Ways introduced to help improved investors protection in

securities market as per Companies Act, 2013

(How the new Act protects the investors in the market)

Submitted by

Ashutosh Mishra

Division: C

Roll No: 18010224182

Batch: 2018-2023

Of

Symbiosis Law School, NOIDA

Symbiosis International (Deemed University)

In

September, 2020

Under the guidance of

Dr. Mohit Sharma

INTRODUCTION

Investors are the part and parcel of the securities market, and they have an important role play
a in stock market along with strengthening the economy of a nation. Earlier, the act that used
to govern and protect the investors of the nation was Companies Act 1956, but after the fallout
of Indian “Enron”, it was felt that the original act was inefficient and the act failed to protect
the investor’s interest and overcome white collar crime. It was incompatible to the changing
business environment. The famous Satyam case was the proof of the shortcomings of the
Companies Act 1956 regarding investor’s protection. The Satyam case rose the topic of
improving and reforming the corporate structure. It was felt that the corporate system shall be
more transparent and reliable so that the interest of the investors may feel safe while making
an independent and/or safe decision. Hence, the Satyam Scam led to some major shift on the
present companies Acton establishing adequate investor protection measures. The Companies
Act 2013 has certain new provisions which is equipped with regulating and ensuring the
transparency and having responsibility in company’s management for protecting the investor’s
interest. One of the main functions of the present act is to attract or increase the penalties for
breaches.1

“The new act introduced the provisions and these provisions were made to ensure that there is
accountability and transparency in the management of the company and such transparency and
accountability shall protect the interest of the stakeholders. Some of the examples are that of
prohibition of Insider Trading, Introduction of Class-Action law Suit, offence of fraud, etc.
These provisions were computed under the Companies Act, 2013, Since the Companies Bill,
2012 received assent of the President of India on the 29th August, 2013, and published in the
Gazette on 30th August, 2013, the Companies Act, 2013 came into force from 30th August,
2013.This assignment provides an insight into certain investor protection measures, namely
stricter regulation of board, class action suits and fraud, and aims at analysing its impact on
investors and the company.”

1
(H. Grove, (2012))
COMPANIES ACT, 1956 AND ITS SHORTCOMINGS

• Introduction and Overview

“The Companies Act 1956 was administered by the Government of India through the Ministry
of Corporate Affairs and the Offices of Registrar of Companies, Official Liquidators, Public
Trustee, Company Law Board, Director of Inspection, etc. The Act is 658 sections long. The
Act contains provisions about Companies, directors of the companies, memorandum and
articles of associations, etc. This act states and discusses every single provision requires or may
need to govern a company. It mentions what type on companies their differences, constitution,
management, members, capital, how should the shares should be issues, debentures,
registration of charge, at the end of the act it concludes the about winding up of a company,
discussing the situations a company needs to be winded up. The ways it should be done by
volunteer or through courts.2

“Companies Act 1956 explains about the whole procedure of the how to form a company, its
fees procedure, name, constitution, its members, and the motive behind the company, its share
capital, about its general board meetings, management and administration of the company
including an important part which is the directors as they are the decision makers and they take
all the important decisions for the company their main responsibility and liabilities about the
company matter the most. The Act explains about the winding of the business as well and what
happens in detail during liquidation period.”

• Satyam Computers Fall-out3

“Satyam's case has been widely regarded as the debacle of the Indian Financial System. The
case of Satyam is often referred to as India's Enron (Enron was a US based company which
was inflicted with a similar accounting fraud). It was a 7,136 crore (nearly $1.5 billion) Fraud
and it is seen as India's Most Colossal Financial Fraud. The fraud shows how disastrously
investors can lose money by simply misstating the figures in the Balance Sheet.”

2
(Arya Tripathy, 2015)
3
(Bhasin, 2016)
“Raju had a knack for acquiring land and the more land he acquired, the more he revelled. But
Raju's story is not merely about his rapacious land acquisition, it is also about how he
masterminded in siphoning funds off funds from his IT company Satyam and Construction
company Maytas Infra by creating a fictitious revenue and profits to satiate his lust.”

