Newsletter Category: 2019

The sixth annual two-day Corporate Governance Summit, Gatekeepers of Governance, took place in Mumbai on 21^st and 22^nd November, 2019. It was truly a congregation of the cognoscenti, comparing notes on concerns and issues in the area of Corporate Governance. For the relatively less informed proponents and protagonists of Corporate Governance, the Summit was a clearing house where experience lent expression to itself in dispelling doubts and difficulties.

SEBI’s, and indeed India’s, formal journey of Corporate Governance commenced with the setting up of the Kumar Mangalam Birla Committee in 1999. 20 years later, the Summit, with Mr. Birla setting the tone in his inaugural address, took a look at the hits and misses in the regulatory space. Some of the issues that surfaced during the conversations are discussed hereinbelow.

There was all round recognition that a properly constituted Board of Directors is a sine qua non for good Corporate Governance. The contemporary issue of separation of the roles of Chairman and Managing Director (MD), witnessed support for separation as well as for combining the two roles. The related question whether the Chairman should be non-executive, and should not be related to the MD also had takers on both sides. Mr. Birla’s contention that so long as there was separation, the non-executive character of the Chairperson’s position should not be insisted on, found reasonable broad-based support. An equally significant point that emerged during the inaugural session was the crying need for increased professionalization of management at the highest levels in the company.

The expectations from Independent Directors (IDs), and the recently prescribed proficiency test, also came up for animated discussions. There was widespread support for the proposition that the proficiency test was not the best method for ascertaining the suitability of an ID. It was felt that the track record of the person concerned, and boardroom experience, would be far better indicators of fitness. To a suggestion that IDs should have x-ray vision to ascertain what was being held back from the Board, one response was that, to begin with, they should keep their eyes open.

Trust and transparency figured significantly in the discussions. The approach “When in doubt, disclose” was accepted as non-negotiable. It was felt that the time had come, in the interest of all stakeholders, to move from a situation of “distrust and terrify”, to “trust and verify”. Non-Executive Directors (NEDs), most of whom were categorised as independent, were expected to function on the “trust but verify” principle, and to resort to a smell test if things were suspected to be going wrong.

The on-off debate whether auditors were bloodhounds or watchdogs surfaced yet again. The fact that they did not pick up signals which, in hindsight could be described as obvious, did not cover the auditing community with glory. Now that the chips were down, it was time for the auditing profession to pull up its socks and to help shareholders understand the nature and extent of irregularities in companies that they were invested in.

The belief that well governed companies attract a governance premium in the market was subjected to scrutiny. It was noticed that several of the largest companies in the United States had governance issues which did not seem to deflect the enthusiasm of the investors. The other view which was canvassed was that companies without good governance were unlikely to survive in the long run, and in any case, should not be allowed to survive, unless, going forward, stakeholder concerns are effectively addressed by good governance practices.

The overarching issue, which is the mother-question of whether regulations are excessive, also came in for animated discussions. The view of corporate leaders, who had created wealth, was that excessive regulation stood in the way of proper attention being paid to the conduct of business. It was felt that the disproportionate time and energy, invested by top management in dealing with compliance issues, led to inadequate time being devoted to strategy, risk management and such other business concerns. Regulatory Impact Assessment was mentioned as a possible response to the perception of excessive regulations. Better regulation, rather than more regulations, was identified as an immediate necessity.

The related question of treating every mistake as one deserving of penal consequences was also addressed. It was noted, with considerable relief, that a committee constituted by the Ministry of Corporate Affairs (MCA) had submitted a report recommending decriminalisation of a large number of offences under the Companies Act, 2013 (the Act). The view that emerged was that urgent decisions needed to be taken on these recommendations so that managements and Boards would be encouraged to grapple with contentious issues, without fear of being held responsible for malafide intent being attributed to errors of judgement.

Conflict of interest was identified as the elephant in the room. Related party transactions (RPTs) which best manifest the possibility of conflict of interest, was discussed threadbare. It was noted that there were major inconsistencies between the Act and the SEBI LODR Regulations, and these needed to be reconciled without further loss of time. Apprehension was expressed that the continuation of a large number of RPTs would lead to foreign investors, as also some domestic investors, staying away from the concerned corporate entities. While Audit Committees have been tasked with approving RPTs, it was noticed that they did not have adequate time, and in many cases, adequate information to conclude that an RPT was completely above board. The setting up of subsidiaries in large number, and having an increasing number of RPTs with them, was identified as one of the problem areas. It was felt that more and more companies should, over time, and in a non-disruptive manner, reduce the dependence on related parties, so that conflict of interest could be gradually phased out of corporate entities.

Asymmetry of information which along with conflict of interest, constitutes the biggest danger to sound Corporate Governance was also gone into, especially with reference to SEBI’s Prohibition of Insider Trading (PIT) Regulations. It was noticed that unlike in many other jurisdictions, it was not necessary for trading to be done based on unpublished price sensitive information (UPSI), to complete the concerned offence. The mere enabling of passing on of UPSI, to persons who did not need to know, itself completes the offence. The preventive and procedural steps to eliminate the unauthorised passing of UPSI, to unconcerned persons was stressed, even as it was recognised that there could be situations in which an offence could be committed without anyone intending to do so. While guardrails and guidelines were necessary, there was some doubt whether they were sufficient to prevent the scourge of insider trading.

Concerns were aired and discussed. Solutions were proffered. The time has clearly come to walk the talk. As someone observed, perhaps in a cynical fashion, “When all is said and done, more will be said than done.” It is time for regulators and regulated entities to prove the cynic wrong.

READERSPEAK – Egress and Ingress

Reena Ramachandran, Former CMD, Hindustan Organic Chemicals
“Every step in the regulatory system needs careful consideration and a well designed consultative mechanism with relevant stakeholders.”

S Vishvanathan, Former MD, SBI
“It has now become imperative for us on the Boards to not only know “what to do“ and “what not to do” but also do what is required of us “in the prescribed manner” in “good time”.”

Nawshir Mirza, Former Senior Partner, M/s S. R. Batliboi & Co.
“One angle on the auditor resignation issue that most commentary does not address: the auditor and the company are bound by a contract under the Indian Contract Act. Either side wanting to renege needs to have a reason that the Act permits, else, they have to deliver on what they committed to do.”

READERSPEAK – Gaps, Overlaps, Traps and Mishaps

S Hajara, Former CMD, Shipping Corporation of India
“A brilliant piece indeed giving account of so many inter regulatory conflicts over the decades. Your example of a case of murder on a football field is really apt and clearly supports your argument that for jurisdiction of regulatory bodies, it’s the function which should take precedence over the structure or the entity.”

RK Nair, Former Member, IRDA and Former ED, SEBI
“The recent PMC Urban Cooperative Bank is another example of Regulatory overlap, underlap or chasm. Chit funds are another area that has been a pain point between different agencies of the Government.”

V. A. George, Managing Director, Thejo Engineering
“You have been able to lucidly bring out the ‘core issue’ (whether it is a proposed entity to be regulated, or its function or activity). If all concerned look at conflicts amongst regulators with the above objective in mind; all the issues can be resolved very fast.”

