PROJECT WORK ON

CLAUSE 49 OF THE LISTING AGREEMENT

RAJIV GANDHI NATIONAL UNIVERSITY OF LAW, PUNJAB

Submission of Project in the Partial Fulfillment of Seventh Semester on October 5, 2013

Submitted to: Ms. GeetikaWalia

Assistant Professor of Law, Rajiv Gandhi National University of Law, Punjab

Submitted by: Karan Sharma

VIIth Semester, B.A., LL.B.(Hons.) Roll No. : (517)

CLAUSE 49 OF THE LISTING AGREEMENT

RAJIV GANDHI NATIONAL UNIVERSITY OF LAW, PUNJAB

Date: 05.10.2013 Patiala (Punjab)

MS. GEETIKA WALIA

SUPERVISORS CERTIFICATE

This is to certify that the Project Entitled: Clause 49 of the Listing Agreement submitted to the Rajiv Gandhi National University of Law, Punjab, Patiala in partial fulfillment of seventh semester, B.A., LL.B. (Hons. in Business Laws & IPRs), is an original and bonafide research work carried out by Mr. Karan Sharma under my supervision and guidance. No part of this study has been submitted to any University for the award of any Degree or Diploma whatsoever.

______________________

Ms. GeetikaWalia Assistant Professor of Law

CLAUSE 49 OF THE LISTING AGREEMENT

RAJIV GANDHI NATIONAL UNIVERSITY OF LAW, PUNJAB

Date: 05.10.2013 Patiala (Punjab)

CANDIDATES CERTIFICATE

I, the undersigned, hereby solemnly declare that the Project titled Clause 49 of the Listing Agreementsubmitted to the Rajiv Gandhi National University of Law, Punjab, Patiala in partial fulfillment of seventh semester, B.A., LL.B. (Hons. in Business Laws & IPRs), is an original and bonafide research work of mine. I hope that this work will be helpful in enhancing the knowledge of readers and framing of the policies in the future course. All the information declared hereby is true to best of my knowledge.

__________________

Mr. Karan Sharma B.A., LL.B.(Hons.) VIIth Semester Roll No.: 517

CLAUSE 49 OF THE LISTING AGREEMENT

ACKNOWLEDGEMENTS

Any attempt at any level cannot be satisfactorily completed without the support and guidance of learned people. My project work is a result of something more than my hard work and dedication to the undertakings. It is a true outcome of the encouragement, support, guidance and constructive criticism of different people that I acknowledge with immense pleasure. First of all we like to thank the ALMIGHTY whose blessings helped us in making this project come out successfully with flying colures. I would like to express my gratitude to all those who made the completion of this project a reality. The attempt for this work which continued over the past few months would not have been possible without banking upon the work of a number of scholars, writers, financial consultants and legal experts to whom I am indebted and express my gratitude. I gratefully acknowledge my deepest sense of gratitude to my revered and intellectual guide, Ms. GeetikaWalia, who provided me with stimulating suggestions and encouragement after the submission of the rough draft. I would like to dedicate my gratitude to Rajiv Gandhi National University of Law, Punjab for giving me permission to commence this project work, to do the necessary research work and to use library and other important resources. Finally I would like to express my deep appreciation to my parents and to all of my friends and faculties of the Rajiv Gandhi National University of Law, Punjab who kept me going with their enthusiasm and encouragement.

________________ Mr. Karan Sharma B.A., LL.B.(Hons.) VIIth Semester Roll No.: 517
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CLAUSE 49 OF THE LISTING AGREEMENT

TABLE OF CONTENTS

SUPERVISORS CERTIFICATE ......................................................................................................... 2 CANDIDATES CERTIFICATE .......................................................................................................... 3 ACKNOWLEDGEMENT .................................................................................................................... 4

INTRODUCTION ........................................................................................................................ 9
1.1 1.2 1.3 1.4 1.5 INTRODUCTORY ..................................................................................................................9 OBJECTIVES OF THE STUDY .............................................................................................. 11 SIGNIFICANCE OF THE STUDY ........................................................................................... 11 DATABASE AND METHODOLOGY....................................................................................... 11 CHAPTERIZATION PLAN ................................................................................................... 11

MEANING OF CLAUSE 49 ...................................................................................................... 13

CORPORATE GOVERNANCE ............................................................................................... 16

3.1 3.2 3.3 HISTORICAL BACKGROUND .............................................................................................. 16 GLOBAL CORPORATE GOVERNANCE ................................................................................. 17 CORPORATE GOVERNANCE IN INDIA ................................................................................ 17 Confederation of Indian Industries Code .................................................................. 17 Kumar Mangalam Birla committee .......................................................................... 18 Naresh Chandra Committee ..................................................................................... 18 Narayan Murthy committee...................................................................................... 18

3.3.1 3.3.2 3.3.3 3.3.4 3.4 3.5 3.6

SCHEDULE OF IMPLEMENTATION ..................................................................................... 19 APPLICATION OF REVISED CLAUSE 49 .............................................................................. 20 OBLIGATIONS ON STOCK EXCHANGES .............................................................................. 20

ISSUES UNDER CLAUSE 49 ................................................................................................... 22

4.1 4.2 4.3 WIDENING THE DEFINITION OF INDEPENDENT DIRECTOR ................................................ 22 COMPENSATION TO NON EXECUTIVE DIRECTORS AND DISCLOSURE THEREOF ................. 23 PERIODICAL REVIEW BY INDEPENDENT DIRECTOR .......................................................... 23 5

