corporate governence -iii
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MODULE III
Role players
By
Prangya Paramita
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Corporate management structure :
Elect Form
Appoints
Shareholders
Board of directors
Chief executives and senior executive
Executive
committee
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Who is a director?
Section 2 (3) of the companies Act defines a
director as follows- A director includes any
person occupying the position of directors by
whatever name called.
Kinds of directors
Full time director
Non executive director
Shadow directors
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Qualifications of directors
A director must :
1. Be an individual
2. be competent to enter into a contract3. hold a share qualification if so required by the Article of
association.
Disqualified
1. A person of unsound mind.2. An un-discharged insolvent or one whose position for declaring
himself so is pending in a court.
3. a person who has been convicted by a court for any offenceinvolving moral turpitude.
4. A person whose calls in respect of shares of the company are heldfor more than 6 months have been in arrears.
5. A person who is disqualified for appointment as director by anorder if the court on grounds of fraud or misfeasance in relation tothe company. And of course, directors can be removed from office.
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Board of directors/ board of trustees/ board of
governors/ board of manager/ executive board
A board of directors is a body of elected or
appointed members who jointly oversee the
activities of a company or organization.
Role of board of director
small size of the board
Independence of the board
Diversity of the board
A well informed board
The board should have a longer vision and
broader responsibility
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Market forces and competition
Accountability disclosures Customer service andsatisfaction
Empowerment and Continuing relationship
pressure to perform
Regulatory compliance Compliance of business ethics
Organizations welfare Providers of service & supplies
Career advancement
& job satisfaction Transparency & fairness in dealings
environmental preservation
Social responsibility
Board
of directorPolicy Compliance
and
Accountability
Top management
Depositors,
borrowers and
other customers
All other stakeholders
Shareholder
Employees
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Who is an independent director?
An independent directors is defined as a nonexecutive directors who is free from any businessor other relationship which could materiallyinterfere with the exercise of his independentjudgment.
The Cadbury Report identifies two areas wherenonexecutive directors can make an importantcontribution to the governance process as a
consequence of their independence from executiveresponsibility. First, reviewing the performance ofexecutive management and 2nd, taking the leadwhere potential conflicts of interest.
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Who are Independent Directors
As per Clause 49 of the Listing Agreements an independent
director shall mean non-executive director of thecompany who
a. apart from receiving directors remuneration, does not
have any material pecuniary relationships or transactions
with the company, its promoters, its senior management orits holding company, its subsidiaries and associated
companies;
b. is not related to promoters or management at the boardlevel or at one level below the board;
c. has not been an executive of the company in the
immediately preceding three financial years;
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d. is not a partner or an executive of the
statutory audit firm or the internal audit firm
that is associated with the company, and has
not been a partner or an executive of any
such firm for the last three years.
e. is not a supplier, service provider or
customer of the company.
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Role of Independent Directors Role Of Independent Directors
The non-executive directors should:
* Contribute to and constructively challenge development of company
strategy.
* Scrutinize management performance.
* Satisfy them that financial information is accurate
* Meet at least once a year without the chairman or executive directors -
and there should be a statement in the annual report saying whether such
meetings have taken place.* Be prepared to attend AGMs and discuss issues relating to their roles.
* Have a greater exposure to major shareholders (particularly the senior
independent director).
Effectiveness of the board as the oversight body to oversee what the managementdoes
Is there a better way to do it, in view of
Recent scandals of disclosures and audits
Size and scope of present day enterprise
Complexity of operations
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Independent Directors under Listing Agreement in India
Composition of the Board:
Not less than 50% of the board to be non-executive directors
Independent Directors:
If the chairman executive:
At least half of the board should comprise of independent directors
If Chairman non-executive:
At least one- third of the board should comprise of independentdirectors
Non-executive directors remuneration to be approved by shareholders
Board meetings to meet at least 4 times, with gap not exceeding 3 months.Minimum information for board meetings laid down
Committees of Directors
Audit Committee:
shall have minimum 3 members all of them being non-executive andmajority of them being independent
Chairman of the committee shall be an independent director To meet at least thrice a year
Company Secretary to act as secretary to the committee
Remuneration Committee
Shareholders/Investors Grievance Committee
Limits on committee memberships and chairmanships
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Auditors
Introduction:Auditors who are expected to be the watchdog ofthe organization are often bought in bymanagements through some profitable
assignments.