Govind Sankaranarayanan, Vice Chairman, ECube Investment Advisors and Former COO, Tata Capital
“Very pertinent. The need for better governance only increases.”

“Jaana hai to jao, bulayenge nahin” no longer holds the field for auditors. They have recently discovered, courtesy a SEBI circular, that resignation is no longer an event, but has transformed into a process.

The spate of auditor resignations has been a matter of concern for all stakeholders for quite some time. Since audit is the function that lends credibility to financial statements, the unscheduled departure of an auditor gives rise to questions regarding the legitimacy of those statements. So, for auditors to walk away in cavalier fashion, as soon as a small degree of discomfort is experienced, can never be a preferred option as far as stakeholders are concerned. Overstaying one’s welcome could also lead to grievous consequences. Clearly therefore, resignation is a decision that cannot be taken too early or left too late.

SEBI has now spoken. When an auditor should resign, what she should do before she resigns, and what reasons she should set out for the resignation, constitute the subject matter of the recent circular. It goes on to state what the recipient of the resignation letter should do, and when. Like many answers, this one also throws up a few questions. But first, the prescription. The requirement, which now stands amended or refined, was that the detailed reasons for the resignation of an auditor of a listed entity should be disclosed to the stock exchanges as soon as possible, but not later than 24 hours of receipt of such reasons from the auditor. It is reasonable to presume that an auditor, when communicating a serious decision such as a resignation, would also indicate the reasons therefor. The time limit indicated would seem to preclude any discussions between the Audit Committee (AC) and the auditor, and consequently, any opportunity for the AC to intervene constructively. Until now, the company was reduced to performing the function of a post office, communicating the decision of the auditor to the exchanges. Things have changed.

Prior to resignation, the auditor shall “approach” the Chairperson of the AC with concerns such as non-availability of information or non-cooperation by the management, and the AC shall receive such concerns “directly and immediately”. This is presumably to provide the AC with an opportunity to take such corrective action, as is possible. What is not elaborated, but is procedurally most appropriate, is for an AC meeting to be convened at short notice, and for the Committee members, without the presence of any management element, to hear the concerns of the auditors. Thereafter, the Committee could hear the management version of its alleged non-cooperation or non-furnishing of information. If the AC is unable to resolve the matter, the auditor’s resignation should be accepted, and should be communicated to the exchanges.

There are some issues that cannot be lost sight of. In a rare case, where the auditor has a general sense of discomfort and would like to leave, it is entirely possible for the auditor to prepare a long list of documents and information required, and to indicate a very short time limit for the management to comply. If the deadline is breached, the auditor could then say that the information has not been furnished, and could then leave. There is also the larger question of the auditor’s state of mind. It is reasonable to believe that a responsible functionary, such as an auditor, would contemplate resignation only after examining all possible alternatives. When she approaches the AC, indicating an intention to resign, it is highly unlikely that the AC will be able to satisfy the concerns of the auditor. Will the revised procedure not amount to an infructuous exercise?

There is also the issue of alleged non-cooperation. In a recent case, the auditor reached the factory gates, only to find it closed, and to be denied admission by the guard. The auditor alleged non-cooperation. The management claimed that the guard had no prior notice of the intended visit of the auditor, and therefore did not let her in. This is a situation in which neither side covered itself with glory. It was not rocket science for the auditor to request a management functionary to accompany her or to pass on information to the guard that the auditor would be visiting.

The recent regulatory intervention also provides for the manner in which an auditor should deal with the issue of limited review or audit report, if the resignation happens during a quarter. The circular contemplates inter alia that if an auditor resigns after 45 days from the end of a quarter, the auditor shall, before such resignation, issue the limited review or audit report for such quarter, and for the next quarter. With resignation, the auditor becomes functus officio. It would be incorrect for her to issue or authenticate any report post her resignation since it will have questionable legal validity. There is also the question of the mental state. What interest can an auditor or any person have, post his resignation, to undertake a detailed inspection or audit, and to engage with management, in order to finalise comments for inclusion in the report? Why not use the sensible formulation of “proposes to resign” which figures in one part of the circular, and replace “if an auditor resigns”?

In this entire exercise, roles have been assigned to the auditor, the AC, the Chairperson of the AC, the Board and the exchanges. There is one missing element and that is the shareholder. It is inadequate for her to receive cryptic information, through the medium of a disclosure on the exchange. The assumption that all shareholders keep track of what is published on the website of exchanges is also questionable. Since it is the admitted position, at least for form’s sake, that the shareholders approve the appointment of statutory auditors, it stands to reason that outgoing auditor, post her resignation, should appear before the shareholders at the next Annual General Meeting (AGM), offer an explanation, and be prepared to respond to queries that shareholders might have in regard to the reasons for, and the circumstances of, the resignation. This, more than a sterile disclosure to the exchanges, would be a manifestation of shareholder democracy.

As for auditors, life has become more complex. When rotation was first mooted, the auditors threatened a revolution. With rotation having been mandated, they scrambled for audit assignments. Now that they have got new audits, at least some of them are asking themselves whether they have landed in the right place. Having battled to get in, a premature exit is not an easy decision. The longer one stays in a company with questionable practices, the more one becomes a part of the problem. Knowing when to leave is critical.

While auditors could find their exit difficult, Independent Directors (IDs) will have to contend with a new entry barrier. Getting 60% in an online “proficiency self-assessment test” will open the gates to boardrooms. Remember however that eligibility is not entitlement.

The test that will inter alia define fitness will cover “Companies (sic) law, securities law, basic accountancy”, and such other areas of relevance. If this is the line of treatment decided on for ailing Boards, it would be useful to step back and look at the diagnosis.

Boards, the world over, have underperformed for a number of years. Both Enron and Satyam, to take just two examples, had marquee Boards, with lawyers and men of finance aplenty. Did they fail because of ignorance of law or finance? In recent corporate history, IL&FS has been a monumental failure. Yet, those Boards had, person for person, IDs that, on the basis of their qualifications and experience, most Boards would have given an arm and a leg for.

Clearly the problems lie elsewhere, and the proposed test is not even remotely relevant. It is no secret that IDs were selected mostly on the basis of comfort levels, clubbability and their being convenient. Peaceful coexistence was the watchword. The constructive tension that ought to exist between the Board and the management rarely figured even in academic conversations.

Enlightened Boards and promoters know that value addition lies in moving from the convenient to the competent. Relevance, rather than relationships, ought to be the key to the boardrooms.

Will the proposed test be an indicator of the maturity and wisdom that resides in Boards, or will it legitimise learning by rote which is, or ought to be, discredited and discontinued even in schools?

It is no one’s case, that new Directors, however accomplished, might need some handholding. Well-intentioned companies that see Boards as value adding entities could introduce a system where the senior most IDs mentor the new IDs in an informal unstructured manner. Yet another matter should not be lost sight of. Inclusion, as well as renewal, of a name in the databank comes at a price. Relevance of the test notwithstanding, the revenue stream of the notified institute has been taken care of.

One last thought. Hopefully, the question paper will not be as peppered with the definitive article “the”, as the application form is!

