirable Corporate Governance: A Code outlined a series of voluntary recommendations regarding best%in%class practices of CORPORATE corporate governance for listed companies. GOVERNANCE It is $orth noting that most of the CII Code $as subse&uently incorporated in '()I*s +umar ,angalam )irla Committee -eport and thereafter in Clause .9 of the /isting Agreement. ,oreover, the CII Code RECOMMENDATIONS FOR $here VOLUNTARY ADOPTION $as the first and probably a uni&ue instance an industry association too" the lead in prescribing corporate governance standards for listed companies. Corporate governance guidelines % both mandated and voluntary % have evolved since 199 , than"s to the efforts of several committees appointed by the ,inistry of Corporate Affairs (,CA) and the '()I. Indeed, it is fair to say that in terms of norms, guidelines and standards set for the board of directors, financial and non%financial disclosures and information to be shared by the management to sta"eholders and the $ider public, Indian corporate governance standards ran" among the best in the $orld. And CII is privileged to be a part of this movement. 0nfortunately, history tells us that even the best standards cannot prevent instances of ma1or corporate misconduct. !his has been true in the 0' % (nron, 2orldcom, REPORT OF THE debt obligations3 in the !yco and, more recently gross miss%selling of collateralised 0+3 in France3 in 4ermany3 in Italy3 in 5apan3 in 'outh +orea3 and many other 6(C7 CII TASK FORCE ON CORPORATE GOVERNANCE nations. !he 'atyam%,aytas Infra%,aytas 8roperties scandal that has roc"ed India since 19 th 7ecember :;; is another e<ample of a massive fraud. CHAIRED BY MR NARESH CHANDRA 'atyam is a one%off incident % especially considering the si=e of the malfeasance. !he over$helming ma1ority of corporate India is $ell run, $ell regulated and does business in a sound and legal manner. >o$ever, the 'atyam episode has prompted a reloo" at our corporate governance norms and ho$ industry can go a step further through some voluntary measures. November 2009 2ith this in mind, the CII set up a !as" Force under ,r ?aresh Chandra in February :;;9 to recommend $ays of further improving corporate governance standards and practices both in letter and spirit. !he recommendations of the ?aresh Chandra !as" Force evolved over a series of meetings. !he leitmotif of the report is to enunciate additional principles that can improve corporate governance in spirit and in practice. !he report enumerates a set of voluntary recommendations $ith an ob1ective to establish higher standards of probity and corporate governance in the country. !he recommendations outlined in this report are aimed at listed companies and Confederation of Indian Industry $holly o$ned subsidiaries of listed companies.

, $hich

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Another comment is in order. /arge, highly visible and publicised corporate scandals often provo"e legislative and regulatory actions. CII advocates caution against over% regulating. It needs to be recognised that $hile the super%structure of corporate governance is built on la$s and regulations, these cannot be anything more than a basic frame$or". ,uch of best%in%class corporate governance is voluntary % of companies ta"ing conscious decisions of going beyond the mere letter of la$. !he spirit of this !as" Force -eport is to encourage better practices through voluntary adoption % based on a firm conviction that good corporate governance not only comes from $ithin but also generates significantly greater reputational and sta"eholder value $hen perceived to go beyond the rubric of la$. !herefore, it is only natural that this report should focus on recommendations, $hich are being placed before corporate India for adopting voluntarily. It is the belief of CII that Indian Industry $ould respond spontaneously and help set standards, $hich $ould define global benchmar"s in the medium term.

@enu 'rinivasan 8resident, CII (:;;9%1;)

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Co"#e"#$

Member$ o% #&e T'$( For)e

***+

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T&e CII T'$( For)e Re-or# . I"#ro!/)#0o" T&e Bo'r! o% D0re)#or$ ***++ 2 T&e Ro3e o% A/!0#or$ ***++ 41 ***+ 20 ***++ 2,

Ro3e o% Re5/3'#or6 A5e")0e$ T&e Ro3e o% E7#er"'3 I"$#0#/#0o"$

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CII T'$( For)e o" Cor-or'#e Gover"'")e Member$ o% #&e T'$( For)e 1. ,r ?aresh Chandra, Chairman, !as" Force on Corporate 4overnance, CII :. 7r 5 5 Irani, 7irector, !ata 'ons /td A. ,r 0day ' +ota", Chairman, CII Corporate 4overnance Council B (<ecutive @ice Chairman and ,anaging 7irector, +ota" ,ahindra )an" /imited .. ,r C > ,alegam, Chairman (meritus, ' ) )illimoria B Co D. 7r 6m"ar 4os$ami, Chairman, C(-4 Advisory 8vt /td 9. ,r 7eepa" , 'at$ale"ar, Independent 7irector E. ,r 'hardul 'hroff, ,anaging 8artner, Amarchand B ,angaldas B 'uresh A 'hroff B Co. . ,r Amal 4anguli, Independent 7irector 9. ,r A1ay )ahl, 8artner, AF) B 8artners

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T&e CII T'$( For)e Re-or# I"#ro!/)#0o" 4ood corporate governance involves a commitment of a company to run its businesses in a legal, ethical and transparent manner % a dedication that must come from the very top and permeate throughout the organisation. !hat being so, much of $hat constitutes good corporate governance has to be voluntary. /a$ and regulations can, at best, define the basic frame$or" % boundary conditions that cannot be crossed. CII has al$ays held the vie$ that $hile la$ may need to be strengthened $hen occasions so demand, there are fundamental limits to using legislative and regulatory instruments to enforce better corporate governance. !he thrust of this report, therefore, is to suggest certain voluntary recommendations for industry to adopt. !he report is structured according to the different elements of corporate governanceG H !he )oard of 7irectors o?on%e<ecutive and independent directors oCommittees of the board o'ignificant related party transactions H Auditors oIndependence of Auditors o-otation of Audit 8artners H -egulatory Agencies o/egal and regulatory standards o(ffective and credible enforcement H (<ternal Institutions oInstitutional investors o!he 8ress