“Raju would not have landed in this position if it hadn't been for the recessionary forces that
hit the Indian shores in 2008. Recession threw Raju off guard and closed all his options. The
market was rife with rumours of Satyam been plagued by hostile takeover threats and in order
to stave away such threats, he falsely increased the turnover so that the companies wanting to
acquire the company wouldn't as it would be a costly affair for the company making the bid for
acquisition. Also, he transferred the funds from Satyam by cooking the books to purchase lands,
so now there was a big hole in the balance sheet. But what if he merged his real estate and
construction company with Satyam? He could then have possibly concealed the fraud. He gave
himself up when he had to abort the merger of Satyam with Mytas Infra since the shareholders
weren't consenting and the rumours had spread a lot.”

“Keen to project a perpetually rosy picture of the company to the investors, employees and
analysts, Raju manipulated the books so that it appeared a far bigger enterprise than it actually
was. To achieve this, they sewed up deals with fictitious clients and had large teams working
on these fictitious projects. Note, here two things are done. One, fictitious Debtors i.e. money
receivable from clients is created and fictitious payroll showing payment of salary to them. He
introduced 7000 fake invoices into the company's computer system to record sales that simply
did not exist. Obviously, over the years, these ghost debtors never paid their bills leading to a
big hole in Satyam's balance sheet meaning only Sales increased, Cash didn't. He further forged
the bank statements to draw a mountain of cash balance. This thing, in-fact was possible that
the auditors would not have known at least for a few years because seldom do auditors do
the Third-Party Confirmation (Whereby the auditors confirm balances not by relying on the
client produced documents, but by privately following up with banks for the balance, to
increase the test reliability). At least in mediocre firms, articles usually oversee this and
completely rely on the client produced documents because even their managers or partners do
not stress on this fact! What were the Internal Auditors (IA) doing? Although, IA can only
recommend action to the clients but According to the sources, the IA were assured by the
finance team that the accounts had been reconciled as in the errors were rectified and Bank
statements were reconciled with the financials.”
Shortcomings of the act: The Satyam scam indicated lacunas in the Companies Act, 1956.
There was no definition and punishment of fraud, no provision for class-action law suit. There
were many other flaws which were corrected in 2013 act.

COMPANIES ACT,2013: HOW THE NEW ACT PROTECTS

THE INTERESTS OF THE INVESTOR4

Duties of the Directors

“S. 166 codifies the duties of directors requiring them to act with good faith, due and reasonable
care, skill, and exercise independent judgment in management. Conceptually, this existed under
the old law too but as part of fiduciary duties. Now, breach of duties entails fine between INR
0.1 million (US$ 1,583)1 to INR 0.5 million (US$ 7,914) on the defaulting director. But the
Act does not provide an objective standard of assessment and whether a director has fulfilled
his duties will be determined on factual basis.”

“Further, under S. 188, related party transactions (RPTs) beyond a certain threshold and which
are not at an arm's-length4 require prior shareholders' approval. Details of RPTs have to be
maintained in registers and disclosed in the board's report. Such provisions should go a long
way in guaranteeing that company's funds are utilized to maximize shareholders' interests. In
India, closely held group entities undertake RPTs on a day-to-day basis for economies of scale
and optimum utilization of resources. Such companies will have to review things afresh and
change their mindsets so as to comply with the strict mandate.”

Disclosure in Board Reports

“Annual board disclosures are tightened to facilitate transparency by presenting a true picture
of a company's state of affairs. S. 134 mandates various additional disclosures to be made in
the board report such as (a) details of RPTs undertaken in a fiscal year, (b) particulars on inter-
corporate loans and investments, (c) directors' responsibility statement containing affirmations
regarding following accounting standards for preparation of financial statements, exercise of
independent judgment, discharge of duties with due care and skill, having adequate mechanism
to prevent fraud, compliance with applicable laws, (d) development and implementation of risk

4
(Khuntia*, July-2014)
management policy, and (e) details of corporate social responsibility initiatives, if applicable.
The penalty for non-compliance has been enhanced and now, breach entails fine on the
company up to INR 2.5 million (US$ 39,572), and imprisonment up to 3 years and/or fine up
to INR 0.5 million (US$ 7,914) on every officer-in-default which includes every director. As
personal liability is imposed on every director, it is imperative that board functions diligently
and makes adequate disclosures in its report to present a true and fair view. While these
additional disclosures will increase accountability of the board, it also will provide more
information to shareholders and enable informed decision making.”