The objective of an audit:
An auditor express an opinion on financial
statements which are prepared within aframework of recognized accounting policies andpractices and relevant statutory requirements.
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Types of audit
1. Financial audit
2. compliance audit
3. Operational audit
1.Financial audit-
The financial statements commonly audited
are balance sheet, the income statement, the
cash flow statement and the statement of
stockholders responsibility.
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2. Compliance audit
Whether the auditee is following specific
procedures, rule or regulations set down by
some higher competent authority.
3.Operational audit
An operational audit is a review of any part of
an organizations operating procedures and
methods for the purpose of evaluating
effectiveness and efficiency.
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Definition of auditor
An auditor is defines as a person appointed by
a company to perform an audit. An auditor is a representative of the
shareholders, forming a link betweengovernment agencies, stockholders, invertors
and creditors.
Types of auditors
1. Internal auditors
2. Independent auditors
3. Government auditors
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Duties of auditor:
whether loans and advances made by the
company on the basis of security have beenproperly secured.
whether loans and advances made by the
company have been shown as deposits.
whether the personal expenses have been
charged to revenue account
Verifying that the statements of accountsdrawn up on the basis of the books exhibits a
true and fair state of affairs of the business.
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Composition of audit committee:
1. The audit committee should have minimum 3
members, all being independent directors with themajority being independent and with at least 1director having financial and accounting knowledge.
2. the chairman of the audit committee should be anindependent director.
3. The chairman should be present at annual generalmeeting to answer shareholder queries.
4. the audit committee should be invite such of the
executives as it considers appropriate to be present atthe meetings.
5. the company secretary should be act as the secretaryto committee.
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Responsibilities Overseeing the financial reporting and disclosure
process.
Monitoring choice of accounting policies andprinciples.
Overseeing hiring, performance and independence ofthe external auditors.
Oversight of regulatory compliance, ethics, andwhistleblower hotlines.
Monitoring the internal control process.
Overseeing the performance of the internal auditfunction. Discussing risk management policiesand practices with management.
http://en.wikipedia.org/wiki/Internal_audithttp://en.wikipedia.org/wiki/Risk_managementhttp://en.wikipedia.org/wiki/Risk_managementhttp://en.wikipedia.org/wiki/Internal_audit -
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Objectives:
1. Audit committee ensures that published
financial statement are not misleader.
2. Audit committee ensures that internal
control are adequate.
3. To recommend the selection of external
auditors.
4. To follow up allegation of material financial,
ethical and legal irregularities
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Powers of the audit committee
1. To investigate any activity within its terms of
reference.2. To seek information from any employee.
3. To obtain outside legal ot other professional
advice.4. To secure attendance of outsiders with relevant
expertise, if it considers necessary.
The committee should meet at least 2 a year.
One meeting must be held before finalization ofannual accounts and one necessarily every 6months.
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Generally the major Functions of Audit Committee are asfollows:
overseeing the Companys financial reporting process anddisclosure of financial information to ensure that thefinancial statements are correct, sufficient and credible,
* recommending the appointment and removal of externalauditor, fixation of audit fee and approval for payment ofany other services,
* reviewing with the Management the annual financialstatements before submission to the Board,* reviewing with the Management the annual financialstatements of the subsidiary companies,* reviewing with the Management and the external andinternal auditors, the adequacy of internal control systems,
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* reviewing the adequacy of internal audit function,* discussing with internal auditors any significant findingand follow up on such issues,* reviewing the findings of any internal investigations by
the internal auditors in matters where there is suspectedfraud or irregularity, or a failure of internal control systemsof a material nature, and then reporting such matters tothe Board,
* discussing with external auditors before the audit
commences on the nature and scope of audit, as well ashaving post-audit discussion to ascertain any area ofconcern,* reviewing the Companys financial and risk managementpolicies; and
* examining reasons for substantial default in the paymentto depositors, debenture holders, shareholders (in case ofnon-payment of declared dividends) and creditors, if any.