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Report of the CII Task Force on Corporate Governance

T&e Bo'r! o% D0re)#or$ 1. Appointment of independent directors An active, $ell%informed and independent )oard is necessary to ensure highest standards of corporate governance. 4etting the right people is crucial3 as is the process of see"ing, vetting and appointing such people. 4ood )oards have a ?omination Committee typically comprising entirely of independent directors (or $here independent directors constitute the ma1ority), $ith the Committee chairman being an independent director. !he )oard as a $hole decides the s"ill sets that are needed going for$ard, "eeping in mind the present and the desired composition3 and the specialised oversight needs of the company in the foreseeable future. !he ?omination Committee then ta"es up the tas" of see"ing such directors % either through its o$n net$or" of contacts or by a formal search process $ith the help of e<ternal consultants. !he shortlist, along $ith the C@s, is then discussed in the full )oard, and the final candidate(s) isIare recommended to the Chairman of the )oard. !he Chairman, then, gets in touch $ith the selected people and invites them to 1oin the )oard as additional directors % after $hich their appointment is sought to be ratified by shareholders in the ne<t shareholders* meeting.

Re)omme"!'#0o" 48 Nom0"'#0o" Comm0##ee !he !as" Force believes that having a $ell functioning ?omination Committee $ill play a significant role in giving investors substantial comfort about the process of )oard%level appointments. It, therefore, recommends that listed companies should have a ?omination Committee, comprising a ma1ority of independent directors, including its chairman. !his Committee*s tas" should be toG H 'earch for, evaluate, shortlist and recommend appropriate independent directors and ?(7s, sub1ect to the broad directions of the full )oard3 and H 7esign processes for evaluating the effectiveness of individual directors as $ell as the )oard as a $hole. !he ?omination Committee should also be the body that evaluates and recommends the appointment of e<ecutive directors. A separate section in the chapter on corporate governance in the annual reports of listed companies could outline the $or" done by the ?omination Committee during the year under consideration.

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2. Duties, lia ilities and remuneration of independent directors !he !as" Force felt that there must be some formality in the appointment of ?(7s and independent directors that goes beyond the ratification by the shareholders. It thus ma"es the follo$ing recommendation.

Re)omme"!'#0o" 28 Le##er o% A--o0"#me"# #o D0re)#or$ H !he !as" Force recommends that listed companies should issue formal letters of appointment to ?(7s and independent directors % 1ust as it does in appointing employees and e<ecutive directors. !he letter shouldG H 'pecify the e<pectation of the )oard from the appointed director3 H !he )oard%level committee(s) in $hich the director is e<pected to serve and its tas"s3 H !he fiduciary duties that come $ith such an appointment3 H !he term of the appointment3 H !he Code of )usiness (thics that the company e<pects its directors and employees to follo$3 H !he list of actions that a director cannot do in the company3 H !he liabilities that accompany such a fiduciary position, including $hether the concerned director is covered by any 7irectors and 6fficers (7B6) insurance3 and 1 H !he remuneration, including sitting fees and stoc" options, if any. !he letter stating the terms and conditions of appointment of any ?(7 or independent director should form a part of the disclosure to shareholders at the time of the ratification of hisIher appointment or re%appointment to the )oard.

!he Companies Act, 19D9, prescribes the ceiling on remunerations that can be paid to ?(7s and independent directors, including stoc" options, restricted stoc"s, sitting fees and commissions on net profit, if any, sub1ect to approval of shareholders. Currently, ?(7s, including independent directors, may be paid compensation $ithin the limit of 1J of the company*s stand%alone net profits for the year (or AJ in case it does not have any $hole%time director). 2hile such remunerations are eventually approved by shareholders, the tas" is usually delegated to the )oard. 'ince propriety demands that the ?(7s and independent directors recuse from discussions regarding their remunerations, in practice the remunerations are actually approved by the promoters or management. !he !as" Force felt that lin"ing the remuneration of ?(7s and independent directors to the net profit of the stand%alone company has problems. 2ell oiled,
1

,ore on this is in -ecommendation A.

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$ell%running constantly profitable companies typically need less intensive )oard oversight than start%ups, companies that are in financial andIor operational distress, or those that are in the beginning of a turnaround. !hese need best%in% class directors $ho $ill give considerably more time in debating strategy, closely monitoring progress and ensuring that systems are put in place for profitable gro$th. >ere lies the difficultyK 'uch companies are either loss%ma"ing or do not ma"e sufficient profits to be able to pay for the proven talents of real e<perts on the )oard. And yet, their re&uirement for such e<pertise is the greatest. !his is $hy there is a need to amend the current la$ $hich only allo$s for remuneration from net profits for such companies.

Re)omme"!'#0o" 98 F07e! Co"#r')#/'3 Rem/"er'#0o" !he !as" Force recommends that the Companies Act, 19D9, be amended so that companies have the option of giving a fi<ed contractual remuneration to ?(7s and independent directors, $hich is not lin"ed to the net profit or lac" of it. !herefore, companies should be given the option to choose bet$eenG a. 8aying a fi<ed contractual remuneration to its ?(7s and I7s, sub1ect to an appropriate ceiling depending on the si=e of the company3 or b. Continuing $ith the e<isting practice of paying out upto 1J (or AJ) of the net profits of the stand alone entity as defined in the Companies Act, 19D9. For any company, the choice should be uniform for all ?(7s and independent directors, i.e. some cannot be paid a commission of profits $hile others are paid a fi<ed amount. If the option chosen is (a) above, then the ?(7s and independent directors $ill not be eligible for any commission on profits. !he current limits and constraints on sitting fees and stoc" options or restricted stoc" may remain unchanged. If stoc" options are granted as a form of payment to ?(7s and independent directors, then these must be held by the concerned director until one year of his e<it from the )oard.