CLAUSE 49 OF THE LISTING AGREEMENT 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 4.12 4.13 4.14 4.15 4.16 4.17 CODE OF CONDUCT .......................................................................................................... 24 NONEXECUTIVE DIRECTORS NOT TO HOLD OFFICE FOR MORE THAN NINE YEARS ....... 24 AUDIT COMMITTEE .......................................................................................................... 24 REVIEW OF INFORMATION BY AUDIT COMMITTEE ........................................................... 25 DISCLOSURE OF ACCOUNTING TREATMENT ..................................................................... 25 WHISTLE BLOWER POLICY .............................................................................................. 26 SUBSIDIARY COMPANIES .................................................................................................. 26 DISCLOSURE OF CONTINGENT LIABILITIES ....................................................................... 27 ADDITIONAL DISCLOSURES .............................................................................................. 27 CERTIFICATION BY CEO/CFO ......................................................................................... 28 REPORT ON CORPORATE GOVERNANCE ........................................................................... 28 COMPANY SECRETARY IN PRACTICE TO ISSUE CERTIFICATE OF COMPLIANCE ................ 29 ADDITIONAL DISCLOSURE IN THE REPORT ON CORPORATE GOVERNANCE ....................... 29 ADDITIONAL DISCLOSURES UNDER NON-MANDATORY REQUIREMENTS ........................... 29

CONCLUSION ........................................................................................................................... 31

CLAUSE 49 OF THE LISTING AGREEMENT

LIST OF AUTHORITIES

1. R.B. Adams & D. Ferreira, A theory of friendly boards .Journal of Finance 62, (2007): 217250. 2. No Exemption for Listed PSUs on independent director norms, Businessline, 3 January 2008, p. 1. 3. A.L Boone, L.C. Field, J.M. Karpoff & C.G. Raheja, The determinants of corporate board size and composition: an empirical analysis, Journal of Financial Economics 85, (2007):66101. 4. R. Kalidas, Corporate Governance-An Analysis of the Prescription Contained in Revised Clause 49, SEBI & Corporate Laws, (2009): 50 (56). 5. A. Agrawal & C.R Knoeber, 19 Firm performance and mechanisms to control agency problems between managers and shareholders The Journal of Financial and Quantitative Analysis 31, (1999): 377397. 6. J.R Varma, Corporate Governance in India: Disciplining the Dominant Shareholder IIMB Management Review, December (1997): 23, 24. 7. Bernard S. Black and Vikramaditya S. Khanna, Can Corporate Governance Reforms Increase Firms' Market Values? Evidence from India, Journal of Empirical Legal Studies, Vol. 4, (2007). 8. K.M. Birla, Committee reports on Corporate Governace, Securities and Exchange board of India, (2001). 9. N R Murthy, Report of committee on corporate Governance, Securities and Exchange board of India, (2003). 10. Y.V. Reddy Corporate Governance in Banks Indian institute of Management Banglore, (2005). 11. Govind Shankaranarayan, What is Corporate Governance?, McGraw-Hill Publishers, New Delhi, 2008, p.234. 12. Prashant Panda, Independent Directors-Only on Paper, SEBI & Corporate Laws, 47(2006): 235. 13. Institute of International Finance, Corporate Governance in India: An Investor Perspective, Washington, DC. USA., (2006).
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CLAUSE 49 OF THE LISTING AGREEMENT

14. C. G. Raheja, Determinants of Board Size and Composition: A Theory of Corporate Boards, Journal of Financial and Quantitative Analysis, 40, 2 June, (2005): 283-306. 15. S. Gopalakrishnan, Role & Responsibilities of Independent Directors, The Chartered Accountant , january 2005, P.86 16. Retrieved from, www.indiainfoline.com/lega/lico/ch03.html, at 15:16 on September 19, 2013. 17. The Hindu, 2006, SEBI warning to cos. defying Clause 49 provisions, The Hindu, 31 August, http://www.hindu.com/2006/08/31/stories/2006083105281800.htm retrieved on 2 October, 2013.

CLAUSE 49 OF THE LISTING AGREEMENT

CHAPTER 1 INTRODUCTION

1.1

INTRODUCTORY

Indian economy has seen number of reforms after, the Government of India has taken steps towards liberalization and globalization of the economy. The size of Indian corporates has increased and the expectations of various stakeholders are also growing. We have seen a rapid increase in accountability pressure on companies due to financial crises, accounting and remuneration scandals, and suspicion about the social and environmental implications of business. All these have led to a growing demand for transparency about corporate behavior on a whole range of issues.

The Indian corporate governance relationships have evolved over time as a result of both formal and informal stakeholder interactions, with changes to Clause 49 triggering a further evolutionary move in Indian corporate governance towards global benchmarks. This study seeks to gain insights into how the regulatory change impacted corporate governance practices in India, and what in addition to the regulation has impacted the particular size and composition of boards.1

The changes to Clause 49 of the Listing Agreement by the Securities Exchange Board of India (SEBI) in 2005 requiring a minimum number of non-executive directors brought mixed reactions. However, as noted by Thornton2, which in April 2006 surveyed a sample of listed firms about compliance with the new regulation, Indian firms generally embraced the changes and thought that it sent positive signals to investors about the quality of corporate governance of Indian business.3

1 2

Revised Clause 49: A global benchmark, Businessline, 13 January 2006, p. 1. Survey conducted in April 2006 by Grant Thorntons Management Assurance & Risk Services practice, published May 2006 3 Id.