Class Action Law Suit

“As a major change, the Act empowers the investor and minority shareholders by introducing
class action suits. During the Satyam scam, where US counterparts could institute such suits
and recover damages, Indian investors were without any recourse. In addition to the remedies
under oppression and mismanagement, the yet-to-be notified S. 245 introduces this concept
and provides collective remedies to investors and claim damages against erring companies. It
vests a right with members or depositors or class thereof (100 in number) to file a representative
application with the National Company Law Tribunal, if they feel that management or
company's affairs is conducted in a prejudicial manner. The positive determination that an
alleged conduct is prejudicial is done if the conduct is prejudicial to the company's interest, or
interest of stakeholders. There is no illustrative list for prejudicial conduct under the Act and
the same may be decided on factual basis. Instances such as drawing funds for personal use,
negligent action or omission, oppressive measures towards minority were considered as
prejudicial conduct under the old law. Factors such as good faith of applicant, availability of
remedy in one's own right, evidence presented relating to involvement of officer, opinion of
non-interested members or depositors, and whether the alleged conduct is or is likely to be
ratified ought to be considered by NCLT.”

Fraud5

“The Act has introduced fraud for the first time and given it a wide scope. Apart from the
definition, the Act also contemplates presumption of fraud in certain instances. For example,
furnishing false information or suppressing material information upon incorporation, providing

5
(Sharma, 2014)
misleading or false statements in prospectus, issuing duplicate share certificates to defraud,
fraudulently transferring or transmitting shares and fraudulently applying for removal of
company's name. For the board, this may have varied connotations. Proof of negligence or
wilful misconduct by a director may weigh heavily in adjudging guilt for fraud. It is immaterial
if there is any actual wrongful gain or loss, and proof of intent to defraud will suffice. Thus,
the directors will now be required to discharge their statutory duties in a reasonable and diligent
manner while exercising independent judgment to provide a positive inference of non-
involvement in any alleged fraudulent conduct.”

CONCLUSION

“Though several provisions were provided under the Companies Act, 1956 for protection of
the interests of the shareholders, it did not keep pace with the changing business environment.
The new companies Act addresses several investor concerns and seeks to provide a more
hospitable environment for minority shareholders especially in the wake of scams and scandals
such as the one that hit the Satyam Computer Services in 2008.”6

“Under the new Act, a prescribed number of members and depositors can file application
against the management or the Company “if its affairs are conducted prejudicial to their interest
or the interest of the Company and may call for specified orders in such respect.””

An application may be filed or any other action may be taken under this section by any person,
group of persons or any association of persons representing the specified persons affected by
any act or omission. Further, where the members seek any damages or compensation or demand
any other suitable action from or against an audit firm, the liability shall lie on the firm and of
each partner who was so involved.

“The companies Act also provides for protection for whistle-blowers. The Act contains
provisions to enable the directors and employees to report genuine concerns. Such a vigil
mechanism will provide for adequate safeguards against victimisation of persons who use such
mechanism and make provision for direct access to the chairperson of the Audit Committee in
appropriate or exceptional cases.”

6
(SHARMA, 2014)
“Analysing the various provisions of the Companies Act, 2013, it can be concluded that
legislature has taken affirmative step to protect the interest of the investors. Since investor’s
contribution is very essential in raising fund by the company, care must be taken to address
their needs. But such provision is necessary in order to balance the interest of the Company
and the investors.”7

REFERENCES

• Arya Tripathy. (2015). Investor Protection Measures Under Companies Act, 2013 –
Lessons From The Past. New Delhi: PSA Legal Journal.

• Bhasin, D. M. (2016). Revisiting the Satyam Accounting Scam: A Case Study.

International Journal of Management and Social Sciences Research (IJMSSR) ISSN:
2319-4421, 31-48.

• Furtado, R. (2014). Provisions For The Protection Of The Investor Under The
Companies Act, 2013. Yale Law Review, 88-112.

• H. Grove, L. P. ( (2012)). Asia‘s Enron: Satyam (Sanskrit word for truth). Journal of
Forensic & Investigative Accounting, 4(2), 142-160.

• Khuntia*, R. ( July-2014). COMPANIES ACT, 2013 – A NEW WAVE OF

EFFECTIVE REGULATION AND CORPORATE GOVERNANCE IN INDIA.
International Journal of Advancements in Research & Technology, Volume 3, Issue 7,
July-2014 , 148-159.

7
(Furtado, 2014)
• Sharma, N. (2014). Analyzing Companies Act: A move towards better Governance.
IOSR Journal of Business and Management (IOSR-JBM), 26-32.

• SHARMA, P. J. (2014). WHAT WENT WRONG WITH SATYAM? Indian Law

Journal, 22-38.