!his is also recommended by the Combined Code of the 0+. It is a good practice that $ill forever eradicate all suspicions of insider trading of vested stoc"s. 'ome argue that since an ?(7 or an independent director is primarily a fiduciary of the shareholders, and since the variable cash flo$ rights of shareholders depend upon the profitability of the company, $hy should these fiduciaries be given a fi<ed compensation at allL !he argument is fla$ed on three counts. First, the fiduciaries and overseers appointed by the shareholders should be loo"ing at ma<imising long term enterprise value, 1ust as the management. If management can get fi<ed contractual payments approved by shareholders, so too can ?(7s % %
Report of the CII Task Force on Corporate Governance

and independent directors. 'econd, even $hen a company does not ma"e a profit, it can pay dividends from reserves. 'o, shareholders may get some cash return on e&uity even in the absence of profits3 ?(7s and independent directors cannot. !hird, it is very difficult to get first rate ?(7s and independent directors to give up a si=eable chun" of their time to serve on boards that ma"e no profits and, hence, pay no commission. : 2hether it is from net profits or as a fi<ed contractual payment, the structure of remuneration to ?(7s and independent directors needs to be transparent, $ell specified and made available to shareholders in the annual report of the company. As the Combined Code of the 0+ states, #/evels of remuneration for non%e<ecutive directors should reflect the time commitment and responsibilities of the role.M !o be sure, this can neither be legislated nor completely specified. >o$ever, there are best practices in transparently setting remuneration guidelines % one of $hich is given belo$.

Re)omme"!'#0o" ,8 S#r/)#/re o% Com-e"$'#0o" #o NED$ !he !as" Force recommends that listed companies use the follo$ing template in structuring their remuneration to ?(7s and independent directors H Fi<ed componentG !his should be relatively lo$, so as to align ?(7s and independent directors to a greater share of variable pay. !ypically, these are not more than A;J of the total cash remuneration pac"age. H @ariable ComponentG )ased on attendance of )oard and Committee meetings (at least E;J of all meetings should be an eligibility pre%condition) H Additional payment for being the chairman of the )oard, especially if heIshe is a non%e<ecutive chairman H Additional payment for being the chairman of the Audit Committee H Additional payment for being the chairman of other committees of the )oard H Additional payment for being members of )oard committeesG Audit, 'hareholder 4rievance, -emuneration, ?omination, etc. !he !as" Force also recommends that if such a structure (or any structure) of remuneration is adopted by the )oard, it should be disclosed to the shareholders in the annual report of the company.

!. Remuneration Committee of the "oard All over the developed $orld, a ma1or source of shareholder grievance has been the levels, structures and payouts of e<ecutive compensation. Although Indian senior e<ecutive pay has been significantly lo$er than those $ho occupy top slots in the Fortune D;; companies N even $hen calculated in terms of purchasing po$er parity N there is a case for creating a sound )oard%level process for approving
: 8aying

a fi<ed contractual amount is, indeed, the practice in most 6(C7 countries, such as the 0'A, 0+, Australia, France, 4ermany, Italy, 'pain, the ?etherlands, the 'candinavian countries, and others.

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remunerations to e<ecutive directors and for those $ho are one level belo$ the )oard. !he basic principle is best stated in the Combined Code of the 0+G #!here should be a formal and transparent procedure for developing policy on e<ecutive remuneration and for fi<ing the remuneration pac"ages of individual directors. ?o director should be involved in deciding his or her o$n remuneration.M

Re)omme"!'#0o" 18 Rem/"er'#0o" Comm0##ee !he !as" Force recommends that listed companies should have a -emuneration Committee of the )oard. H !he -emuneration Committee should comprise at least three members, ma1ority of $hom should be independent directors. H It should have delegated responsibility for setting the remuneration for all e<ecutive directors and the e<ecutive chairman, including any compensation payments, such as retiral benefits or stoc" options. It should also recommend and monitor the level and structure of pay for senior management, i.e. one level belo$ the )oard. H !he -emuneration Committee should ma"e available its terms of reference, its role, the authority delegated to it by the )oard, and $hat it has done for the year under revie$ to the shareholders in a separate section of the chapter on corporate governance in the annual report.

#. Audit Committee of the "oard In its present form, Clause .9 of the /isting Agreement contains detailed mandatory provisions for the Audit Committee of the )oard. (ven so, it has one fla$ that needs immediate remedy. In the earlier version of Clause .9, only ?(7s could be members of the Audit Committee. !he revised Clause .9 omitted this re&uirement. 0nder the present dispensation, t$o%thirds of the members of the Audit Committee must be independent directors as must the chairman, but the rest may be either ?(7s or e<ecutive directors. !his is clearly a mista"e, and runs counter to a fundamental operating principle of good corporate governance, namely that the Audit Committee must comprise entirely of non%e<ecutive directors $ith independent directors forming the ma1ority. Another counter%vie$ that the !as" Force also considered $as that the presence of e<ecutive directors on the audit committee needs to be appreciated since they are $ell versed $ith the internal $or"ing of the company and bring first hand information to the table $hich helps an ob1ective and meaningful analysis of the discussions by the Committee. !he !as" Force, ho$ever, suggests that for bolstering the independence of the internal as $ell as the e<ternal auditors and ensuring a free and fran" discussion $ith the audit committee, it is important that the Audit Committee must necessarily constitute of ?(7s. !he e<ecutive directors can be invited to attend the audit committee meetings to provide the necessary clarifications. % 1; %
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Re)omme"!'#0o" 28 A/!0# Comm0##ee Co"$#0#/#0o" /isted companies should have at least a three%member Audit Committee comprising entirely of non%e<ecutive directors $ith independent directors constituting the ma1ority.