CLAUSE 49 OF THE LISTING AGREEMENT

The extension of Clause 49s requirements to public sector undertakings was also welcomed, with many suggesting that the regulations relating to the minimum number of independent directors was likely to improve investment flows to India.4

The Indian economy is one of the fastest growing economies in the world, and is having a significant impact on world economic growth through both its domestic and international business activities. Its stock market has had to mature quickly to cope with the ever increasing capital requirements necessary to fuel the spectacular private corporate growth. The role of private enterprise as the driver of this growth has been a particular feature of Indias economy, unlike China where government owned businesses have led the economic change.5 The very largeness of Indias potential as a market, and the relative large size of many of its successful private companies make India a huge driving force within the global economic landscape. With this, the changes in Indian regulation of corporate governance announce the intention to create a business landscape which embodies international governance standards. There is no doubt that the corporate governance relationships within India have evolved over time as a result of both formal and informal stakeholder interactions, and the changes to Clause 49 in 2006 produced a further evolutionary move towards global benchmarks.

With boards playing such a centrally important role in the corporate governance of publicly listed companies, any research which improves our understanding of various aspects of the board, including board structure and related issues is of particular interest to students of corporate governance. The changing corporate governance landscape in India is of particular interest, as more and more global investment and business activity is directed towards this large and growing economy.

This project uses the impact of the 2006 change to Clause 49 particularly with respect to the requirement for a minimum number of independent directors to study the determinants of board

4 5

No Exemption for Listed PSUs on independent director norms, Businessline, 3 January 2008, p. 1. R.B. Adams & D. Ferreira, A theory of friendly boards .Journal of Finance 62, (2007): 217250.

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CLAUSE 49 OF THE LISTING AGREEMENT

size and the proportion of independent directors.6 In particular, it examines the determinants in the post Clause 49 amendment environment which requires a minimum number of independent directors (50% where the chairman is an insider, and 30% when the chairman is independent). 1.2 OBJECTIVES OF THE STUDY

We have conducted extensive research work and have highlighted the various points: 1. To Trace origin and development of Corporate Governance practices in India. 2. To examine the recent amendments in clause 49 of listing agreement in India. 1.3 SIGNIFICANCE OF THE STUDY

This particular topic discusses the new clause of the listing agreement i.e. the clause 49 which came into force in the year 2005. The clause 49 of the Listing Agreement talks about the Corporate Governance and the implications of it on the listed companies. Along with it there are various clauses and the amendments which a company must follow for a better Corporate Governance. 1.4 DATABASE AND METHODOLOGY

This project paper is basically exploratory and explanatory. This study is based on library study and analysis of secondary data gathered from various sources such as books and journals. 1.5 CHAPTERIZATION PLAN

Whole of the project is divided into four chapters. Chapter One deals with Introduction. Apart from the introduction to the topic, this chapter contains objective, purpose, significance and likely contribution of the study. Database Methodology and Research Questions are also dealt in this chapter. Chapter Two deals with the background of the clause 49. In Chapter Three, we have discussed the Origin and development of Corporate Governance in India. Chapter

A.L Boone, L.C. Field, J.M. Karpoff & C.G. Raheja, The determinants of corporate board size and composition: an empirical analysis, Journal of Financial Economics 85, (2007):66101.

11

CLAUSE 49 OF THE LISTING AGREEMENT

Fourdeals with the Issues under clause 49 of the Listing Agreement.Chapter Five deals with the concluding note.

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CLAUSE 49 OF THE LISTING AGREEMENT

CHAPTER 2 MEANING OF CLAUSE 49

After completing all the formalities for listing its securities, including of entering into listing agreement, the securities of the company are listed and traded at the concerned stock exchanges. Before listing, the company enters into a listing agreement with the concerned stock exchanges.7 Almost all the stock exchanges have a standard listing agreement (which is amended from time to time by issuing circulars by each of the stock exchanges). Companies listed on stock exchanges have many obligations to discharge. These obligations are elaborated in all the relevant clauses of the Listing Agreement which the company has entered into with the Stock Exchange(s).8 Clause 49 of the Listing Agreement to the Indian stock exchange comes into effect from 31 December 2005. It has been formulated for the improvement of corporate governance in all listed companies. The term Clause 49 refers to clause number 49 of the Listing Agreement between a company and the stock exchanges on which it is listed (the Listing Agreement is identical for all Indian stock exchanges, including the NSE and BSE). This clause is an addition to the Listing Agreement and was inserted as late as 2000 consequent to the recommendations of the Kumarmangalam Birla Committee on Corporate Governance constituted by the Securities Exchange Board of India (SEBI) in 1999. Clause 49 of the SEBI guidelines on Corporate Governance as amended on 29 October 2004 has made major changes in the definition of independent directors, strengthening the responsibilities of audit committees, improving quality of financial disclosures, including those relating to related party transactions and proceeds from public/ rights/ preferential issues, requiring Boards

Easterbrook, Frank H. and Daniel R. Fischel, The Economic Structure of Corporate Law. Listing Agreements entered into by the listed companies with the respective Stock exchanges where the shares of the company are listed has over the times emerged to be the prime document for ensuring corporate transparency and investor protection. 8 Retrieved from, www.indiainfoline.com/lega/lico/ch03.html, at 15:16 on September 19, 2013.