For our views on PMC Bank, “As Safe As a Bank”, please click here.

Mere angne main tumhara kya kaam hai…is a question that has been asked in the regulatory space on quite a few occasions. Replace “mere” with “uske” and it will be seen that the recent order of the Securities Appellate Tribunal (SAT), setting aside Securities and Exchange Board of India (SEBI)’s findings in the matter of some entities and some partners of the Price Waterhouse Group, poses exactly this question. SAT has held that the Institute of Chartered Accountants of India (ICAI), and not SEBI, can, and should, regulate the profession of Chartered Accountants and the practice of auditing. Does this render SEBI toothless when it comes to dealing with suspected negligence, or worse, while seeking to ensure that the accounts of regulated entities present a true and fair picture?

Turf battles between regulators are not new. More than a decade ago, and consequent on an announcement in the budget regarding the setting up of Gold Exchange Traded Funds (GETFs), SEBI constituted a committee to give effect to this decision. Objections were raised at the threshold. It was contended on behalf of the Reserve Bank of India (RBI) that gold being a surrogate for currency, the RBI should take the initiative in the setting up of such funds. The Forward Markets Commission (FMC) (since merged with SEBI) expressed the view that gold being a commodity, it should be left to the commodities regulator, namely the FMC, to act on this matter. SEBI’s contention was that the announcement was regarding a fund, the units of which will be traded in the market and therefore it was for the securities market regulator to enable the setting up of such funds.

A few years later, there was a standoff between SEBI and the Insurance Regulatory and Development Authority of India (IRDAI) on the regulation of the Unit Linked Scheme. It was SEBI’s view that the nature of the activity lent itself to regulation only by SEBI. On the other hand, the IRDAI held that the entities offering these products were insurance companies, which were regulated by the IRDAI, and hence, by extension, IRDAI should regulate these products. The matter remaining unresolved, the Ministry of Finance (MoF) got into the act and set up the Financial Stability and Development Council (FSDC) to provide inter alia for inter-regulatory coordination. Questioned on the necessity of setting up such a body, the then Finance Minister stated in Parliament that if two regulatory bodies were fighting like children, the MoF could not stand aside and watch. In some ways, it was a timely reminder of the story of the two cats and the monkey.

Outside the public glare, there is the difference of opinion, to put it mildly, between the RBI and SEBI on some matters relating to the regulation of the debt market. Yet another disagreement is on whether institutions that are functioning as exchanges can remain outside the regulatory ambit of SEBI.

If perceived regulatory overlaps were not enough, there has been at least one significant instance of regulatory gap. Between 1996 and 1998, a number of unincorporated bodies raised money from unsuspecting retail investors, by promising extraordinary returns. The most prominent of these were tree plantation schemes which were launched to persuade the common man that money could grow on trees. There were several other similar shared ownership schemes which promised a bounty after a few years. These schemes proliferated since there was no clarity on who would regulate them. This regulatory gap was exploited by several unscrupulous persons and entities, and predictably, many investors came to grief. When it was finally decided in 1998 that such schemes should be treated as collective investment schemes, and should be regulated by SEBI, there were no applicants for registration. From then till now, SEBI is dealing with the pre-1998 cases, and trying to recover the money raised fraudulently by these entities.

Post the coming into force of the Companies Act, 2013, questions arose as to the manner in which inconsistencies between the Statute and Clause 49 (since replaced by SEBI (Listing Obligations and Disclosure Requirements) Regulations (LODR)) should be tackled. The commonsense view, which has stabilised after a few years, is that while the Ministry of Corporate Affairs (MCA) would have jurisdiction over the entire universe of corporate entities, SEBI would be well within its rights to prescribe higher standards of governance for the much smaller universe of listed entities.

The story will be incomplete without referring to the recent measures announced by the Government of India, ostensibly in public interest. Relevant to our purpose is the reported decision of the Government that banks would not classify Micro, Small and Medium Enterprises’ (MSME) accounts as non-performing assets (NPAs) till 31st March, 2020. Ever since the income recognition and asset classification (IRAC) norms were given effect to in the early 1990s, and even before that, it was the Central Bank that had the responsibility for prescribing when, and on what basis, an account ought to be treated as an NPA. Is the present announcement an aberration and are we likely to see RBI gently reminding the Government of the inappropriateness of the announcement? Will Mint Street stand up and be counted or will it sit back and watch?

Underlying these standoffs is one common question. Is it the entity that is proposed to be regulated or is it the function or activity that should be the focus of regulation? For example, in the standoff between SEBI and IRDAI on the Unit-Linked Insurance Plans (ULIPs), would it not have been appropriate to hold that it was the function that was sought to be regulated, and therefore it fell within SEBI’s domain, while the entities, namely the insurance companies, would continue to be regulated by IRDAI in its role as the entity regulator. To put the matter differently, is it the structure that is sought to be regulated, or is it the function? If both of these are to be regulated, can they not be regulated by two regulators, without stepping on each other’s toes? To give an extreme, and hopefully a theoretical, example, if a player commits premeditated murder in a football field, should the basic crime be dealt with by the police or by the Football Association? The Association as entity regulator would be well within its rights to ban the player for life and even to impose penalties on the club to which she/he belongs; but dealing with the offence of culpable homicide will be the function of the police.

There are innumerable examples of crimes remaining unresolved because police stations were protesting the absence of jurisdiction, while the criminals made good their escape. Regulatory gaps, if unattended to, will play out in the same fashion.

Before the next turf dispute emerges among regulatory entities, the FSDC should think through all possible gaps and overlaps, and address them appropriately. “If it ain’t broke, don’t fix it” won’t work if potential problems are ignored. The SEBI-SAT standoff is expected to end up in the Supreme Court. My unsolicited advice is simply this: Let ICAI regulate the profession of Chartered Accountants, and leave it to SEBI to discipline auditors who negligently, or otherwise, aid in the publication of accounts, that are neither true nor fair.

READERSPEAK – A Tale of Two Boards

TN Manoharan, Member, Govt appointed Satyam board, Chairman, Canara Bank, and Past President, ICAI
“The incisive analysis bringing out the similarities and differences between the Satyam and IL&FS and the take away in the form of right lessons is comprehensive and meaningful. Having been part of the Government nominated Board of Satyam, I can vouch that the advantages we derived in terms of diversity of expertise among the Board members, support drawn from second line of Management and the absolute freedom of operation were instrumental in turning around and resurrecting the Company.”

BS Raghavan, IAS (Retd), GoI
“Brilliant, Damodaran….the comparative analysis of how both situations were handled is full of penetrating insights.”

B. P. Vijayendra, Former Principal CGM, RBI
“The comparison between the Satyam and IL&FS events, separated by a decade, is extremely interesting. The relevance of CA and Lawyer on the Board and significance of the middle level functionaries in the rehabilitation efforts are important lessons to be learnt.”

S Hajara, Former CMD, Shipping Corporation of India
“I totally concur with you that for an entity like ILFS, involved with such diversified business segments, a multi disciplinarian composition of the Board was the best suited approach. Today somehow diversity in the corporate sector has fashionably become synonymous with gender diversity but diversity in knowledge, experience and wisdom is a far more important issue. Legal and financial acumen and knowledge should form the pillars of any corporate revival.”