$. %eparation of the offices of the Chairman and the Chief &'ecutive (fficer )C&(* !he !as" Force deliberated at length on $hether it is desirable to separate the offices of the Chairman of a publicly listed company from that of the C(6. 2hile it $as observed that there is no obvious causality bet$een such a separation and better corporate governance or performance, it $as nevertheless true that there is a gro$ing trend internationally of separating the offices of the Chairman and the C(6. It is the dominant practice in the 0+3 increasingly so throughout continental (urope3 and even the 0'A N $hich has had a long tradition of having the same person as Chairman and C(6 N is increasingly moving to$ards a separation of offices. !his trend to$ards separation of the role of Chairman and the C(6 has never been mandated by the legislation or regulation N $hich is e<actly as it should be. Instead it has been driven either voluntarily or by ma1or long%term institutional investors such as pension funds. !he !as" Force felt that the situation is different in India. ,ost Indian listed companies are controlled by promoters, often holding over D; per cent of the voting stoc". Indeed, many in corporate India feel that the separation is not desirable N that the dominant, ris" ta"ing shareholder being both the Chairman and Chief (<ecutive of a company gives a greater notion of commitment than other$ise. A vie$ running counter to the argument $as also presented for consideration of the !as" Force &uoting absence of evidence supporting that separation of the t$o offices improves corporate performance or promotes good corporate governance practices. Further, separating Chairman B C(6 provides no guarantee of better leadership and can add to a layer of potential conflict.

!he Chairman and C(6 roles are separate in 9DJ of the Fortune D;; O this figure is significantly s"e$ed by the 0', $hich accounts for 1D: of the D;;, and $here only A9J of companies have separate roles. Companies from countries other than the 0' that contribute significantly to the Fortune D;; have generally high rates of C(6%Chairman separation (usually up$ards of ;J). Company si=e (revenue) does correlate $ith role separation trends, and is predominantly s"e$ed by the number of companies from a particular country (especially 0'). : of the E Indian companies in the Fortune D;; have separate C(6s and Chairmen.

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After e<tensive deliberation on the sub1ect, on balance, the !as" Force e<pressed its preference for separating the t$o offices.

Re)omme"!'#0o" :8 Se-'r'#0o" o% O%%0)e$ o% C&'0rm'" ; C&0e% E7e)/#0ve O%%0)er !he !as" Force recognised the ground realities of India. +eeping these in mind, it has recommended, $herever possible, to separate the office of the Chairman from that of the C(6.

+. Attendin, "oard and Committee -eetin,s throu,h Tele.conferencin, and video conferencin, (%presence of a director $ould ensure larger participation at )oardICommittee meetings and shall also step up the fre&uency of such meetings as $ell as the interaction of )oard members, $hile at the same time bringing do$n the cost of holding physical meetings. !he Companies )ill, :;;9 has also proposed participation of 7irectors in board meetings through electronic means. (ven prior to the adoption of the Companies )ill, in a meeting in relation to matters $hich do not re&uire a physical meeting, directors ought to be able to participate through e% presence ($here they $ould other$ise not be able to attend). !he decisions may be subse&uently recorded as a circular resolution signed by the directors physically present and those participating through audio or video%conferencing.

Re)omme"!'#0o" <8 Bo'r! Mee#0"5$ #&ro/5& Te3e.)o"%ere")0"5 If a director cannot be physically present but $ants to participate in the proceedings of the board and its committees, then a minuted and signed proceeding of a tele% conference or video conference should constitute proof of his or her participation. Accordingly, this should be treated as presence in the meeting(s). >o$ever, minutes of all such meetings or the decisions ta"en thereat, recorded as circular resolutions, should be signed and confirmed by the directorIs $ho hasIhave attended the meeting through video conferencing.

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/. &'ecutive %essions of the Independent Directors 2hile the independent directors are "ept updated of all business%related issues and ne$ initiatives by the management, it is imperative that the independent directors have e<ecutive sessions (as their internal discussion and debating process to evolve a consensus among independent directors). >aving such interactions $ithout the presence of any of the non%independent directors $ould promote open discussions among independent directors and also assist in independent appraisal of corporate performance, strategic issues, determining a #smell testM for #greyM or #border lineM proposals.

Re)omme"!'#0o" 98 E7e)/#0ve Se$$0o"$ !o empo$er independent directors to serve as a more effective chec" on management, the independent directors could meet at regularly scheduled e<ecutive sessions $ithout management and before the )oard or Committee meetings discuss the agenda. !he !as" Force also recommends separate e<ecutive sessions of the Audit Committee $ith both internal and e<ternal Auditors as $ell as the ,anagement.