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CLAUSE 49 OF THE LISTING AGREEMENT

to adopt formal code of conduct, requiring CEO/CFO certification of financial statements and for improving disclosures to shareholders. Certain non-mandatory clauses like whistle blower policy and restriction of the term of independent directors have also been included.9 Clause 49, when it was first added, was intended to introduce some basic corporate governance practices in Indian companies and brought in a number of key changes in governance and disclosures (many of which we take for granted today). It specified the minimum number of independent directors required on the board of a company. The setting up of an Audit committee, and a Shareholders Grievance committee, among others, were made mandatory as were the Managements Discussion and Analysis (MD&A) section and the Report on Corporate Governance in the Annual Report, and disclosures of fees paid to non-executive directors. A limit was placed on the number of committees that a director could serve on. In late 2002, SEBI constituted the Narayana Murthy Committee to assess the adequacy of current corporate governance practices and to suggest improvements. Based on the recommendations of this committee, SEBI issued a modified Clause 49 on 29 October 2004 (the revised Clause 49) which came into operation on 1 January 2006.10 The revised Clause 49 has suitably pushed forward the original intent of protecting the interests of investors through enhanced governance practices and disclosures. Five broad themes predominate. The independence criteria for directors have been clarified. The roles and responsibilities of the board have been enhanced. The quality and quantity of disclosures have improved. The roles and responsibilities of the audit committee in all matters relating to internal controls and financial reporting have been consolidated, and the accountability of top managementspecifically the CEO and CFOhas been enhanced. Within each of these areas, the revised Clause 49 moves further into the realm of global best practices (and sometimes, even beyond). By Circular dated 8 April 2008, the Securities and Exchange Board of India amended Clause 49 of the Listing Agreement to extent the 50% independent directors rule to all Boards of Directors

10

SEBI-Clause 49-Amendments" (Press release). R. Kalidas, Corporate Governance-An Analysis of the Prescription Contained in Revised Clause 49 , SEBI & Corporate Laws, (2009): 50 (56).

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CLAUSE 49 OF THE LISTING AGREEMENT

where the Non-Executive Chairman is a promoter of the Company or related to the promoters of the company.11 At the end of the first India Corporate Week in December 2009, the Ministry of Corporate Affairs issued new Corporate Governance Voluntary Guidelines and new Corporate Social Responsibility Voluntary Guidelines.

11

The Hindu, 2006, SEBI warning to cos. defying Clause 49 provisions, The Hindu, 31 August, http://www.hindu.com/2006/08/31/stories/2006083105281800.htm retrieved on 2 October, 2013.

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CLAUSE 49 OF THE LISTING AGREEMENT

CHAPTER 3 CORPORATE GOVERNANCE

Corporate Governance may be defined as A set of systems, processes and principles which ensures that a company is governed in the best interest of all stakeholders. It ensures Commitment to values and ethical conduct of business; Transparency in business transactions; Statutory and legal compliance; adequate disclosures and Effective decision-making to achieve corporate objectives.In other words, Corporate Governance is about promoting corporate fairness, transparency and accountability. Good Corporate Governance is simply Good Business. Corporate governance is about maximizing shareholders value legally, ethically and on a sustainable basis, while ensuring fairness to every stakeholder the Companys customer employee, investor, vendor partner, government of the land and the community. Thus, corporate governance is a reflection of a companys culture, policies, its relationship with stakeholders and its commitment to values. Corporate Governance is essentially all about how organizations are directed, controlled and held accountable to the shareholders. In India, the question of Corporate Governance has come up mainly in the wake of economic liberalization and de-regularization of industry and business. The demand for corporate ethics and stricter compliance with the laws of the land has also contributed to the need for Corporate Governance. The ability of the Board, the commitment of the individual members of the Board, the integrity of the management team, alertness of the inspection and audit team, adequacy and quality of the process and reporting are the real factors which will ensure good corporate governance.12 3.1 HISTORICAL BACKGROUND

The pioneering report on Corporate Governance was framed by the CADBURY Committee set up in May 1991 by the London Stock Exchange. This committee was set up to prevent the recurrence of corporate failures, which arose primarily out of poorly managed business practices.

12

A. Agrawal & C.R Knoeber, 19 Firm performance and mechanisms to control agency problems between managers and shareholders The Journal of Financial and Quantitative Analysis 31, (1999): 377397.

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CLAUSE 49 OF THE LISTING AGREEMENT

The committee investigated the accountability of the Board of Directors to Shareholders and to the society. It submitted its report and associated Code of Best Practices in December 1992, wherein it spelt out the method of governance needed to achieve a balance between the essential powers of the Board of Directors and their proper accountability. Following the corporate governance scandals in the US, the Sarbanes Oxley Act was enacted which brought about fundamental changes in virtually every area of corporate governance and particularly in auditor independence, conflict of interest, corporate responsibility and enhanced financial disclosures. 3.2 GLOBAL CORPORATE GOVERNANCE

The government of the 30 countries in the Organization for Economic Cooperation and Development (OECD) approved revised version of OECDs principles of corporate governance. The principles are intended to assist government in their efforts to evaluate and improve the legal, institutional and regulatory framework for corporate governance in their countries, and to provide guidance and suggestions for stock exchanges, investors corporations and other parties that have a role in the process of developing good corporate governance. 3.3 CORPORATE GOVERNANCE IN INDIA

Increasing globalization is generating a highly competitive business climate across all the countries. 13 It is in this context that there is a pressing need to identify best Corporate Governance standards, which will help countries like India to face global competition more effectively.14

3.3.1 Confederation of Indian Industries Code In India, the industry, rather than the government, provided the initial impetus for corporate governance reform. 15 Driven by desire to make Indian businesses more competitive and respected globally, the Confederation of Indian Industries (CII) published a voluntary code of Corporate Governance in 1998, one of the first code in Asia.16
13

J.R Varma, Corporate Governance in India: Disciplining the Dominant Shareholder IIMB Management Review, December (1997): 23, 24. 14 Bernard S. Black and Vikramaditya S. Khanna, Can Corporate Governance Reforms Increase Firms' Market Values? Evidence from India, Journal of Empirical Legal Studies, Vol. 4, (2007). 15 Id. 16 R. Bajaj (1997) Draft code on Corporate Governance, Confederation of Indian Industry New Delhi.