Gen (Retd) Ved Malik, Former Chief of Army Staff, GoI
“Enjoyed reading this column with very sane advice, especially on the QR for Independent Directors.”

Many moons ago, two very distinguished persons were contesting for a single seat in the Graduates Constituency of a Legislative Council. Being opponents, but not enemies, they decided to address a segment of the electorate from the same platform. The first speaker, a distinguished medical practitioner, made an elaborate appeal, the centrepiece of his argument being that the person who gets elected must be a person of tact and courage. When it came to his turn, the second speaker, the soul of brevity, agreed wholeheartedly with his opponent that the person who gets elected, must be a person of tact and courage. He added that when there were problems back home, his opponent tactfully retreated to the cooler climes of the Continent, and he courageously returned once normalcy had been restored. It is worth pondering as to which of these two types inhabit modern corporate boardrooms.

A little over a decade ago, corporate India witnessed a governance scandal of mammoth proportions. In his letter to the stock exchanges and to the Securities and Exchange Board of India (SEBI), B. Ramalinga Raju, the Chairman of Satyam Computers Limited (Satyam) admitted that the accounts of the company presented, year after year, for several years, did not reflect the correct position. He added, for good measure, that he had mounted a tiger, and that it was difficult to dismount it. Of more significance to his stakeholders was the fact that his company had also mounted the tiger at his instance, and that there was no easy way to return to normalcy.

Desperate situations call for desperate measures. In a move that was both unprecedented and lightning fast, the Ministry of Corporate Affairs (MCA) petitioned the Company Law Board (CLB) to remove the entire Board, and to replace it with carefully chosen persons of repute. In a matter of a few days, a new 6 member Board, constituted at the instance of the Government, with members appointed by the CLB, and given statutory protection, assumed control. The composition of the new Board merits elaboration, if only to draw lessons therefrom. Deepak Parekh, a veteran of the corporate scene, Kiran Karnik, a former Chairman of NASSCOM, Tarun Das, who was synonymous with Confederation of Indian Industry (CII), C. Achuthan, a former Chairman of the Securities Appellate Tribunal (SAT) and T. N. Manoharan, a former President of the Institute of Chartered Accountants of India (ICAI), were handpicked to lead the recovery effort. At the instance of Life Insurance Corporation of India (LIC), a significant shareholder, B. Mainak was also appointed to the Board.

The backgrounds that the gentlemen had, and the rich and varied experience and exposure that they brought to the Board, ensured that the division of responsibilities could be easily attempted. Therefore while the legal luminary grappled with court cases and other legal issues, both existing and threatened, the financial expert did a deep dive into the questionable accounting entries leading to incorrect rendition of accounts. 3 other members reached out to the companies, and stakeholders, including investors, employees and clients, to assure them that matters would be set right soon.

In the effort of rescuing the company from its near-death situation, the Board sought and received information and support from the middle and senior management persons who were not prima facie culpable in this massive scam. The recognition that they were there for the short term, until an investor was brought in, imparted a sense of urgency and direction to the rescue efforts by the Board.

A decade later, the Infrastructure Leasing and Financial Services (IL&FS), a very large Non-Banking Financial Company (NBFC) and a systemically important institution, bit the dust. Unable to service its outstandings, it defaulted on a few payments, thereby attracting the adverse notice of the markets and the Government. Their reasonably well-publicised efforts to bring in a strategic investor, or to get the major shareholders to commit funds, also drew blank. The MCA ordered an investigation by the Serious Frauds Investigation Office (SFIO), and based on the report, moved the National Company Law Tribunal (NCLT) to dismiss the Board, and to allow the nomination of fresh Directors. This move was executed as soon as the NCLT passed favourable orders.

Recent reports seem to indicate that the rehabilitation efforts have not proceeded at the desired pace. It is useful to look at the similarities and the differences to take away the right lessons, should such a major meltdown happen in the foreseeable future.

The composition of the Board is a good starting point. It could not have asked for a more experienced or relevant leadership than that provided by Uday Kotak, a relatively young veteran of the financial sector. Vineet Nayyar, who led the integration efforts of Tech Mahindra and Satyam, was brought in as the Vice Chairman and Managing Director. A number of other persons with good track records in public administration, but no known experience in the corporate world, were also inducted on the Board. Conspicuously absent from the Board was a Chartered Accountant and a lawyer, the two specialisations that contributed phenomenally to the Satyam rescue efforts. Many insiders were taken out of the equation, and persons at the supporting levels were also brought in from the outside. It is entirely possible, though not certain, that this impeded the flow of information to the Board. One significant fact, that should not be lost sight of, is that Satyam was involved with only one sector, whereas IL&FS had its presence across a wide spectrum of businesses, with some companies in the group performing reasonably well and some others, especially in the infrastructure space, manifesting under-performance. It is a moot point whether having regard to the multiplicity of businesses, the reconstituted IL&FS Board should have appointed separate empowered Boards to deal with individual businesses in a focussed manner. If these problems were not enough, the IL&FS group was also owed a very large sum of money by Ministries as well as Government organisations.

The IL&FS saga played out after the NCLT and National Company Law Appellate Tribunal (NCLAT) mechanisms had come into being. Resultantly, even proposals for disinvesting some group companies had to contend with procedural issues, causing delay, a problem that Satyam did not face in the CLB days.

Of equal import is the fact that once the reconstituted Board of Satyam was appointed, it was left to its own devices. In the IL&FS case, in contrast, forensic audit reports that found their way into the public domain, and the near universal condemnation emanating from different official sources, of Independent Directors and auditors did not help the rescue efforts. It is also possible that the IL&FS Board saw itself as fully empowered. It is also not known whether such a perception is shared by all stakeholders.

The conclusions are obvious. When a large corporate entity goes under, it is necessary to place persons with expertise and relevant track records in charge of the process of reconstruction. Having done that, the Government and its agencies should ensure that they do not expressly, or by necessary implication, signal that the real power does not reside in the Board. Fast tracking legal mechanisms, that factor in the enormity of the problem, and the need for speedy resolution, must be activated to ensure that there are no procedural obstacles. Above all, the separation of the grain from the chaff as far as the senior management is concerned, should be completed quickly so that persons that are not culpable can be a part of the solution.

Column centimetres of space in the national press cannot be the answer to a serious problem. The entries in the various columns in the books need to be given much more attention.

 

READERSPEAK – Room at the top

Ananta Barua, Whole Time Member, SEBI
“Good one. Leading a board is a major challenge”

B.P. Vijayendra, Former Principal CGM, RBI
“Thanks for the “Room at the Top”. Has several pertinent observations and I am sure it would provide very useful food for thought to many.”

Dr. Pritam Singh, Former Director General, IMI
“Excellent piece.”

