In August 2013, India replaced its 57 year old Companies Act with a new Act. The new Act whilst easing the efficacy of doing business has some serious provisions that are bound to give headaches to preparers of financial statements and directors. It touches on areas such as corporate governance, corporate social responsibility, auditor rotation, directors responsibilities, strengthening of internal financial controls, controlling related party transactions and investor protection. Most of these provisions are already implemented in many countries and even Sri Lanka revised the Act in 2007.
When the New Act is fully implemented, it should improve corporate governance and reduce misconduct by Indian companies, provided enforcement is carried out transparently. The new financial regulatory body will hopefully ensure that the Act is enforced as intended.
The main features of the new law are set out below.
# Requirement for independent directors in Public companies. Also places responsibility on them for certain decisions taken by the board.
# It codifies the duties of directors, specifically, the duties to act in good faith, to avoid any direct or indirect conflict of interest with the company, and to exercise due diligence and reasonable care in decision-making. It also includes penal provisions for non compliance.
# Defines related parties and mandates disclosure of related party transactions and requires a confirmation of the arms length nature of the transactions. It has also widened the the net to include the CFO, company secretary, subsidiary directors and officers, their relatives as key management people where transactions with them also should be reported as related party transactions.
# It provides for mandatory auditor rotation for listed and other specified companies with a cooling-off period of five years after completion of such a term.
# A serious amendment is that the auditor will be required to report to the central government upon suspicion of any offense involving fraud committed against the company by its officers or employees.
# It has SOX like rules for confirming Internal financial controls but with a wider scope than what’s being implemented in the US?
# It also includes an innovative Corporate Social Responsibility (CSR) rule. A company meeting specified thresholds will be required to spend annually at least 2% of its average net profits of the preceding three financial years on social and charitable causes. The thresholds are set to include a company with a net worth of INR 500 crores, a turnover of INR 1,000 crores, or net profits of INR 5 crores or more during any financial year. It’s worded in a ‘comply to explain’ style, presently.
# Facilitates class action lawsuits against companies.
These provisions though rather late in the day, assume great significance in light of the recent corporate accounting scam at Satyam and other similar scandals like the Chit Fund issue. A stringent enforcement mechanism should drive a higher level of governance in companies and reduce corruption and fraud.