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CLAUSE 49 OF THE LISTING AGREEMENT

3.3.2 Kumar Mangalam Birla committee The Securities and Exchange Board of India (SEBI) followed by setting up the Kumar Mangalam Birla committee on Corporate Governance. Recommendation of the committee in December 1999 formed the bases for clause 49 of the Listing Agreement.17

3.3.3 Naresh Chandra Committee In addition, the department of company affairs, Government of India constituted a nine- member committee under chairmanship of Mr. Naresh Chandra, former Indian ambassador to U.S., to examine various corporate governance issues.

3.3.4 Narayan Murthy committee SEBI instituted a committee under the chairmanship of Mr. Narayan Murthy in 2004, which recommended enhancements in corporate governance. SEBI has incorporated the

recommendations made by the Narayan Murthy committee on corporate governance report in clause 49 of the listing agreement.18

Good Governance in capital market has always been high on the agenda of SEBI. Corporate Governance is looked upon as a distinctive brand and benchmark in the profile of Corporate Excellence. This is evident from the continuous updation of guidelines, rules and regulations by SEBI for ensuring transparency and accountability. In the process, SEBI had constituted a Committee on Corporate Governance under the Chairmanship of Shri Kumar Mangalam Birla. The Committee in its report observed that the strong Corporate Governance is indispensable to resilient and vibrant capital markets and is an important instrument of investor protection. It is the blood that fills the veins of transparent corporate disclosure and high quality accounting practices. It is the muscle that moves a viable and accessible financial reporting structure. 19 Based on the recommendations of the Committee, the SEBI had specified principles of Corporate Governance and introduced a new clause 49 in the Listing agreement of the Stock Exchanges in
17 18

K.M. Birla, Committee reports on Corporate Governace, Securities and Exchange board of India , (2001). N R Murthy, Report of committee on corporate Governance, Securities and Exchange board of India, (2003). 19 Institute of Company Secretaries of India (2003) Corporate Governance Module of Best Practices, Taxman publishers (P) Ltd.

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the year 2000. These principles of Corporate Governance were made applicable in a phased manner and all the listed companies with the paid up capital of Rs 3 crores and above or net worth of Rs 25 crores or more at any time in the history of the company, were covered as of March 31, 2003. SEBI, as part of its endeavour to improve the standards of corporate governance in line with the needs of a dynamic market, constituted another Committee on Corporate Governance under the Chairmanship of Shri N. R. Narayana Murthy to review the performance of Corporate Governance and to determine the role of companies in responding to rumour and other price sensitive information circulating in the market in order to enhance the transparency and integrity of the market. The Committee in its Report observed that the effectiveness of a system of Corporate Governance cannot be legislated by law, nor can any system of Corporate Governance be static. In a dynamic environment, system of Corporate Governance needs to be continually evolved. 20 With a view to promote and raise the standards of Corporate Governance, SEBI on the basis of recommendations of the Committee and public comments received on the report and in exercise of powers conferred by Section 11(1) of the Securities and Exchange Board of India Act, 1992 read with section 10 of the Securities Contracts (Regulation) Act 1956, revised the existing clause 49 of the Listing agreement vide its circular SEBI/MRD/SE/31/2003/26/08 dated August 26, 2003. It clarified that some of the sub-clauses of the revised clause 49 shall be suitably modified or new clauses shall be added following the amendments to the Companies Act 1956 by the Companies (Amendment) Bill/Act 2003, so that the relevant provisions of the clauses on Corporate Governance in the Listing Agreement and the Companies Act remain harmonious with one another.21

3.4

SCHEDULE OF IMPLEMENTATION

The circular specifies following schedule of implementation of the revised clause 49: (i) All entities seeking listing for the first time, at the time of listing,

20 21

Y.V. Reddy Corporate Governance in Banks Indian, Institute of Management Banglore, (2005). Govind Shankaranarayan, What is Corporate Governance?, McGraw-Hill Publishers, New Delhi, 2008, p.234.

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CLAUSE 49 OF THE LISTING AGREEMENT

(ii) All listed entities having a paid up share capital of Rs 3 crores and above or net worth of Rs 25 crores or more at any time in the history of the company. The companies are required to comply with the requirements of the clause on or before March 31, 2004. The companies which are required to comply with the requirements of the revised clause 49 have been put under an obligation to submit a quarterly compliance report to the stock exchanges as per sub clause (IX) (ii), of the revised clause 49, within 15 days from the quarter ending 31st March, 2004. The report is required to be submitted either by the Compliance Officer or the Chief Executive Officer of the company after obtaining due approvals.

3.5

APPLICATION OF REVISED CLAUSE 49

The revised clause 49 is applicable to the listed companies, in accordance with the schedule of implementation given above. All companies which were required to comply with the requirement of the erstwhile clause 49 i.e. all listed entities having a paid up share capital of Rs 3 crores and above or net worth of Rs 25 crores or more at any time in the history of the entity, are required to comply with the requirement of this clause. This clause does not apply to other listed entities, which are not companies, but body corporates, incorporated under other statutes. Clause 49 will apply to these institutions as long as it does not violate their respective statutes, guidelines or directives.22The revised clause is not applicable to the Mutual Fund Schemes.

