Author: indiafreenotes

SEBI constituted this Committee under the chairmanship of N.R. Narayana Murthy, chairman and mentor of Infosys, and mandated the Committee to review the performance of corporate governance in India and make appropriate recommendations. The Committee submitted its report in February 2003.

The main items of Committee recommendations are as follows:

(a) Persons should be eligible for the office of non-executive director so long as the term of office did not exceed nine years (in three terms of three years each, running continuously).

(b) The age limit for directors to retire should be decided by companies themselves.

(c) All audit committee members shall be non-executive directors. They should be financially literate and at least one member should have accounting or related financial management expertise.

(d) Audit committee of listed companies shall review mandatorily the information, viz.:

(i) Financial statements and draft audit reports,

(ii) Management discussion and analysis of financial condition and operating results,

(iii) Risk management reports,

(iv) Statutory auditors’ letter to management regarding internal control weaknesses, and

(v) Related party transactions.

(e) The audit committee of the parent company shall also review the financial statements, in particular, the investments made by the subsidiary company.

(f) A statement of all transactions with related parties including their bases should be placed before the independent audit committee for formal approval/ratification. Of any transaction is not on an arm’s length basis, management should provide an explanation to the audit committee, justifying the same.

(g) Procedures should be in place to inform board members about the risk assessment and minimisation procedures.

(h) Companies raising money through an Initial Public Offering (IPO) shall disclose to the audit committee, the uses/application of funds 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 offer document/prospectus. This statement shall be certified by the independent auditors of the company. The audit committee should make appropriate recommendations to the board to take up steps in this matter.

(i) 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. They 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.

(j) A director to become independent shall satisfy the various conditions laid down by the Committee.

(k) Personnel two observe an unethical or improper practice (not necessarily a violation of law) should be able to approach the audit committee without necessarily informing their supervisors. Companies shall take measures to ensure that this right of access is communicated to all employees through means of internal circulars etc. Companies shall annually affirm that they have not denied any personal 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. Such affirmation shall form a part of the board report on corporate governance that is required to be prepared and submitted together with the annual report.

(l) For all listed companies there should be a certification by the CEO and CFO confirming, the financial statements as true and fair in compliance with the existing accounting standards, effectiveness of internal control system, disclosure of significant fraud and significant changes in internal control and/or of accounting policies to the auditors and the audit committee. It is worth noting here that majority of the recommendations of this committee have been accepted by SEBI and thereby incorporated in the revised Clause 49 of the Listing Agreement in 2003 and 2004.

Chandra Committee

Consequent to the several corporate debacles in the USA in 2001, followed by the stringent enactments of Sarbanes Oxley Act, Government of India appointed Naresh Chandra Committee in 2002 to examine and recommended drastic amendments to the law pertaining to auditor-client relationships and the role of independent directors.

The main recommendations of the Committee are given below:

(a) The minimum board size of all listed companies as well as unlisted public limited companies with paid-up share capital and free reserves of Rs. 100 million and above, or turnover of Rs. 500 million and above, should be seven, of which at least four should be independent directors.

(b) No less than 50% of the board of directors of any listed company as well as unlisted public limited companies with a paid-up share capital and free reserves of Rs. 100 million and above or turnover of Rs. 500 million and above, should consist of independent directors.

(c) In line with the international best practices, the committee recommended a list of disqualification for audit assignment which included prohibition of:

(i) Any direct financial interest in the audit client,

(ii) Receiving any loans and/or guarantees,

(iii) Any business relationship,

(iv) Personal relationship by the audit firm, its partners, as well as their direct relatives, prohibition of

(v) Service or cooling off period for a period of at least two years, and

(vi) Undue dependence on an audit client.

(d) Certain services should not be provided by an audit firm to any audit client, viz.:

(i) Accounting and book keeping,

(ii) Internal audit,

(iii) Financial information design,

(iv) Actuarial,

(v) Broker, dealer, investment advisor, investment banking,

(vi) Outsourcing,

(vii) Valuation,

(viii) Staff recruitment for the client etc.