This is AGM season. It is that time of the year when the faithful find their way to some distant hall or auditorium to be a part of the congregation that gazes with curiosity, and sometimes with fondness, at the women and men in charge of the destiny of their investment. Some of the annual reports that are carried to these meetings have been reasonably well-thumbed in the search for information, inconsistencies, or worse. In recent times, some of the attendees have also resorted to taking selfies with Directors as they descend from the stage, and on occasion, taking photographs of the wise men and women seated on the stage.

This year is a good year to take such photographs. Many of the persons who have graced boardrooms and AGMs for years will not be around as Directors in the days ahead. Some would have left of their own volition. Some others who would have intended to serve in the same capacity would have been persuaded to leave because of recommendations of proxy advisory firms to the effect that the day you complete 10 years as an Independent Director (ID), you cannot be independent of the management or the promoter(s), no matter how hard you try.

Change in the composition of Board is a normal phenomenon post the expiry of tenures of serving Directors. Boards will now be a combination of change and continuity, with the expectation that fresh ideas, layered on existing wisdom, will serve the company very well. Come 2020 and there will be another major change not seen hitherto. A number of persons who chair the Boards of large listed entities will make way for new Chairpersons. Yet others will remain, but get recategorised as Non-Executive Chairpersons. Accompanying this will be the phenomenon of Managing Directors (MDs) or Chief Executive Officers (CEOs) unrelated to the Chairpersons.

How will this play out? In a few companies where the same person is the Chairperson and the MD (CMD), she/he will have to decide, before it is too late, which of the two roles would be better to retain. Anyone keen on an executive role and the responsibilities attached thereto, could opt to remain the MD, while bringing on an unrelated person as the Non-Executive Chairperson. This could, in many cases, be a serving ID who is unlikely to rock the boat and will provide unquestioning support for whatever the management does. A variation on this theme would be the MD also getting designated as the Vice Chairperson of the Board. There have been a few instances in recent times where Non-Executive Chairpersons embraced anonymity and were not visible, while the Vice Chairperson and MD remained the face of the company.

Another combination will make for an even more interesting proposition. The incumbent Executive Chairperson could transit, as required by law, to a non-executive role, and designate his daughter or son as Additional MD or Joint MD (JMD), while inducting an outsider as a MD, with a circumscribed role that is largely decorative or ceremonial.

It is also useful to reflect on whether persons who have been Executive Chairpersons and MDs can easily move to a non-executive role. There are recent instances of persons whose designation has undergone recategorisation, but whose desire to exercise power and control has in no way diminished. If this becomes a more widespread phenomena, the well-intentioned regulatory prescription could be rendered meaningless. Let us not forget that one celebrated company had an Executive Chairperson, an Executive Vice Chairperson and a Chief Executive Officer. Did someone say “Two is company and three is a crowd”?

Given this context, it is not easy to comprehend why, on the demise of a longtime legendary Chairperson, the MD was given that additional responsibility. With 1st April, 2020 not too far away, companies such as these will have to contemplate yet another change involving the division of responsibilities.

There is an even more recent case where a widely respected patriarch has made way for his son as Executive Chairperson of the Board. Would it be fair to expect that when the statutory bifurcation of responsibilities kicks in, the young Chairperson, with several decades of executive responsibility ahead of him, will transit to a non-executive role?

Two promoter brothers, one a Non-Executive Chairperson, and the other a Non-Executive Vice Chairperson have accommodated a next generation person as Executive Vice Chairperson, while having a professional MD. There clearly is room for everyone!

Leading a Board is a major challenge. It would be unfair to the Board, the company, and the individual concerned if a person is brought in from the cold as a Non-Executive Chairperson, and expected to provide constructive leadership.

The good news is that there is room at the top. The not-so-good news could be that some sub-optimal occupants might head for that room, especially if a meaningful search has not yet started.

 

READERSPEAK – An open letter to Minister, Corporate Affairs

We received a record number of responses. What follows is a small sample. Please keep the responses coming

                                                                                                                                                                                       Editor

Rangachary N, Former Chairman, IRDAI
“It has now become a fashion to deride institutions and professional bodies without appreciating their role, capability and relevance.”

Kiran Mazumdar Shaw, CMD, Biocon
“Excellent letter throwing up key issues with very sensible recommendations.”

Madhavan Nambiar, Former Secretary, Ministry of Civil Aviation
“A system of getting quality persons on Board as IDs and training and mentoring them is key.”

Nilesh Vikamsey, Past President, ICAI
“Assuming all those connected with a ‘tainted’ company as wrongdoers or abettors without assessing their role / responsibilities with an unbiased mind, needs looking into.”

S Vishavanathan, Former MD, SBI
“It is the need of hour to take a nuanced approach, as opposed to a broad brush one size fits all view, of the institution of IDs and the other entities that you have alluded to.”

V. Santhanaraman, Former Executive Director, Bank of Baroda
“Video recording of the entire proceeding could be made compulsory, as the individual directors’ discussions are not minuted and only the final outcome is recorded.”

Raghu Palat, Director on Boards
“The biggest hurdle I see for independent directors is the lack of information they receive. Certain companies have been known to be selective in the information they make available, arguing that should the ID require specific information they would make it available.”

Hon’ble Minister,

Recent developments in the corporate world have led most persons to believe that what was said of princes some centuries ago, is applicable to Independent Directors (IDs).

It is with utmost reluctance that I am reaching out to you at a time when you are giving final shape to your first budget as the Union Finance Minister. Ordinarily, I would have held this back. However, with new developments, almost every day, impacting on significant functionaries in the corporate space, I believe that this letter cannot be postponed.

Let me also make the necessary disclosure. I have been, and continue to be, an Independent Director (ID) on the Boards of some large companies. I also happen to be a member of the Board of Directors of a rating agency (the one major agency that did not rate IL&FS).

For some time now, IDs, as a “community”, have had to cope with criticism and ridicule as well as attacks on their honesty and intellectual integrity. More recently, the auditing profession and the rating agencies have been added to the ever-expanding list of villains in the Corporate Governance movie.

It is not my case, nor can it be anyone’s case, that persons who have acted in a malafide manner and have actively colluded, conspired or connived with management, should be allowed to go scot-free. However, tarring an entire group of professionals with the same brush, can run counter to the stated objective of cleaning up the system.

Let me begin with IDs. The institution of IDs, which was first introduced by SEBI through Clause 49 of the then Listing Agreement, and later given statutory recognition by the Companies Act, 2013, was conceived as an instrumentality to provide a sense of balance in corporate boardrooms. Deriving from the distrust that the system had in promoters, the IDs were expected to ensure that the interests of all stakeholders in a company were addressed in a balanced manner. It is my sincere belief that every attempt should be made to strengthen the institution of IDs, rather than frighten away existing and potential IDs from the boardrooms, or have them function as the opposition party in the boardroom. The perception that IDs cannot be independent or act independently merely because the promoter or other controlling interests, including the Government of India, had something to do with their appointment, is unfair both to the IDs and to the stakeholders, whose interest they are intended to safeguard while promoting the interests of the company. I am not aware whether the Government of India, at a senior level, has engaged with an adequate number of IDs to find pragmatic solutions to the problem of perceived non-independence. Arranging for training programmes which impart knowledge of the laws and the regulations does not travel far enough. Lectures on ethics will also be empty exercises since they are premised on the assumption that mature persons sitting in boardrooms are unaware of what constitutes ethical practices.