3.6

OBLIGATIONS ON STOCK EXCHANGES

The Stock Exchanges are put under obligation to ensure that all the provisions of Corporate Governance have been complied with the company seeking listing for the first time, before granting any new listing. For this purpose, it would be satisfactory compliance if these companies set up the Boards and constitute committees such as Audit Committee, shareholders/ investors grievances committee, etc. before seeking listing. The stock exchanges have been empowered to grant a reasonable time to comply with these conditions if they are satisfied that genuine legal issues exists which will delay such compliance. In such cases while granting listing, the stock exchanges are required to obtain a suitable undertaking from the company. In
22

Prashant Panda, Independent Directors-Only on Paper, SEBI & Corporate Laws, 47(2006): 235.

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CLAUSE 49 OF THE LISTING AGREEMENT

case of the company failing to comply with this requirement without any genuine reason, the application money shall be kept in an escrow account till the conditions are complied with. The Stock Exchanges have also been required to set up a separate monitoring cell with identified personnel to monitor the compliance with the provisions of the Corporate Governance, and to obtain the quarterly compliance report from the companies which are required to comply with the requirements of Corporate Governance. The stock exchanges are required to submit a consolidated compliance report to SEBI within 30 days of the end of each quarter.23

23

Institute of International Finance, Corporate Governance in India: An Investor Perspective, Washington, DC. USA., (2006).

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CLAUSE 49 OF THE LISTING AGREEMENT

CHAPTER 4 ISSUES UNDER CLAUSE 49

4.1

WIDENING THE DEFINITION OF INDEPENDENT DIRECTOR

Under the revised clause 49, the definition of the expression independent director24 has been expanded. The expression independent director mean non-executive25 director of the company who (a) Apart from receiving directors remuneration, does not have any material pecuniary relationships or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associated companies; (b) Is not related to promoters or management at the board level or at one level below the board; (c) Has not been an executive26 of the company in the immediately preceding three financial years; (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. This will also apply to legal firm(s) and consulting firm(s) that have a material association with the entity. (e) Is not a supplier, service provider or customer of the company. This should include lessorlessee type relationships also; and (f) Is not a substantial shareholder of the company, i.e. owning two percent or more of the block of voting shares.
24 25

SEBI/CFD/DIL/CG/1/2004/12/10 October 29, 2004 A non-executive director (NED, also NXD) or outside director is a member of the board of directors of a company who does not form part of the executive management team. He or she is not an employee of the company or affiliated with it in any other way. 26 An executive director is the senior manager or executive officer of an organization, company, or corporation. The position is comparable to a chief executive officer (CEO) or managing director. An executive director is usually remunerated for his or her work.

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CLAUSE 49 OF THE LISTING AGREEMENT

It has been clarified that the Institutional Directors on the boards of companies are independent directors whether the institution is an investing institution or a lending institution.

4.2

COMPENSATION TO NON EXECUTIVE DIRECTORS AND DISCLOSURE THEREOF

As per earlier clause 49, the compensation to be paid to non-executive directors was fixed by the Board of Directors, whereas the revised clause requires all compensation paid to non-executive directors to be fixed by the Board of Directors and to be approved by shareholders in general meeting. There is also provision for setting up of limits for the maximum number of stock options that can be granted to non-executive directors in any financial year and in aggregate. The stock options granted to the non-executive directors to be vested after a period of at least one year from the date of retirement of such non-executive directors. 27 Placing the independent directors and non-executive directors on equal footing, the revised clause provides that the considerations as regards compensation paid to an independent director shall be the same as those applied to a non-executive director. The companies have been put under an obligation to publish their compensation philosophy and statement of entitled compensation in respect of non-executive directors in its annual report. Alternatively, this may be put up on the companys website and a reference thereto in the annual report. The company is also required to disclose on an annual basis, details of shares held by non-executive directors, including on an if-converted basis. The revised clause also requires non-executive directors to disclose prior to their appointment their stock holding (both own or held by / for other persons on a beneficial basis) in the listed company in which they are proposed to be appointed as directors,. These details are required to be accompanied with their notice of appointment.

4.3

PERIODICAL REVIEW BY INDEPENDENT DIRECTOR

27

C. G. Raheja, Determinants of Board Size and Composition: A Theory of Corporate Boards, Journal of Financial and Quantitative Analysis, 40, 2 June, (2005): 283-306.

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CLAUSE 49 OF THE LISTING AGREEMENT

The revised clause 49 requires the Independent Director to periodically review legal compliance reports prepared by the company and any steps taken by the company to cure any taint. The revised clause specifies that no defence shall be permitted that the independent director was unaware of this responsibility in case of any proceedings against him in connection with the affairs of the company.28

4.4

CODE OF CONDUCT

The revised clause 49 requires the Board of a company to lay down the code of conduct for all Board members and senior management of a company and the same to be posted on the website of the company. Accordingly, all Board members and senior management personnel have been put under an obligation to affirm compliance with the code on an annual basis and a declaration to this effect signed by the CEO and COO is to be given in the Annual Report of the Company. It has been clarified that the term senior management will include personnel of the company who are members of its management / operating council (i.e. core management team excluding Board of Directors). Normally, this would comprise all members of management one level below the executive directors.

4.5

NONEXECUTIVE DIRECTORS NOT TO HOLD OFFICE FOR MORE THAN NINE YEARS

Revised clause 49 limits the term of the office of the non-executive director and provides that a person shall be eligible for the office of non-executive director so long as the term of office does not exceed nine years in three terms of three years each, running continuously.