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SEBI1. Audit committees
Audit committees of publicly listed companies should berequired to review the following information mandatorily:
Financial statements and draft audit report, including
quarterly / half-yearly financial information;
Management discussion and analysis of financial conditionand results of operations;
Reports relating to compliance with laws and to risk
management;
Management letters / internal auditors; and
Records of related party transactions
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2. Financial literacy of members of the audit committee:
All audit committee members should be financially literate and
at least one member should have accounting or related financial
management expertise. It was also suggested that all audit committee members should be
able to read and understand financial statements at the time of
their appointment rather than within a reasonable period.
3. Audit Reports In case a company has followed a treatment different from that
prescribed in an accounting standard, management should justify
why they believe such alternative treatment is more
representative of the underlying business transaction. Management should also clearly explain the alternative
accounting treatment in the footnotes to the financial statements.
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4. Related Party Transactions
A statement of all transactions with related parties including
their bases should be placed before the independent audit
committee for formal approval / ratification.
If any transaction is not on an arms length basis,
management should provide an explanation to the audit
committee justifying the same.
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5. Risk Management
a. Board disclosure
Procedures should be in place to inform Board membersabout the risk assessment and minimization procedures.
These procedures should be periodically reviewed to ensure
that executive management controls risk through means of a
properly defined framework. Management should place a report before the entire Board of
Directors every quarter documenting the business risks faced
by the company, measures to address and minimize such
risks, and any limitations to the risk taking capacity of thecorporation.
This document should be formally approved by the Board.
b Training of Board member
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b. Training of Board member
Non-mandatory recommendation
Companies should be encouraged to train their Board members inthe business model of the company as well as the risk profile of thebusiness parameters of the company, their responsibilities asdirectors, and the best ways to discharge them.
6. Proceeds from Initial Public Offerings (IPO)
Companies raising money through an Initial Public Offering (IPO)should disclose to the Audit Committee, the uses / applications offunds by major category (capital expenditure, sales and marketing,working capital, etc), on a quarterly basis.
On an annual basis, the company shall prepare a statement of
funds utilized for purposes other than those stated in the offerdocument/prospectus.
This statement should be certified by the independent auditors ofthe company.
The audit committee should make appropriate recommendations
to the Board to take up steps in this matter.
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7. Code of Conduct
it should be obligatory for the Board of a company to lay
down the code of conduct for all Board members and senior
management of a company.
This code of conduct shall be posted on the website of the
company.
All Board members and senior management personnel shall
affirm compliance with the code on an annual basis.
The annual report of the company shall contain a
declaration to this effect signed off by the CEO and COO.
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8. Nominee directors
Where an institution wishes to appoint a director on theBoard, such appointment should be made by the
shareholders.
An institutional director, shall have the same responsibilities
and shall be subject to the same liabilities as any other
director.
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9. Non-Executive Director Compensation
The Committee discussed the following issues relating to
compensation of independent directors:1. Whether limits should be set for compensation paid to
independent directors and how should these limits be
determined
2. What are the disclosures to be made to ensure transparency;
3. In case of stock-based compensation, the vesting timeframe of
the options and the parameters that trigger vesting such as
average return on capital employed, turnover criteria, etc.
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10. Independent Directors
1. Apart from receiving director remuneration, does not haveany material pecuniary relationships or transactions with the
company, its promoters, its senior management or its holding
company, its subsidiaries and associated companies;
2. is not related to promoters or management at the board level or
at one level below the board;
3. has not been an executive of the company in the immediatelypreceding 3 financial years;
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4. is not a partner or an executive of the statutory audit firm or the
internal audit firm that is associated with the company, and has
not been a partner or an executive of any such firm for the last
3 years.5. is not a supplier, service provider or customer of the company.