(e) The audit partners and at least 50% of the engagement team responsible for the audit of either a listed company, or companies whose paid-up capital and free reserves exceeds Rs. 100 million or companies whose turnover exceeds Rs. 500 million, should be rotated every 5 years.

(f) Before agreeing to be appointed (Section 224 (i)(b)), the audit firm must submit a certificate of independence to the audit committee or to the board of directors of the client company.

(g) There should be a certification on compliance of various aspects regarding corporate governance by the CEO and CFO of a listed company.

It is interesting to note that majority of the recommendations of this committee are the culmination of the provisions of Sarbanes Oxley Act of the USA.

The Sarbanes-Oxley Act of 2002 is a law the U.S. Congress passed on July 30 of that year to help protect investors from fraudulent financial reporting by corporations. Also known as the SOX Act of 2002 and the Corporate Responsibility Act of 2002, it mandated strict reforms to existing securities regulations and imposed tough new penalties on lawbreakers.

The Sarbanes-Oxley Act of 2002 came in response to financial scandals in the early 2000s involving publicly traded companies such as Enron Corporation, Tyco International plc, and WorldCom. The high-profile frauds shook investor confidence in the trustworthiness of corporate financial statements and led many to demand an overhaul of decades-old regulatory standards.

The rules and enforcement policies outlined in the Sarbanes-Oxley Act of 2002 amended or supplemented existing laws dealing with security regulation, including the Securities Exchange Act of 1934 and other laws enforced by the Securities and Exchange Commission (SEC). The new law set out reforms and additions in four principal areas:

• Corporate responsibility
• Increased criminal punishment
• Accounting regulation
• New protections

Major elements

Public Company Accounting Oversight Board (PCAOB)

Title I consists of nine sections and establishes the Public Company Accounting Oversight Board, to provide independent oversight of public accounting firms providing audit services (“auditors”). It also creates a central oversight board tasked with registering auditors, defining the specific processes and procedures for compliance audits, inspecting and policing conduct and quality control, and enforcing compliance with the specific mandates of SOX.

Auditor Independence

Title II consists of nine sections and establishes standards for external auditor independence, to limit conflicts of interest. It also addresses new auditor approval requirements, audit partner rotation, and auditor reporting requirements. It restricts auditing companies from providing non-audit services (e.g., consulting) for the same clients.

Corporate Responsibility

Title III consists of eight sections and mandates that senior executives take individual responsibility for the accuracy and completeness of corporate financial reports. It defines the interaction of external auditors and corporate audit committees, and specifies the responsibility of corporate officers for the accuracy and validity of corporate financial reports. It enumerates specific limits on the behaviors of corporate officers and describes specific forfeitures of benefits and civil penalties for non-compliance. For example, Section 302 requires that the company’s “principal officers” (typically the Chief Executive Officer and Chief Financial Officer) certify and approve the integrity of their company financial reports quarterly.

Enhanced Financial Disclosures

Title IV consists of nine sections. It describes enhanced reporting requirements for financial transactions, including off-balance-sheet transactions, pro-forma figures and stock transactions of corporate officers. It requires internal controls for assuring the accuracy of financial reports and disclosures, and mandates both audits and reports on those controls. It also requires timely reporting of material changes in financial condition and specific enhanced reviews by the SEC or its agents of corporate reports.

Analyst Conflicts of Interest

Title V consists of only one section, which includes measures designed to help restore investor confidence in the reporting of securities analysts. It defines the codes of conduct for securities analysts and requires disclosure of knowable conflicts of interest.

Commission Resources and Authority

Title VI consists of four sections and defines practices to restore investor confidence in securities analysts. It also defines the SEC’s authority to censure or bar securities professionals from practice and defines conditions under which a person can be barred from practicing as a broker, advisor, or dealer.