4.6

AUDIT COMMITTEE

Two explanations have been added in the revised clause 49. The first explanation defines the term financially literate to mean the ability to read and understand basic financial statements
28

S. Gopalakrishnan, Role & Responsibilities of Independent Directors, The Chartered Accountant , january 2005, P.86

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CLAUSE 49 OF THE LISTING AGREEMENT

i.e. balance sheet, profit and loss account, and statement of cash flows. It has also been clarified that a member is considered to have accounting orrelated financial management expertise if he or she possesses experience in finance or accounting, or requisite professional certification in accounting, or any other comparable experience or background which results in the individuals financial sophistication, including being or having been a Chief Executive Officer(CEO), Chief Financial Officer(CFO), or other senior officer with financial oversight responsibilities.

4.7

REVIEW OF INFORMATION BY AUDIT COMMITTEE

The Audit Committee is required to mandatorily review financial statements and draft audit report, including quarterly / half-yearly financial information, management discussion and analysis of financial condition and results of operations, reports relating to compliance with laws and to risk management, management letters/ letters of internal control weaknesses issued by statutory / internal auditors, and records of related party transactions. The appointment, removal and terms of remuneration of the Chief Internal Auditor shall be subject to review by the Audit Committee. The auditor owes a duty to the shareholders of the company to ensure that the rights of the shareholders are safeguarded. An auditor has a fiduciary relationship Vis-a` Vis the shareholders as a body. 29 The audit is intended for the protection of the shareholders and the auditor is expected to examine the accounts maintained by the directors with a view to inform the shareholders of the true financial position of the company. It was held by the Supreme Court in Institute of Chartered Accountants v. P.K Mukherjee that "directors occupy a fiduciary position in relation to the shareholders and in auditing the accounts maintained by the directors, the auditor acts in the interests of the shareholders who are in a position of beneficiaries ". A similar view was also reflected in CIT v. Dandekar.

4.8

DISCLOSURE OF ACCOUNTING TREATMENT

The revised clause 49 requires that in case a company has followed a treatment different from that prescribed in an Accounting Standards, the management of such company shall justify why
29

Capro Industries v. Dickman, (1996) 1 All E.R 568: (1990) 2 AC 605 (HL).

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CLAUSE 49 OF THE LISTING AGREEMENT

they believe such alternative treatment is more representative of the underlined business transactions. Management is also required to clearly explain the alternative accounting treatment in the footnote of financial statements.

4.9

WHISTLE BLOWER POLICY

Companies have been required to formulate an Internal Policy on access to Audit Committees. Personnel who observe any unethical or improper practice (not necessarily a violation of law) can approach the Audit Committee without necessarily informing their supervisors. Companies are also required to take measures to ensure that this right of access is communicated to all employees through means of internal circulars, etc. The employment and other personnel policies of the company should also contain provisions protecting whistle blowers from unfair termination and other unfair or prejudicial employment practices. Companies have also been required to affirm that it has not denied any personnel access to the Audit Committee of the company (in respect of matters involving alleged misconduct) and that it has provided protection to whistle blowers from unfair termination and other unfair or prejudicial employment practices. Such affirmation should form part of the Boards report on Corporate Governance that is required to be prepared and submitted together with the annual report.

4.10

SUBSIDIARY COMPANIES

The revised clause 49 provides that the provisions relating to the composition of the Board of Directors of the holding company are also applicable to the composition of the Board of Directors of subsidiary companies. The clause further requires that at least one independent director on the Board of Directors of the holding company should be a director on the Board of Directors of the subsidiary company. The Audit Committee of the holding company has been empowered to review the financial statements, in particular the investments made by the subsidiary company and the minutes of the Board meetings of the subsidiary company to be placed for review at the Board meeting of the
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CLAUSE 49 OF THE LISTING AGREEMENT

holding company. It is further required that the Boards report of the holding company should state that they have reviewed the affairs of the subsidiary company also.

4.11

DISCLOSURE OF CONTINGENT LIABILITIES

The revised clause 49 requires the management to provide a clear description in plain English of each material contingent liability and its risks, which shall be accompanied by the auditors clearly worded comments on the managements view. This section is required to be highlighted in the significant accounting policies and notes on accounts, as well as, in the aud itors report, where necessary.

4.12

ADDITIONAL DISCLOSURES

The revised Clause 49 of the Listing Agreement requires the following additional disclosures: (A) Basis of related party transactions A statement of all transactions with related parties shall be placed before the Audit Committee for formal approval/ratification. If any transaction is not on an arms length basis, management is required to justify the same to the Audit Committee. (B) Board Disclosures Risk management The Board members should be informed about the risk assessment and minimization procedures. These procedures shall be periodically reviewed to ensure that executive management controls risk through means of a properly defined framework. Management shall place a quarterly report certified by the compliance officer of the company, before the entire Board of Directors documenting the business risks faced by the company, measures to address and minimize such risks, and any limitations to the risk taking capacity of the corporation. This document shall be formally approved by the Board. (C) Proceeds from Initial Public Offerings (IPOs)
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CLAUSE 49 OF THE LISTING AGREEMENT

When money is raised through an Initial Public Offering (IPO), it shall disclose to the Audit Committee, the uses / applications of funds by major category (capital expenditure, sales and marketing, working capital, etc), on a quarterly basis as a part of their quarterly declaration of financial results. Further, on an annual basis, the company shall prepare a statement of funds utilized for purposes other than those stated in the offer document/prospectus. This statement shall be certified by the independent auditors of the company. The Audit Committee shall make appropriate recommendations to the Board to take up steps in this matter.