6. The considerations as regards remuneration paid to an
independent director shall be the same as those applied to anon-executive director.
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11. Whistle Blower Policy
Personnel who observe an unethical or improper practice
(not necessarily a violation of law) should be able toapproach the audit committee without necessarily
informing their supervisors.
Companies shall take measures to ensure that this right
of access is communicated to all employees throughmeans of internal circulars, etc.
The employment and other personnel policies of the
company shall contain provisions protecting whistle
blowers from unfair termination and other unfairprejudicial employment practices.
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Whistle blower policy
Companies shall annually affirm that they have not denied
any personnel access to the audit committee of the company(in respect of matters involving alleged misconduct) and that
they have provided protection to whistle blowers from
unfair termination and other unfair or prejudicial employment
practices.
The appointment, removal and terms of remuneration of the
chief internal auditor must be subject to review by the Audit
Committee.
the Board report on Corporate Governance that is required to
be prepared and submitted together with the annual report.
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12. Subsidiary Companies
Audit committee requirements
It should be recommended to the Central Government
that the Companies Act, 1956 should be amended to
exclude common directorships in holding and subsidiary
companies, in computing the limits on directorships that
an individual may hold;
The provisions relating to the composition of the Board
of Directors of the holding company shall also be made
applicable to the composition of the Board of Directors
of subsidiary companies;
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Cont
At least 1/3rd of the Board of Directors of the subsidiary
company shall be non-executive directors of the parent
company;
The Audit Committee of the parent company shall also review
the financial statements of the subsidiary company;
The minutes of the Board meeting of the subsidiary company
shall be placed for review at the Board meeting of the parent
company; and
The Board report of the parent company should state that theyhave reviewed the affairs of the subsidiary company also.
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13. Analyst Reports
SEBI should make rules for the following:
Disclosure in the report issued by a security analyst whetherthe company that is being written about is a client of the
analysts employer or an associate of the analysts employer,
and the nature of services rendered to such company, if any;
and
Disclosure in the report issued by a security analyst whether
the analyst or the analysts employer or an associate of the
analysts employer hold or held (in the
12 months immediately preceding the date of the report) or
intend to hold any debt or equity instrument in the issuer
company that is the subject matter of the report of the
analyst.
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Role of the Government in C.G.
C&AG of India as the govt. auditor plays an
important role in effective public sectorgovernance.
The principles of accountability, transparency,probity, equity and fairness are reviewed by C &
AG and audit observations thereon are reportedin the various Audit Repots.
C.G. legislations
Important amendments introduced in the year2000 to sections 217 and 292 of the co. Act ,1956set the tone for C.G.
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1) Directors Responsibility statement:-
Directors which should affirm the following:
annual accounts have been prepared in accordancewith applicable accounting standards with properexplanation relating to material departures.
The selection and application of Accounting policies
by Directors is consistent and prudent so as to give atrue and fair view of the state of affairs of thecompany.
Proper and sufficient care has been taken by theDirectors for the maintenance of adequate accountingrecords for safeguarding the assets of the companyand for preventing and detecting frauds andirregularities.
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2) Formation of audit committee:
Sec. 292A of the companies Act. 1956 requires
every public limited company having paid upcapital up not less than Rs. 5 crore toconstitute at the board level.
The Audit committee should have a minimum
pf 3 Directors and 2/3rd of the total number ofmembers of Audit committee shall be directorsother than managing or whole time directors.
The terms of reference of the Audit Committeeinclude all matters related to financialreporting and the audit thereof includingefficacy of the internal control system.
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3) Guidelines of department of publicEnterprises (DPE)on C.G. of central publicsector enterprises.