It is also useful to reflect on the fact that IDs, because of their non-executive position, suffer from information asymmetry. This problem is compounded by their being overwhelmed, especially in banks, with an extraordinary amount of material, passing for relevant information, dumped on them. These are often in the nature of weapons of mass distraction and prevent focus on the essentials.
There are two specific suggestions I wish to make. Firstly, the process of evaluation of Directors should be undertaken by outside experts who have first-hand boardroom experience, and are not headhunters or general management consultants seeking yet another revenue stream. Secondly, whenever there are allegations that IDs have, either conspiratorially or negligently, aided malafide action by management, they should be looked at by a high level standing committee comprising credible persons, who have spent long years in the boardrooms, to examine whether there is any prima facie indication of malafide action or inaction by the IDs concerned. This could be a body on the lines of the Advisory Board on Bank Frauds which screened complaints against senior level bankers, and referred to the CBI only such cases as were indicative of prima facie negligence or misconduct, warranting criminal action.

There was a time when the opinion of the auditor was regarded as the ultimate truth. Then Satyam happened and the first signs of doubt and disbelief emerged. The spate of scandals that have come to surface in recent times has severely impacted the credibility of the auditing profession. While there can be no excuse for an auditor who saw something wrong and looked the other way, or whose professional instincts should have helped unearth irregularities, it is necessary to ensure that the reputation of the entire profession is not tarnished. Commercial operations require to be audited to ensure that the interests of the stakeholders are protected. Therefore, while the errant should be brought to book, the credibility of the auditing function requires to be protected and preserved. This is a balancing act that must be attempted with all categories of stakeholders agreeing on what the scope of audit ought to be. Unless this is done, we will witness the spectacle of auditors departing mid-year from companies with which they had a comfortable, if not a cosy, relationship for many years. Auditors that resign should be required to appear before the shareholders that appointed them and explain why they chose to discontinue their engagement. The disclaimers and hedges, behind which some of them hide, should be reduced, even if they cannot be eliminated. Most important however is that representatives of the profession are heard so that no one is punished without factoring in any possible explanation that they might have for alleged omissions or commissions. The expectation that the auditors will identify and bring out every irregularity is misplaced since the function of audit is not to undertake a comprehensive transaction-wise review. As in the case of IDs, it is necessary that an auditor or an auditing firm which is being hauled up is enabled to present its case to a high level professional group (perhaps NFRA) so that an informed view is taken before they are accused of criminal intent and collusion. While examples must be made of the dishonest, it is necessary that the profession is saved from uninformed criticism.

Rating agencies are also presently in the doghouse for rating actions and inactions. While there have been delayed responses to developments that ought to have been responded to earlier, it is perhaps necessary to avoid reading criminality into every rating error. Accountability must be enforced by the functional regulator, which in recent times has considerably tightened the regulatory framework and taken it to levels far higher than those that obtain in the developed world. To straightaway accuse officials of rating agencies as being involved in criminal activities, except where clear evidence exists, is to undermine a value-adding process which has, for the most part, been credible and reliable. Here again, while punishing those that have stepped out of line for the wrong reasons, it is necessary to preserve and protect the entities that perform a critical function that cannot be wished away.

Hon’ble Minister, the recent scandals in the financial sector present an invaluable opportunity to put in place a legal and regulatory framework that is consistent with the objectives that they seek to achieve. While investigative agencies can and must do what they are tasked to do, those responsible for the safety and soundness of the financial sector should, without loss of time, work on a framework that encourages honest decision-making, and comes down with a heavy hand on those with ill-intent. Every crisis, it is said, is an opportunity. I am confident that, in your widely acknowledged pragmatic no-nonsense manner, you will re-engineer the legal and regulatory framework to make it in sync with the need of a healthy confident financial sector.

READERSPEAK – The IDentity Crisis

S. Sandilya, Chairman, Eicher Group
“Companies which had excellent reputation on governance seem to have had problems. Some of them would have had high quality IDs as well. Did they miss the symptoms or close their eyes and ears? Or the issues were well buried under the plethora of documents presented in the last minute?”

K.K. Srinivasan, Former Member, IRDAI
“”Independent Director” is different from “Quality Director”. Perhaps the issue is not merely of ‘independence’ but also ‘quality’. How do we ensure quality?”

S. Hajara, Former CMD, Shipping Corporation of India
“I think there appears to be no clarity of thinking and unless situation improves, the basic purpose of having independent directors may be defeated.”

B. P. Vijayendra, Former Principal Chief General Manager, Reserve Bank of India
“They certainly do have an important role to play and should do so at all times.”

N. Suryanarayanan, Former Head, Group Secretarial and Compliance, L&T Financial Services
“I fear that what is not done by self-regulation would lead to ham-handed regulation (by the government). My post-corporate experience tells me that seldom is this aspect given any importance, even in large corporates.”

“Put not your trust in princes, for in them there is no salvation”.

Recent developments in the corporate world have led most persons to believe that what was said of princes some centuries ago, is applicable to Independent Directors (IDs).

There was a time, not so long ago, when the institution of ID was seen as the “great white hope” to ensure that companies are run in the right manner and with the right intentions. These knights in shining armour were expected to ride into Boardrooms and mount the offensive on questionable practices and processes. Fast forward to today, and the jury is out on whether this category of Directors continues to be relevant, especially given the fact that many of them have fled Boardrooms just when they are most needed. The exit explanations vary from the time honoured broad-spectrum “personal reasons” and “inability to commit quality time” to the most recent one relating to GST raids. Mercifully, demonetization has not yet surfaced as an excuse.

If the diagnosis is incorrect, the prescription will be worthless, and the treatment disastrous. The perceived failure of IDs to prevent corporate disasters has led to questionable solutions such as training programmes being designed by persons who are academically inclined and have no Boardroom experience. What is lost sight of is that independence is a state of mind that cannot be created by training programmes. Equally important is the fact that many IDs, who do not challenge questionable proposals in Boardrooms, are holding themselves back not for want of knowledge, but for fear of rocking the boat.

What went wrong? Were the expectations too high or unrealistic? Did Boardrooms get overly populated by the “retired and tired” types? Did a recognition of their relative lack of relevance make them look in the direction of the exit door?

The mismatch between expectations and reality is at the root of underperformance by many Directors. Many such Directors continue on Boards without any role clarity. In an atmosphere in which setbacks are treated as flowing from unconscionable decisions, and there is an ab initio presumption of malafide, there would seem to be merit in indecision, or in routinely opposing all management proposals. Such an attitude, if persisted with, could significantly obstruct the carrying on of business by a company. IDs were never intended to be the opposition party in the Boardroom.

There is also the important issue of statutory duties which the IDs have to discharge. The exhortation that Directors should not “unfairly” obstruct the functioning of the Board or its committees is also a red rag to an activist Director pushing for procedural and substantive improvements. How does one draw the line between incisive questions on a continuing basis and the charge of obstruction?