<+ The role of the oard and shareholders in related part0 transactions !he Audit Committee members, at a meeting held prior to the )oard ,eeting in $hich related party transaction shall be discussed, should be given access to the contract I terms of all proposed related party transactions, before they are entered into. In the event of the Company proposing to enter into or amending an e<isting related%party transaction $hich is not in the ordinary course of business or not on #arms length* basis, the management shall present it to the Audit Committee. !he Committee should discuss all related party transactions $hich are not in the ordinary course of business or not on #arms lengthM basis and, in approving or re1ecting the transactions shall consider all relevant facts and circumstances including (i) ris"s, costs and benefits to the Company (ii) impact on a directorPs independence, if such related party contract concerns an independent director (iii) availability of other sources Iunrelated third parties for comparable services or products % and shall approve only those transactions that are in the best interests of the Company. !he !as" Force also noted that the 5 5 Irani Committee had considered that, any contract by an independent director or his firm, $hich e<ceeds 1;J of the director*s or the firm*s turnover renders such director dependent and shall be presumed to affect the independence of such a director.

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Re)omme"!'#0o" 408 Re3'#e! P'r#6 Tr'"$')#0o"$ Audit Committee, being an independent Committee, should pre%approve all related party transactions $hich are not in the ordinary course of business or not on #arms length basisM or any amendment of such related party transactions. All other related party transactions should be placed before the Committee for its reference.

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T&e Ro3e o% A/!0#or$ 1. Auditor 2 Compan0 Relationship !he report of the ?aresh Chandra Committee on Corporate Audit and 4overnance had suggested that auditors should refrain from providing non%audit services to their audit clients and had recommended an e<plicit list of prohibited non%audit services. !he !as" Force, noted that the recommendation $as endorsed by the ,inistry of Corporate Affairs and has also been proposed under the Companies )ill, :;;9. !he !as" Force concurred $ith the recommendation that legislation should e<pressly prohibit auditors from rendering certain services to their audit clients. Audit firms should have to mandatorily disclose net$or" agreements bet$een audit firms and non%audit companies, pecuniary interests e<ceeding :J bet$een the audit firm and its affiliate non%audit service firm or company and measures of Chinese $alls and data protectionIconfidentiality that are in place bet$een them. !he !as" Force noted the e<isting practice in this regard. And found it to be sufficient.

13. Independence of Auditors In order to build capacity, consulting firms underta"e audit assignments through their associateIaffiliates organisations. >o$ever, such affiliations could lead to too much revenue dependence on a particular client causing potential threats to auditor independence. 2hile a blan"et ban cannot be imposed on such business relationships, in case more than 1;J of consolidated revenue of a firm or its net$or" affiliate emanates from a single client, $ith $hom there is also an audit engagement, the auditor should not be construed as independent of its client. >o$ever, to help ne$er and smaller audit firms, this re&uirement should not be applicable to audit firms for the first five years from the date of commencement of their activities, and for those $hose total revenues are less than -s.1D la"hs per year.

Re)omme"!'#0o" 448 A/!0#or$= Reve"/e$ %rom #&e A/!0# C30e"# ?o more than 1;J of the revenues of an audit firm singly or ta"en together $ith its subsidiaries, associates or affiliated entities, should come from a single corporate client or group $ith $hom there is also an audit engagement.

11. Certificate of Independence !he !as" Force considered the re&uirement of ensuring Independence of Auditors throughout the period of engagement as recommended by the ?aresh Chandra Committee on Corporate Audit and 4overnance and recommended the practice of see"ing a Certificate of Independence from the Auditors before appointment I re% appointment. !he Audit Committee must prescribe a specific form for disclosures % 1D %
Report of the CII Task Force on Corporate Governance

concerning the auditor, any net$or" relationship agreements rendering non%audit service firms or companies or group entities and any pecuniary interest bet$een members or firms inter%se e<ceeding :J of the net$or" or the capital or the profit ratio, $hichever is lo$er.

Re)omme"!'#0o" 428 Cer#0%0)'#e o% I"!e-e"!e")e (very company must obtain a certificate from the auditor certifying the firm*s independence and arm*s length relationship $ith the client company. !he Certificate of Independence should certify that the firm, together $ith its consulting and specialised services affiliates, subsidiaries and associated companies or net$or" or group entities have not I has not underta"en any prohibited non%audit assignments for the company and are independent vis%Q%vis the client company, by reason of revenues earned and the independence test are observed.

12. Audit 4artner Rotation !he !as" Force considered the on%going debate on the re&uirement of rotation of auditor versus rotation of audit partner after a specified period of time. !he vie$ that audit firms should be changed after 9 or 1; years $as discussed. In line $ith international practice, the !as" Force considered it e<pedient to recommend mandatory rotation of audit partners after t$o terms of three years each. !his $ould help discourage creation of any affinity bet$een auditors and controlling shareholders or promoters or the management and may help to prevent #captureM of the audit process by corporate insiders. An initial e<perience of the impact of rotation of the audit partner should be studied. If this measure does not improve or prevent #capture of audit process by corporate insidersM, then the alternative of rotation of auditors after nine years should be made mandatory.

Re)omme"!'#0o" 498 Ro#'#0o" o% A/!0# P'r#"er$ !he partners handling the audit assignment of a listed company should be rotated after every si< years. !he partners and at least D;J of the audit engagement team responsible for the audit should be rotated every si< years, but this should be staggered so that on any given day there isn*t a change in partner and engagement manager. A cooling off period of A years should elapse before a partner can resume the same audit assignment.

1!. Auditor 5ia ilit0

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Report of the CII Task Force on Corporate Governance

!he liability of the auditor for dereliction of duty needs to be prescribed for listed companies. !his should not be limited to the signing partner only but the audit firm and I or any net$or" affiliates providing non%audit services to the company, $hich have resulted in dereliction of duty should also be held liable.