The DPE issued guideline on the composition ofboard:
The guideline requires at least 1/3rd of the
directors on the board of Central public sectorEnterprises (CPSEs) to be non official Directors.
The number of independent directors should
be at least 1/3rd
of the Board if the chairman isnonexecutive and not less than.
50 % if the Board has an executive chairman.
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4) SEBIS guidelines on C.G. for listed Co.s:-
Clause 49 of the Listing Agreement specifies among other things,the following:
1) Composition of the Board of Directors of listed GovernmentCo.s:
Where the chairman of the Board is a non-executive director, atleast 1/3rd of the Board should comprise of independentdirectors and in case he/she is an executive director, at least 1/2
of the Board should comprise independent directors.2) Audit Committee in listed govt. Co.s:-
A qualified and independent Audit Committee shall be set up,giving the terms of reference.
The audit committee shall have minimum 3 directors as
members and 2/3rd of the members of Audit committee shallbe independent directors.
All members of Audit Committee shall be financially literate andat least one member shall have accounting or related financialmanagement expertise.
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5) Constitution and composition of Audit Committee inlisted Govt. Co.s:
the following compliance were notices with respect tocomposition of Audit committee:
the 7 govt. co.s , the Audit committee didnt consist ofrequired number of independent directors like, IndianTourism Development corporation Ltd., NationalFertilizer Ltd., Mangalore Refinery and PetrochemicalsLtd. etc
In case of Neyveli Lignite Corporation Ltd. There wasonly 1 independent director, as on 31 March 2007, on
the Audit Committee of 4 members. The compliancewith Clause 49 of the Listing agreement was made onlyon 1 June 2007 by induction of 3 independent directorson the Audit committee.
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6) Constitution and composition of Audit Committee inunlisted Govt. Co.s:
sec. 292 A of the Companies Act 1956, every public limited
companies having paid up capital of not less than Rs. 5crore shall constitute an Audit committee at the Board levelconsisting of minimum of 3 directors and 2/3rd of whichshall be directors other than managing or whole timedirectors.
The following instances of noncompliance were noticed No audit committee was formed by the following
companies like- HMT M achines Tools Ltd., HMT WatchedLtd., Bharat Heavy Plated and Vessels ltd. etc.
Audit committee formed by Indian Renewable Energy
Development Agency Ltd. Consisted of 2 directors asagainst the requirement of minimum 3. The committee didnot consist of 2/3 of directors as directors other thanmanaging or whole time directors as there was only onesuch director.
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Central Public Sector Enterprises
The government-owned corporations play a
pivotal role in the economic development ofemerging economies because theirparticipation is higher in the industrial andcommercial activities of these economies.
Resource constraints and limited scope of theprivate sector in the early stages ofdevelopment and planning have set the stagefor predominance of the public enterprises inthese economies.
Thus, public sectors in the leading developingcountries of the world play a very important
role.
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Q. Critically examine the role played by Govt. in
promoting corporate Governance in India?
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Growth of corporate governance in India / Corporategovernance of India has undergone a paradigm shift
In 1996, Confederation of Indian Industry (CII), took aspecial initiative on Corporate Governance.
The objective was to develop and promote a code for
corporate governance to be adopted and followed byIndian companies, be these in the Private Sector, thePublic Sector, Banks or Financial Institutions, all ofwhich are corporate entities.
This initiative by CII flowed from public concernsespecially the regarding the protection of investorinterest, small investor, the promotion of transparencywithin business and industry
S i i d E h B d f I di
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Securities and Exchange Board of India
The Government of India's securities watchdog ,
Securities Board of India, announced strict corporategovernance norms for publicly listed companies in India.
The Indian Economy was liberalized in 1991 . In order toachieve the full potential of liberalization and enable the
Indian Stock Market to attract huge investments fromforeign institutional investors (FIIs), it was necessary tointroduce a series of stock market reforms.
SEBI, established in 1988 and became a fully autonomousbody by the year 1992 with defined responsibilities to coverboth development and regulation of the market.