In recent times, investigative agencies have been tasked with identifying, investigating and taking to their logical conclusion, any offence under the Companies Act, 2013 or under SEBI LODR Regulations. Their second-guessing of commercial decisions, and that too with the benefit of hindsight, often places Directors in a disadvantageous and defensive position, persuading them to believe that safety lies in decision-avoidance. The ever expanding list of duties and responsibilities, coupled with serious penal consequences, if things go wrong, has persuaded, and will continue to persuade, good men and women not to accept Board positions. Some Boardrooms have transformed into places where “angels fear to tread”.

What then needs to be done? Firstly, the institution of ID has to be strengthened by giving to such persons more legitimacy and relevance in Boardrooms, and encouraging them to raise the right issues. At the same time, it must be understood that a part-time Non-Executive ID should not be treated like an ordinary criminal when a decision or two has turned out to be incorrect, ill-informed or even capricious. While a rap on the knuckles is certainly warranted in a few cases, the real remedy would lie in removing non-performing Directors from Boardrooms, and bringing in persons that have the ability, the willingness and the courage to contribute to Boardroom discussions.

It is universally acknowledged that the Board ought to be the seat of wisdom. It is not charged with operational responsibilities, and its essential role is one of providing guidance to management. To treat such persons as active decision-makers on transactional matters is to show lack of clarity in understanding the essential character of Boardrooms.

A partial solution for ensuring performing Boards is a robust process of Board evaluation that helps to identify the non-performers, and to get them replaced sooner rather than later. If the mandatory process of Board evaluation degenerates into the creation of mutual admiration societies, as has happened, and continues to happen, a very significant tool for strengthening Boards would be blunted, and the results would be counterproductive.

Should we persist with IDs in Boardrooms, or should we treat them as a non-productive element that can, and should be dispensed with? There are some who believe that the sins of the managements are visited on the Boards. Yet others subscribe to the view “she doth protest too much”. The latest attack on the credibility of IDs is from the Regulatory body which has mandated that the veracity of assertions of independence by the IDs ought to be ascertained by the Board.

IDs meanwhile grapple with the Hamletian dilemma
”To be, or not to be, that is the question:
Whether ‘tis nobler in the mind to suffer
The slings and arrows of outrageous fortune
Or to take arms against a sea of troubles
And by opposing, end them.”

READERSPEAK – Aspects of ACCOUNTability

S Rajgopal, Former Cabinet Secretary, Government of India
“I have been seeing from the past few issues you have been highlighting various issues concerning corporate governance, specially the role of Independent Directors. Very useful readings.”

Rajeev Kumar Agarwal, Former Whole time Member, SEBI
“I must say it’s very insightful and very valuable piece of advice for the Directors.”

RK Nair, Former Member, IRDA and Former ED, SEBI
“Boards and Independent Directors must spend more time on strategy, leadership, HR, executive compensation, succession planning, risk management and internal control.”

Vinita & Bali, Former MD, Britannia Industries
“I am wondering if Boards spend enough time, even articulating which information they would like to see – at a point in time, over a period of time. One of the issues I find on Indian boards in particular is that we hardly see any trend line analysis. On top of that, if you layer the large numbers of boards some people sit on…and make no notes, it is not surprising that so many things are forgotten or just fall by the wayside.”

S Hajara, Former CMD, Shipping Corporation of India
“The concepts like healthy skepticism and constructive tension between Board and Management are really apt.”

The role of Directors, especially Independent Directors (IDs), has come up for close scrutiny and significant adverse comment, in the light of governance failures, in an increasing number of companies. It is both easy, and entertaining, to conclude that these Board-level functionaries, brought in not only for their experience, but also for their commitment, were sleeping on the job while things were going wrong around them. The more plausible explanation, which surfaces in private conversations, is the feeling of inadequacy that even well intentioned Directors experience in the face of increasing demands on their time and their competence. This sense of inadequacy is especially heightened when it comes to decoding financial statements and recognising early warning signals. While the signals that one should look out for are many and varied, it is useful to focus, as has been done hereinbelow, on some of the more impactful signs of impending bad times.

Cash is the uncrowned king of the financial sector. It does not lie. Anyone that takes his/her eyes off the cash situation and cash flow, even fleetingly, ends up paying a very high price. Inexplicable volatility in the figures relating to cash constitute, without argument, a very major warning signal.

The structure of a corporate group is often the root cause of its problems. There is enough evidence to show that while things might seem alright in the parent company, subsidiaries are the preferred vehicles for fraudulent activities. Directors need to look at structures, the number of layers involved, and the reporting relationships that hold the structure together. Intercorporate transfers, without rhyme or reason, and improperly priced, is often a clear giveaway that there is something that does not meet the eye.

Of equal import is the patchy track record in meeting statutory dues and payments to lenders, vendors and other creditors. While defaults bring with them penalties and prohibitions, the larger picture that emerges is one of inability, and on occasion, unwillingness, to make payments in time, and that clearly is a flashing red light that cannot be ignored.

Attrition of key personnel, especially Key Managerial Personnel (KMPs), should bring with it the presumption that the company is in dire straits. While some exits might be for legitimate reasons, the exit of a KMP at a time when negative news regarding the company is gaining ground, should be a cause for serious concern. The question should arise whether “well-informed rats” are deserting sinking ships.

Audit reports and inspection reports constitute a valuable source of information regarding the health of the company. Companies that do not act on adverse observations are prime candidates for disaster. To use the colourful words of a distinguished Regulator of yore, when it comes to audit and inspection reports, the company and its officials should eschew an attitude of contestability.

The carrying on of business will entail a number of legal cases of different types. While they cannot be wished away, it is useful to subject them to a thorough review to ascertain whether there has been any error or irregularity on the part of the company, with financial consequences that could be destabilising. To ignore adverse rulings in the fond hope that appellate action will be positive, is to willingly suspend disbelief.

Whistle-blowers constitute a very valuable source of information to Directors. Some companies have developed a response mechanism by which anonymous or pseudonymous complaints are ignored, even though the contents are both serious and verifiable. If such a practice is allowed to continue, Directors will soon come to grief by ignoring what are obvious warning signals. While every such complaint is not necessarily genuine, the lack of seriousness in the manner in which complaints are dealt with could give rise to grave issues. The history of corporate meltdowns, both in India and elsewhere, has clearly demonstrated that more often than not, it was some whistle-blower whose conscience lit the spark which engulfed the company in flames. The overarching warning signal is the phenomenon of the executive element of the Board denying related information to the non-executive element of the Board. Treating important developments as operational matters that the Board should not be concerned with, managements have been known to trip up badly when major problems surface. Treating the Board as an avoidable nuisance is a major management falling that Directors, especially IDs, should watch out for, on a continuing basis.