Re)omme"!'#0o" 4,8 A/!0#or=$ L0'b030#6 !he firm, as a statutory auditor or internal auditor, has to confidentially disclose its net$orth to the listed company appointing it. (ach member of the audit firm is liable to an unlimited e<tent unless they have formed a limited liability partnership firm or company for professional services as permitted to be incorporated by the relevant professional disciplinary body (ICAI). (ven in the case of a limited liability firm underta"ing audit in the future, under the ne$ la$, the individual auditor responsible for dereliction of duty shall have unlimited liability and the firm and its partners shall have liability limited to the e<tent of their paid%in capital and free or undistributed reserves.

1#. Appointment of Auditors !he !as" Force decided to propose the recommendation of the ?aresh Chandra Committee relating to appointment of auditors for adoption by companies.

Re)omme"!'#0o" 418 A--o0"#me"# o% A/!0#or$ !he Audit Committee of the board of directors shall be the first point of reference regarding the appointment of auditors. !he Audit Committee should have regard to the entire profile of the audit firm, its responsible audit partner, his or her previous e<perience of handling audit for similar si=ed companies and the firm and the audit partner*s assurance that the audit cler"s and I or understudy chartered accountants or paralegals appointed for discharge of the tas" for the listed company shall have done a minimum number of years of study of Accounting 8rinciples and have minimum prior e<perience as audit cler"s. !o discharge the Audit Committee*s duty, the Audit Committee shallG
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discuss the annual $or" programme and the depth and detailing of the audit plan to be underta"en by the auditor, $ith the auditor3 e<amine and revie$ the documentation and the certificate for proof of independence of the audit firm, and recommend to the board, $ith reasons, either the appointmentIre%appointment or removal of the statutory auditor, along $ith the annual audit remuneration.

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Report of the CII Task Force on Corporate Governance

1$. 6ualifications Introduced 0 %tatutor0 Auditors or Internal Auditors in their Audit Reports, Ta' Audit Report or CAR( Reports. !he !as" Force discussed the issues of the e<tensive disclaimers $hich are being introduced time and again by firms of auditors, in relation to their certification follo$ing their audit function. !he auditors have to discharge a significantly important responsibility concerning the accuracy of the accounts and the absence of any systemic fraud due to controls established in the listed company. It is important to provide regular audit information, thereby preventing clubbing of $or" to$ards the end of a &uarter or near the end of the financial year and audit period before publishing the audited accounts3 resulting in hurried and hasty clearance. !he auditor has the role of a $atchdog and ought not to escape liability for dereliction of duty to sta"eholders by introducing &ualifications in to their reports. !he notes of accounts ought to facilitate the Audit Committee and analysts by their ease of conversion into financial terms having impact on the accounts presented. !he !as" Force recommends that the ICAI appoint a committee $ith a significant membership of government directors and invite management professionals and la$yers having an understanding of accounts, to standardise the language of disclaimers or &ualifications permissible to the audit firms. Anything beyond the scope of such permitted language should re&uire the auditor to provide a sufficient e<planation and should not create a ne$ escape route for avoiding responsibility for discharging the audit function diligently, as the public relies upon them to do a thorough 1ob.

Re)omme"!'#0o" 428 >/'30%0)'#0o"$ 0" A/!0#or=$ Re-or# ICAI should appoint a committee to standardise the language of disclaimers or &ualifications permissible to audit firms. Anything beyond the scope of such permitted language should re&uire the auditor to provide sufficient e<planation.

1+. 7histle "lo8in, 4olic0 Clause .9 has recommended that companies establish a mechanism for employees to report to the management concerns about unethical behaviour, actual or suspected fraud or violation of the companyPs code of conduct or ethics. (ven though companies have adopted and communicated the e<istence of a $histle%blo$ing policy, $e have not seen any success on this front in corporate India. !he !as" Force pondered over $hat organisations can do to create an environment $hich helps employees to prevent undesirable practices. It $as felt that adoption and encouragement of the policy should be made mandatory for all listed companies. !his is bound to send a positive signal to employees that the management is $illing and able to prevent any illegal activity and also ensure that there is a process by $hich the individuals can e<pose the problem to the appropriate authority $ho can ta"e action. !he employees $ould need to be oriented to$ards the company*s ethics policy. >- 7epartment can play an effective role in the process by assigning %1 %
Report of the CII Task Force on Corporate Governance

ombudsmen, providing special telephone numbers and email I7s. 'ince $histle% blo$ers need to be provided high degrees of protection, the /isting Agreement should consider providing statutory protection from dismissal or $rongful termination for acting as a $histle blo$er. !here are ade&uate precedents in other 1urisdictions for such la$s and these could be e<amined. Fostering a culture $hich promotes and supports institutionalisation of $histle blo$ing policy shall deter corrupt practices and help in preventing corporate disgrace and debacles.

Re)omme"!'#0o" 4:8 I"$#0#/#0o" o% Me)&'"0$m %or ?&0$#3e B3o 0"5 !he !as" Force recommends institution of a mechanism for employees to report concerns about unethical behaviour, actual or suspected fraud, or violation of the company*s code of conduct or ethics policy. It should also provide for ade&uate safeguards against victimi=ation of employees $ho avail of the mechanism, and also allo$s direct access to the Chairperson of the audit committee in e<ceptional cases.

1/. Risk -ana,ement Frame8ork !he sources of ris", and their magnitude, have changed dramatically. 7ue to globalisation, changing ris"s and their global dimension, pose challenges not only to business and governments but also to society and economies. Inade&uate ris" evaluation for credit derivatives is identified as one of the causes for the global meltdo$n of :;; . !he !as" Force felt that the board must be provided $ith information on the most significant ris"s and ho$ they are being managed to integrate ris" management in decision ma"ing activity. A strategy must be instituted to deal $ith and manage or mitigate each of the identified ris"s $ith an ob1ective of creating e&uilibrium bet$een ris" minimisation and ris" optimisation. 2hile the policy need not be made public for reasons that confidential information ought not to be published as $ould compromise competitiveness, the fact that the ris" management strategy has been implemented and responsibility allocated, as certified by the C(6 and countersigned by the Chairman of the Audit Committee, $ould act as a deterrent to those $ho may ta"e un1ustifiable ris"s $ith the ob1ective of increasing compensations and incentives by short%term individual performance.