Studies and Reports

Title VII consists of five sections and requires the Comptroller General and the SEC to perform various studies and report their findings. Studies and reports include the effects of consolidation of public accounting firms, the role of credit rating agencies in the operation of securities markets, securities violations, and enforcement actions, and whether investment banks assisted Enron, Global Crossing, and others to manipulate earnings and obfuscate true financial conditions.

Corporate and Criminal Fraud Accountability

Title VIII consists of seven sections and is also referred to as the “Corporate and Criminal Fraud Accountability Act of 2002”. It describes specific criminal penalties for manipulation, destruction or alteration of financial records or other interference with investigations, while providing certain protections for whistle-blowers.

White Collar Crime Penalty Enhancement

Title IX consists of six sections. This section is also called the “White Collar Crime Penalty Enhancement Act of 2002”. This section increases the criminal penalties associated with white-collar crimes and conspiracies. It recommends stronger sentencing guidelines and specifically adds failure to certify corporate financial reports as a criminal offense.

Corporate Tax Returns

Title X consists of one section. Section 1001 states that the Chief Executive Officer should sign the company tax return.

Corporate Fraud Accountability

Title XI consists of seven sections. Section 1101 recommends a name for this title as “Corporate Fraud Accountability Act of 2002”. It identifies corporate fraud and records tampering as criminal offenses and joins those offenses to specific penalties. It also revises sentencing guidelines and strengthens their penalties. This enables the SEC to resort to temporarily freezing transactions or payments that have been deemed “large” or “unusual”.

Borrowed capital consists of money that is borrowed and used to make an investment. It differs from equity capital, which is owned by the company and shareholders. Borrowed capital is also referred to as “loan capital” and can be used to grow profits but it can also result in a loss of the lender’s money.

Businesses need capital to operate. Capital is wealth that is used to generate more wealth. For businesses, capital consists of assets property, factories, inventories, cash, etc. Businesses have two options to acquire these: debt financing and equity financing. Debt is money that is borrowed from financial institutions, individuals, or the bond market. Equity is money the company already has in its coffers or can raise from would-be owners or investors. The term “borrowed capital” is used to distinguish capital acquired with debt from capital acquired with equity.

There are many different borrowing methods that constitute borrowed capital. These can take the form of loans, credit cards, overdraft agreements, and the issuance of debt, such as bonds. In all instances, a borrower must pay an interest rate as the cost of borrowing. Typically, debt is secured by collateral. In the case of a home purchase, the mortgage is secured by the house being acquired. Borrowed capital may also take the form of a debenture, however, and in that case, it is not secured by an asset.

Borrowed capital is commonly used in the economy whether that be for personal reasons or for business reasons.

The upside of investing with borrowed capital is the potential for greater gains. The downside is the potential for greater losses, given that the borrowed money must be paid back somehow, regardless of the investment’s performance.

Capital contributed by the owner or entrepreneur of a business, and obtained, for example, by means of savings or inheritance, is known as own capital or equity, whereas that which is granted by another person or institution is called borrowed capital, and this must usually be paid back with interest. The ratio between debt and equity is named leverage. It has to be optimized as a high leverage can bring a higher profit but create solvency risk.

Borrowed capital is capital that the business borrows from institutions or people, and includes debentures:

• Redeemable debentures
• Irredeemable debentures
• Debentures to bearer
• Ordinary debentures
• Bonds
• Deposits
• Loans

International bonds are bonds issued by a country or company that is not domestic for the investor. The international bond market is quickly expanding as companies continue to look for the cheapest way to borrow money. By issuing debt on an international scale, a company can reach more investors. It also potentially helps decrease regulatory constraints.

Three Categories of International Bonds

There are three general categories for international bonds: domestic, euro, and foreign. The categories are based on the country (domicile) of the issuer, the country of the investor, and the currencies used.

• Domestic bonds: Issued, underwritten and then traded with the currency and regulations of the borrower’s country.
• Eurobonds: Underwritten by an international company using domestic currency and then traded outside of the country’s domestic market.
• Foreign bonds: Issued in a domestic country by a foreign company, using the regulations and currency of the domestic country.