4.13

CERTIFICATION BY CEO/CFO

CEO (either the Executive Chairman or the Managing Director) and the CFO (Whole-Time Finance Director or other person discharging this function) of the company has been put under an obligation to certify that, to the best of their knowledge and belief, they have reviewed the balance sheet and profit and loss account and all its schedules and notes on accounts, the cash flow statements as well as the Directors Report and these statements do not contain any materially untrue statement, omits any material fact or do they contain statements that might be misleading. Further they are required to certify that these statements together present a true and fair view of the company, and are in compliance with the existing accounting standards and/or applicable laws/regulations. The revised clause requires them to be responsible for establishing and maintaining internal controls, to evaluate the effectiveness of internal control systems of the company, and to disclose to the auditors and the Audit Committee, deficiencies in the design or operation of internal controls, if any. They are also required to disclose to the auditors as well as the Audit Committee, instances of significant fraud, if any, that involves management or employees having a significant role in the companys internal control systems, whether or not there were significant changes in internal control and / or of accounting policies during the year.

4.14

REPORT ON CORPORATE GOVERNANCE

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CLAUSE 49 OF THE LISTING AGREEMENT

The companies have been required to submit a quarterly compliance report in the prescribed format to the stock exchanges within 15 days from the close of the quarter. The report has to be submitted either by the Compliance Officer or the Chief Executive Officer of the company after obtaining due approvals . 4.15 COMPANY SECRETARY IN PRACTICE TO ISSUE CERTIFICATE OF COMPLIANCE

This is a landmark amendment authorizing Company Secretaries in Practice among other professionals to issue certificate of compliance of clause 49. The revised clause requires the company to obtain a certificate from either the auditors or practicing company secretaries regarding compliance of conditions of corporate governance and annex the certificate with the directors report, which is sent annually to all the shareholders of the company. The same certificate is also required to be sent to the Stock Exchanges along with the annual returns filed by the company.

4.16

ADDITIONAL DISCLOSURE IN THE REPORT ON CORPORATE GOVERNANCE

The following additional items are required to be disclosed in the suggested list of Items to be included In the Report on Corporate Governance in the Annual Report of Companies. (i) Disclosure of accounting treatment, if different, from that prescribed in Accounting Standards with explanation. (ii) Whistle Blower policy and affirmation that no personnel have been denied access to the audit committee.

4.17

ADDITIONAL DISCLOSURES UNDER NON-MANDATORY REQUIREMENTS

The following additional disclosures are required to be made under the non-mandatory requirements:

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CLAUSE 49 OF THE LISTING AGREEMENT

(i) Audit qualifications Company may move towards a regime of unqualified financial statements. (ii) Training of Board Members Company shall train its Board members in the business model of the company as well as the risk profile of the business parameters of the company, their responsibilities as directors, and the best ways to discharge them. (iii)Mechanism for evaluating Non-Executive Board Members The performance evaluation of non-executive directors should be done by a peer group comprising the entire Board of Directors, excluding the director being evaluated; and Peer Group evaluation should be the mechanism to determine whether to extend / continue the terms of appointment of non-executive directors.

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CLAUSE 49 OF THE LISTING AGREEMENT

CHAPTER 5 CONCLUSION

The recent events worldwide, particularly in the United States have renewed the emphasis on Corporate Governance the world over. These events have highlighted the need for ethical governance and require management to look beyond their systems and procedures. Reacting swiftly and spontaneously, the United States enacted Sarbans Oxley Act, 2002 bringing out fundamental changes in every dimension of Corporate Governance. Back home in India, the need for strengthened norms for Corporate Governance is also felt. The revised clause 49 of the Listing Agreement is, therefore, most timely and provides much needed disclosure requirements, widened definition of independent director, periodical review by independent director, whistle blower policy, quarterly compliance report in the prescribed format and issue of certificate of compliance. It is hoped that the revised clause 49 would go a long way in providing corporates good governance framework. Since 2006, listed companies are required to submit quarterly compliance reports to the SEBI, similar to those required in the US by Sarbanes-Oxley. However, enforcement of compliance remains an issue due to the relatively weak legal framework. While still an emerging economy, India is pre-eminently a common law country with a well-developed system of law and justice. However, while there is a good foundation of law, critics argue that the legal and judiciary system moves too slowly. Enforcement of Clause 49 falls to the SEBI. With over 6000 listed companies, monitoring andenforcement are significant challenges in the immediate term. While SEBIs ultimate sanction in cases of serial non-compliance is delisting, this is unpopular as delisting penalizes the non -controlling dispersed shareholders and closes their exit options. Hence, SEBI has tended to enforce the recommendations through dialog (The Hindu, 2006), and

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in some cases monetary penalties (The Economic Times, 2007). 30 While the incidence of monetary penalties has been reported, the names of the non-complying companies have not been disclosed, suggesting that this action acts more of a signal for non-compliant companies to mend their ways. While the effectiveness of enforcement of the framework remain an interesting empirical question, the corporate governanceframework established is robust and in principle as effective as those of the UK and US and in many areas superior to continental European and other emerging markets, in view of many commentators (for example Grant, Gavin, et al., 2007; and Institute ofInternational Finance, 2006). Critics argue that India is behind countries like Singapore and Hong Kong in terms of some governance parameters (Kaufmann, Kraay, and Mastruzzi, 2008).

However, despite the support and criticism of the new framework, there is no dispute about the significant importance of corporate governance in India. Early evidence suggests that the new regulatory regime is working. For example, a recent study by Black and Khanna (2007) found that firms market value increased along with corporate governance reforms. This suggests that despite slow regulatory enforcement, the financial market rewards companies with good governance.

30

For example in September 2007, SEBI imposed monetary penalties on 20 companies which did not comply with Clause 49 (The Economic Times, 2007). The identity of these 20 companies were however, not disclosed. Rounding up 20 companies for disciplinary action seems to be a small step compared to the perceived number of non-compliant companies remaining to be acted against.

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