SEBI
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SEBI
On April 12, 1988, the Securities and Exchange Board of India
(SEBI) was established with a dual objective of protecting therights of small investors and regulating and developing the stockmarkets in India.
In 1992, the Bombay Stock Exchange (BSE), the leading stock
exchange in India, witnessed the first major scam mastermindedby Harshad Mehta.
Analysts unanimously felt that if more powers had been given toSEBI the scam would not have happened.
As a result the Government of India (GoI) brought in a separate
legislation by the name of SEBI Act 1992 and conferred statutorypowers to it.
Since then, SEBI had introduced several stock market reforms.These reforms significantly transformed the face of Indian Stock
Markets.
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SEBI and Clause 49
SEBI asked Indian firms above a certain size to
implement Clause 49, a regulation that
strengthens the role of independent directors
serving on corporate boards.
On August 26, 2003, SEBI announced an
amended Clause 49 of the listing agreement which
every public company listed on an Indian stock
exchange is required to sign.
The amended clauses come into immediate effect
for companies seeking a new listing.
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Clause 49
Clause 49, which has recently been revised by the
SEBI, of the listing agreement between listedcompanies and the to enhance the corporatestock exchanges is all set governance (CG)requirements, primarily through increasing theresponsibilities of the Board, consolidating the
role of the Audit Committee and makingmanagement more accountable
These changes are aimed at moving Indiancompanies rapidly up the evolutionary path
towards business processes and managementoversight techniques.
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The major changes to Clause 49
1. Independent Directors 1/3 to depending whether the
chairman of the board is a non-executive or executive position.
2. Non-Executive Directors ----The total term of office of non-
executive directors is now limited to three terms of three years each.
3. Board of Directors-----The board is required to frame a code of
conduct for all board members and senior management and each ofthem have to annually affirm compliance with the code.
4. Audit Committee---- Financial statements and the draft audit report
/ reports of management discussion and analysis of financial condition
and result of operations/ report of compliance with laws conditionand result of operations/ reports of compliance with laws and riskmanagement / management letters and letters of weakness ininternal controls issued by statutory and internal auditors/appointment, removal and terms of remuneration of the chiefinternal auditor.
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Clause 49..
5. Whistleblower Policy ---- This policy has to be communicated to allemployees and whistleblowers should be protected from unfair
treatment and termination.
6. Subsidiary Companies-----50% non-executive directors & 1/3 &
independent directors depending on whether the chairman is non-
executive or executive.
7. Disclosures---- Contingent liabilities / Basis of related partytransactions./ Risk management/ Proceeds from initial publicoffering /Remuneration of directors .
8. Certifications----reviewed the necessary financial statements anddirectors report; established and maintained internal controls, and
disclosed to the auditors and informed the auditors and audit
committee of any significant changes in internal control and/or ofaccounting policies during the year.
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Clause 49 amended
The Clause 49 of the Listing agreement of SEBI
Act is the outcome of Narayana MurthyCommittee, which has come into effect
January 1st 2006.
Amended Clause 49 of the Listing Agreement. Aid to Corporate Governance
1. Control Environment
2. Risk Assessment and Management.
I d i l li
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Industrial policy
Industrial policy--- The governments liberalization andeconomic reforms programme aims at rapid and substantialeconomic growth, and integration with the global economy in
a harmonized manner. The industrial policy reforms haveremoved the industrial licensing requirements, removedrestrictions on investment and expansion, and facilitated easyaccess to foreign technology and foreign direct investment.
Foreign Direct Investment Government wishes to facilitate
foreign direct investment (FDI) and investment from Non-Resident Indians (NRI)s including Overseas Corporate Bodies(OCBs), that are predominantly owned by them, tocomplement and supplement domestic investment.Investment and returns are freely repatriable, except wherethe approval is subject to specific conditions such as lock inperiod on original investment, dividend cap, foreign exchangeneutrality etc. as per the notified sectoral policy.
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