A foreign bond is a bond issued in a domestic market by a foreign entity in the domestic market’s currency as a means of raising capital. For foreign firms doing a large amount of business in the domestic market, issuing foreign bonds, such as bulldog bonds, Matilda bonds, and samurai bonds, is a common practice.

Dollar-denominated Bonds

Dollar-denominated bonds are issued in US dollars and offer investors more choices to increase diversity. The two types of dollar-denominated bonds are Eurodollar bonds and Yankee bonds. The difference between the two bonds is that Eurodollar bonds are traded outside of the domestic market while Yankee bonds are issued and traded in the US.

Eurodollar bonds

Eurodollar bonds are the largest component of the Eurobond market. A Eurodollar bond must be denominated in U.S. dollars and written by an international company. Since Eurodollar bonds are not registered with the SEC, they can not be sold to the U.S. public. However, they can be traded on the secondary market. Even though many portfolios do include Eurodollar bonds in U.S. portfolios, U.S. investors do not participate in the primary market for such bonds. Therefore, the primary market is dominated by foreign investors.

Yankee bonds

Yankee bonds are another type of dollar-denominated bonds. However, unlike the Eurodollar bonds, the Yankee bonds’ target market is within the U.S. These bonds are issued by a foreign company or country that has registered with the Securities and Exchange Commission (SEC). Since Yankee bonds are meant to be purchased by U.S. citizens in the primary market, they must follow regulations set by the SEC. For example, the company issuing the bond needs to be financially stable and capable of making payments throughout the period of the bond.

Non-dollar-denominated Bonds

Non-dollar-denominated international bonds are all the issues denominated in currencies other than the dollar. Since there is currency volatility, U.S. investors face the question of whether to hedge their currency exposure. The different types of non-dollar-denominated bonds depend on the domicile of the issuer and the location of the primary trading market. The three major types are the domestic market, the foreign market, and the Euro market.

Domestic market

The domestic market includes bonds that are issued by a borrower in their home country using that country’s currency. Domestic markets have seen significant growth for several reasons. First of all, for companies, issuing debt in the domestic currency allows them to better match liabilities with assets. By doing so, they also don’t need to worry about the currency exchange risk. Also, by issuing debt in dollar-denominated markets and the domestic market, companies gain access to more investors. This allows them to obtain a better borrowing rate.

Foreign market

The foreign bond market includes the bonds that are sold in a country, using that country’s currency, but issued by a non-domestic borrower. For example, the Yankee bond market is the U.S. dollar version of this market. This is because they are sold in the U.S. using the dollar, but issued by a syndicate outside of the U.S. Other examples include the Samurai market and the Bulldog market. The Samurai market is Yen-denominated bonds issued in Japan but by non-Japanese borrowers. The Bulldog market is pound-denominated bonds issued in the U.K. by non-Brtish groups.

Euro market

Securities that are issued into the international market are called Eurobonds. This market encompasses all the bonds that are not issued in a domestic market and can be issued in any currency. Eurodollar bonds are an example of a U.S. dollar-denominated version of a Eurobond as they are sold in the international markets.

Most of the time, the bonds are written by an international syndicate and sold in several different national markets simultaneously. Issuers of Eurobonds include international corporations, supranational companies, and countries.

Private Ltd. Company

A Private Limited Company is a joint stock company, incorporated under The Indian Companies Act, 2013 or any other previous act. The maximum number of members is 200, excluding the current employees and the ex-employees who were the members during their employment or continues to be the member after the termination of employment in the company.

The company restricts the transfer of shares and prohibits invitation to the public for the subscription of shares and debentures. It uses the term ‘private limited’ at the end of its name.

Public Ltd. Company

A Public Limited Company or PLC is a joint stock company formed and registered under The Indian Companies Act, 2013 or any other previous act.

There is no defined limit on the number of members the company can have. Also, there is no restriction on the transferability of the shares. The company can invite the public for the subscription of shares or debentures, and that is why the term ‘Public Limited’ gets added to its name.