The flow of information is the lifeblood of any organisation. Informed decision-making would require that the Directors are kept apprised in time regarding every aspect that is relevant, in any problem that is being grappled with. Directors bring multiple skillsets and diverse experience to the boardroom. In pursuit of popularity and acceptance by the management, they neither challenge the management, nor ask questions that could elicit more information. Equally problematic is the gullible manner in which all information that is brought to the boardroom, especially through colourful presentations, is accepted as the gospel truth. While there is no place for negativism or obstructionism in a boardroom, it is useful to recognise that healthy scepticism does not hurt. If the essence of the Board-management relationship is one of constructive tension, premised on continuing curiosity and the willingness to engage, the company will benefit immeasurably. Absent these behaviour patterns, companies, that once seemed good, will sooner, rather than later, belong to the dustbin of economic history.

The Bard might forgive the adaptation of his immortal lines:
“The evil that companies do lives after them;
The good is oft interred with their bones.”

 

READERSPEAK – TELLING IT LIKE IT IS

Gopal Pillai, Former Home Secretary, Government of India
“Good article. But will anything change? We are in for difficult times.”

SN Talwar, Founder Partner, Talwar Thakore & Associates (TTA)
“Great and thought-provoking piece. It hits the nail on the head. Brilliantly captured by you.”

Vinita Bali, Former MD, Britannia Industries
“As always…you have told it like it is and packed with valuable insights!”

Vikram Singh Mehta, Executive Chairman, Brookings India, and former CEO, Shell India
“Super .. constructive … elegant.”

S Hajara, Former CMD, Shipping Corporation of India
“It’s always better to be transparent and truthful as stakeholders don’t mind mistakes as much as falsification and suppression of truth.”

Milind Kulkarni, Senior Advisor and Former CFO, Tech Mahindra
“This is one of the best communications on ‘Communication’”

“Those who know do not speak. Those who speak do not know.”

– Lao-Tzu

If securities market regulators had a wishlist, the first part of Lao-Tzu’s observation would rank very high. In an ideal market, with greed being non-existent, and with unjust enrichment being frowned upon, Unpublished Price Sensitive Information (UPSI) will be internalised and absorbed, and shared only with those that need to know.

The real world is a lot different. With asymmetry of information being one of the two major negatives in a securities market, regulators have to work overtime to ensure that the person who has information that is better, faster and more complete, does not translate it to her/his financial benefit. In attempting to strike at the root of this evil, the Indian regulator has drawn the battlelines differently. Whereas in many jurisdictions, trading on the basis of UPSI is an essential ingredient for the offence to be complete, in India, the mere sharing of information with persons who are not entitled to such information, and even enabling the access, of unauthorised persons, to such information, is in itself an offence.

There is a large universe of persons to whom the regulatory restrictions apply. The large body of “Insiders” includes a connected person as well as a person in possession of, or having access to, UPSI. Immediate relatives, defined to, inter alia, include either financially dependent persons or persons in the habit of consulting the insider in taking decisions relating to trading in securities, also fall within the ambit of “connected persons”.

Since the late 1980s, and especially with SEBI being set up as a statutory organisation in 1992, India, like most other jurisdictions, opted for a disclosure based regime in the securities market. Simply put, a disclosure based regime makes it incumbent on those seeking to raise capital, or those carrying on business, to make, on a continuing basis, all disclosures that are relevant for the entire body of stakeholders to take informed decisions. “Publicise or perish” became the regulatory edict. Consistent with this regulatory philosophy, changes have been, and are continuing to be, made in regard to the Prohibition of Insider Trading Regulations (the Regulations).

Normal jurisprudence casts the responsibility, of proving an allegation, on the person making the allegation. The area of insider trading, and the prohibition attached to the passing on of information in an unauthorised manner, or enabling access to such information, is one instance where jurisprudence is being stood on its head. Once a person is in possession of UPSI and carries out trade in securities, there is a presumption that she/he acted on the basis of UPSI. It is for that person to prove the absence of a causal relationship between possession of UPSI and trading in securities. As in the case of many other laws and regulations, there has been a carveout of the circumstances in which such trades can be proved to be legitimate, but that does not detract from the general proposition that the burden of proof lies on the person complained against.

Information, like money, is admittedly the lifeblood of business. It follows, that persons that need to know, in the company’s interest, must receive information and must have access to information. To address this requirement, a number of categories of persons such as partners, collaborators, lenders, customers, suppliers, merchant bankers, legal advisors, auditors, insolvency professionals and other advisors or consultants have been included in the list of persons to whom UPSI may flow, provided that the purpose is legitimate. This long list of persons leaves one wondering whether what is being taken with one hand is being given away with the other. Persons included in this list, and receiving UPSI pursuant to a legitimate purpose, shall be considered Insiders and shall be given due notice to maintain confidentiality of such UPSI. It would be left to the Board to craft such confidentiality agreements, as do not leave loopholes for persons to evade or circumvent the prohibitions of these Regulations.

The Board has also been tasked with ensuring that the CEO formulates a code of conduct, with its approval, to regulate, monitor and report trading by its Designated Persons and immediate relatives of Designated Persons. It does not stand to reason that a CEO, whose principal responsibility is to run the business in a manner consistent with the interest of stakeholders, should be charged with this additional responsibility of formulating a code of conduct considering that this would seem to fall squarely within the responsibility of the Compliance Officer.

Elsewhere in the Regulations, auditors, accountancy firms, law firms, analysts, insolvency professional entities, consultants, banks etc. who are assisting or advising listed companies, have been referred to as fiduciaries for the purpose of the Regulations. The conduct of their Designated Persons (along with their immediate relatives) would also be required to conform to a code of conduct that they would be required to put in place.

Schedule B of the Regulations, which lays down the minimum standards for code of conduct for listed companies to regulate, monitor and report trading by Designated Persons, provides inter alia, in the language of the Regulations, that “the gap between clearance of accounts by audit committee and board meeting should be as narrow as possible and preferably on the same day to avoid leakage of material information.” It is entirely possible that this stipulation arose on account of a few incidents of material information being leaked between audit committee meetings and board meetings. The solution prescribed is worse than the problem. Companies that treated audit committee meetings as a formality to be gone through for a few minutes before board meetings, would now happily comply with this stipulation. Other companies with multiple businesses, and of reasonable size, will have to reconsider whether the present practice of having audit committee meetings in the afternoon of the day prior to the board meeting should be revisited. One major fallout will be that the audit committee would not be left with enough time to go through the voluminous documents, absorb the information contained therein, and take decisions or make recommendations thereon. The problem is compounded by the fact that the mandatory workload of audit committees has been increasing and therefore adequate time for their meetings is of the essence. One failsafe solution would be for the Regulator to mandate that all audit committee meetings should take place on Friday afternoon, after market hours, and that the board meetings could take place on Saturdays, which are non-trading days. A positive fallout of such a step would be that a number of board meetings would take place at the same time and make it a little more difficult for Independent Directors who are on an unacceptably large number of boards and committees.

The burden of knowledge was never known to be so heavy. Rightly has it been observed that where ignorance is bliss, it is folly to be wise. The last word must necessarily belong to George Bernard Shaw who remarked – “The things most people want to know about are usually none of their business.”

READERSPEAK – DIVIDE AND RULE

Vikram Singh Mehta, Executive Chairman, Brookings India
“Such a well-written, timely and comprehensive article.”

Shailesh Dhuri, Executive Director, Decimal Point Analytics
“Excellent article.”