Re)omme"!'#0o" 4<8 R0$( M'"'5eme"# !he )oard, its audit committee and its e<ecutive management must collectively identify the ris"s impacting the company*s business and document their process of ris" identification, ris" minimisation, ris" optimi=ation as a part of a ris" management policy or strategy. !he )oard should also affirm that it has put in place critical ris" management frame$or" across the company, $hich is overseen once every si< months by the )oard.

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Report of the CII Task Force on Corporate Governance

Ro3e o% Re5/3'#or6 A5e")0e$ 19. The 5e,al and Re,ulator0 %tandards 8rovisions under the e<isting and proposed company la$ pertaining to the re&uirement of independent directors, constitution of audit committee, definition of independent director, promoter, "ey managerial personnel should be aligned $ith the e<isting /isting Agreement and other '()I legislations to achieve uniformity in corporate governance standards in the country. !he !as" Force recognises the varying degree of best in practice standards for ',(s, listed companies and unlisted public companies, $hich have significant impact on the economy. !he !as" Force suggests that regulations I prescriptions should be set under the Companies /a$ and its regulations from time to time and should be in%sync $ith '()I, as far as listed companies are concerned. For that purpose, 1oint committees of '()I and the ,inistry of Corporate Affairs should be constituted so that uniform, agreed upon standards are prescribed for listed companies under both la$s.

Re)omme"!'#0o" 498 H'rmo"0@'#0o" o% Cor-or'#e Gover"'")e S#'"!'r!$ !he !as" Force suggests that the 4overnment and the '()I as a mar"et -egulator must concur in the corporate governance standards deemed desirable for listed companies to ensure good corporate governance.

11. The Capa ilit0 of Re,ulator0 A,encies . &nsurin, 6ualit0 in Audit 4rocess )ased on the recommendations of the ?aresh Chandra Committee on Corporate Audit B 4overnance, an independent Ruality -evie$ )oard (R-)) $as set up, $hich could be entrusted to provide transparent and e<peditious oversight. !he )oard $as funded by ICAI and also depended on the Institute to provide infrastructural support. >o$ever, the ICAI R-) has not achieved the ob1ectives for $hich it $as established and the !as" Force, thus considered it imperative that the R-) is made functional going for$ard to ensure &uality in the audit process by a critical revie$ of the intensity and integrity of auditors by peer auditors on an annual basis.

Re)omme"!'#0o" 208 A/!0# Over$05&# Me)&'"0$m In the interest of investors, the general public and the auditors, the !as" Force recommends that the 4overnment intervenes to strengthen the ICAI Ruality -evie$ )oard and facilitate its functioning of ensuring the &uality of the audit process through an oversight mechanism on the lines of 8ublic Company Accounting 6versight )oard (8CA6)) in the 0nited 'tates.

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Report of the CII Task Force on Corporate Governance

23. &ffective and Credi le &nforcement ,ultiplicity of investigating agencies leads to delay in the overall 1udicial process and possible misinterpretation of information. -egulators under the Company /a$, the 'ecurities /a$s and the 'erious Fraud Investigation 6ffice should have an inter%se cooperation agreement. In fact, the ?aresh Chandra Committee -eport on Corporate Audit and 4overnance (:;;:), set up by the then 7epartment of Company Affairs, had recommended that there should be a !as" Force constituted for each case under a designated team leader and in the interest of ade&uate control and efficiency, a Committee each, headed by the Cabinet 'ecretary should directly oversee the appointments to, and functioning of this office, and coordinate the $or" of concerned department and agencies. !he mode of cooperation and the specification of inter%se duties, areas of investigation ought to be determined at the initiation of the investigation so as to avoid conflicting reports. !he inter%regulator committee for instituting criminal and civil recovery proceedings should be supported by highly trained professionals so that serious frauds are controlled and ade&uate deterrence measures are put in place against defaulters. 7uring the >arshad ,ehta scandal, the 'pecial Courts Act $as empo$ered to consider both civil and criminal actions from the securities fraud transaction. A special bench of the Company /a$ )oard or its successor, the ?ational Company /a$ !ribunal should be invested $ith special po$ers for ad1udication of civil recovery actions and for criminal offences and penalties to be levied thereunder. 'uch a bench should have time management processes for disclosure and pre%trial discovery admissions for determining the issues to be proved, leading of evidence on a day%to%day basis and a specified time line for rendering the 1udgement after a collaborative time%table bet$een the court I ?C/! I prosecutors and defence counsel is set at commencement after the charge sheet or the plaint is instituted. !he bench should endeavour to dispose off matters concerning securities frauds or serious frauds $ithin a time frame of 9 to 1: months from commencement.

Re)omme"!'#0o" 248 E%%e)#0ve ; Cre!0b3e E"%or)eme"# !he !as" Force recommends that instances of investigations of serious corporate fraud must be coordinated and 1ointly investigated. 5oint investigations I interrogation by the regulators for e<ample, the 'FI6 and the C)I should be conducted in tandem. 6n the lines of the recommendations of the ?aresh Chandra Committee -eport on Corporate Audit and 4overnance, a !as" Force should be constituted for each case under a designated team leader and in the interest of ade&uate control and efficiency, a Committee each, headed by the Cabinet 'ecretary should directly oversee the appointments to, and functioning of this office, and coordinate the $or" of concerned department and agencies. Civil recovery for acts of misfeasance, malfeasance, nonfeasance and recovery from the $rongdoers and criminal offences and penalties and punishments should be ad1udicated appropriately, $ithout conflicting reports and opinions, and disposed off bet$een 9 to 1: months.

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Report of the CII Task Force on Corporate Governance

21. Confiscation of %hares In case of securities fraud by a shareholder or other securities holder, the company should aide the regulators (i.e. ,inistry of Corporate Affairs and '()I) as decided by an inter%se agreement bet$een the t$o to ta"e actions such as free=ing the shares, intimating the stoc" e<changes of the details of the relevant securities and in case of physical share certificates, confiscation and cancellation thereof3 as fraud conveys no title. !he po$er of confiscation and cancellation in relation to securities fraud, should e<tend to cancellation of such fraudulent securities even if it concerns creation of one or more (multiple) pledges subse&uent to the first act of securities fraud.

Re)omme"!'#0o" 228 C'")e33'#0o" o% Fr'/!/3e"# Se)/r0#0e$ A provision of confiscation and cancellation of securities of a person $ho perpetrates a securities fraud on the company or security holders ought to be prescribed for the protection of capital mar"ets.

22. 4ersonal 5ia ilit0 In case any director or employee(s) of the company commits an offence $ith an intention to ma"e personal monetary gains or profits, personal penalty should be imposed on such directors or the employees commensurate $ith the $rongful gains made in addition to disgorgement of $rongful gains. !he 'hardul 'hroff Committee constituted by the 7epartment of Corporate Affairs has provided for conse&uences of repeat offences and ad valorem fines and penalties based upon the magnitude of unla$ful or un1ust enrichment and gains from a fraudulent or illegal act under the Company /a$. 2ith mega frauds, the financial penalty of -s.:D Crores prescribed under '()I and 'ecurities /a$s are inade&uate and an ad valorem rate based upon the e<tent of the securities fraud may be considered. !he collection of fines and penalties should be employed for restitution of those shareholders or the company $hich has been a victim of the fraud or the offence and should not be accumulated to government coffers. !he deterrence aspect of a serious fraud must be significant and serious and the victims $ho suffer such frauds must en1oy the benefits of distribution of such fines and penalties after recovery of costs of the conduct of any trial to prove the offences or the recovery from the $rongdoer and the disgorgement of $rongful gains. 6n the other hand, if a director is not informed or does not possess any "no$ledge of any non%compliance on part of the company, he should not be held liable, !he !as" Force dre$ a reference to the 1udgment in the case of >omi 8hiro=e -anina @s. !he 'tate of ,aharashtra $here it $as held that M non%e<ecutive directors cannot be made to undergo the ordeal of a trial for offence of non%compliance $ith a % :: %
Report of the CII Task Force on Corporate Governance

statutory provision unless it can be established prima facie that they $ere liable for the failure on part of the companyM

Re)omme"!'#0o" 298 L0'b030#6 o% D0re)#or$ ; Em-3o6ee$ 8ersonal penalties should be imposed on directors and employees $ho see" un1ust enrichment and commit offence $ith such intentions. 'uch punishments should be commensurate $ith the $rongful act and be imposed in addition to disgorgement of $rongful gains. Further, non%e<ecutive directors cannot be made to undergo the ordeal of a trial for offence of non%compliance $ith a statutory provision unless it can be established prima facie that they $ere liable for the failure on part of the company.

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Report of the CII Task Force on Corporate Governance

T&e Ro3e o% E7#er"'3 I"$#0#/#0o"$ 2!. Institutional Investors /ong term institutional shareholders, pension funds or infrastructure funds $ith significant holdings in securities of listed companies across all of the 2est but largel y in the 0nited 'tates, are "no$n to be po$erful players in shaping corporate governance norms. >edge funds and FIIs have a shorter term vie$ but are e&ually concerned $ith observance of corporate governance norms and the protection of capital mar"ets. !heir role assumes more significance as dispersed sha reholders have neither resources nor incentive to invest the significant resources re&uired to effectively monitor and sometimes agitate against ineffective or even fraudulent boards and managements.

Re)omme"!'#0o" 2,8 S&'re&o3!er A)#0v0$m /ong term institutional investors, pension funds or infrastructure funds can help to develop a vibrant state of shareholder activism in the country. !he oversight by such investors of corporate conduct can be facilitated through internal participation of their nominees as directors or e<ternal proceedings for preventing mis%management. 'uch institutional investors should establish model codes for proper e<ercise of their votes in the interest of the company and its minority shareholders, at general meetings, analy=e and revie$ corporate actions intended in their investee companies proactively and assume responsi ble roles in monitoring corporate governance and promoting good management of companies in $hich they invest.

2#. The 4ress Capacity building in the area of corporate governance, has assumed critical importance in India, given the rene$ed emphasis on the sub1ect in the light of the recent events. ,edia has an important part to play in raising general a$areness and understanding of corporate governance and potentially as a $atch dog in the area of corporate governance. )eing a significant sta"eholder itself, the fourth estate should consider upgrading capacity to carry out analytical and investigative reporting in matters impacting best in practice standards of corporate governance as they can play the role of a responsible and an effective sta"eholder in protecting capital mar"ets or securities mar"ets from in1ury from corporate fraud.

Re)omme"!'#0o" 218 Me!0' '$ ' $#'(e&o3!er !he !as" Force recommends that media, especially in the financial analytics and reporting business should invest more in analytical, financial and legal rigour and enhance their capacity for analytical and investigative reporting.

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Report of the CII Task Force on Corporate Governance