Difference Public Company:

1. Ownership: Owned by the State Government or Central Government or both.
2. Objective/Motive: To promote public welfare.
3. Social Objectives: They are launched to achieve social objectives like development of backward regions, creation of employment opportunities, etc.
4. Forms of Organisation: Departmental undertakings, Statutory Corporation and Government Companies.
5. Management: Managed by bureaucrats; hence efficient.
6. Financial Resources: Huge financial resources; no problem in expansion and growth.
7. Accountability: Accountable to the public through Parliament.
8. Political Interference: Comparatively more Political Interference.
9. Government Control: They are subject to strict financial control by the government.
10. Distribution of Income: Equitable distribution of income.

Difference Private Company:

1. Ownership: Owned by private individuals.
2. Objective/Motive: To maximize profits.
3. Social Objectives: Social objectives are not very important.
4. Forms of Organisation: Sole proprietorship, partnership, joint Hindu family business, cooperative societies and joint stock company
5. Management: Managed by professional managers; hence efficient.
6. Financial Resources: Limited financial resources; less scope for expansion.
7. Accountability: Accountable to the owners.
8. Political Interference: Less political interference
9. Government Control: They are not subject to strict financial control by the government.
10. Distribution of Income: Concentration of wealth in few hands.

A private company is owned by either a small number of shareholders, company members, or a non-governmental organization, and it does not offer its stocks for sale to the general public. Instead, its stock is offered, owned, or exchanged privately among a small number of shareholders or even held by a single individual. Private companies are also referred to as privately-held companies, limited companies, limited liability companies, or private corporations, depending on the country where they’re incorporated and how they are structured.

Section 2(68) of Companies Act, 2013 defines private companies. According to that, private companies are those companies whose articles of association restrict the transferability of shares and prevent the public at large from subscribing to them. This is the basic criterion that differentiates private companies from public companies.

The Section further says private companies can have a maximum of 200 members (except for One Person Companies). This number does not include present and former employees who are also members. Moreover, more than two persons who own shares jointly are treated as a single member.

This definition had previously prescribed a minimum paid-up share capital of Rs. 1 lakh for private companies, but an amendment in 2005 removed this requirement. Private companies can now have a minimum paid-up capital of any amount.

Features of Private Companies

• No minimum capital required: There was a minimum paid-up share capital requirement of Rs. 1 lakh previously, but that is omitted now.
• Minimum 2 and maximum 200 members: A private company can have a minimum of just two members (but just one is enough if it a One Person Company), and a maximum of up to 200 members.
• Transferability of shares restricted: Private companies cannot freely transfer their shares to the public like public companies. This is why stock exchanges never list private companies.
• “Private Limited”: All private companies must include the words “Private Limited” or “Pvt. Ltd.” in their names.
• Privileges and exemptions: Since private companies do not freely transfer their shares and involve limited interest by members, the law has granted them several exemptions that public companies do not enjoy.

Privileges of Private Companies

The Companies Act has provided certain privileges and exemptions to private companies that public companies do not possess. These privileges accord them greater freedom in conducting their affairs. Here are some examples of them:

• No need to prepare a report for annual general meetings.
• Only 2 minimum directors required.
• No need to appoint independent directors.
• They can adopt additional grounds for the disqualification of directors and vacation of their office.
• They can pay greater remuneration to their directors than compared to some other types of companies.

Merits

Owning Property

A company being a juristic person, can acquire, own, enjoy and alienate, property in its own name. No shareholder can make any claim upon the property of the company so long as the company is a going concern. The shareholders are not the owners of the company’s property. The company itself is the true owner.

Free & Easy transferability of shares

Shares of a company limited by shares are transferable by a shareholder t any other person. The transfer is easy as compared to the transfer of interest in business run as a proprietary concern or a partnership. Filing and signing a share transfer form and handing over the buyer of the shares along with share certificate can easily transfer shares.

Limited Liability

Limited Liability means the status of being legally responsible only to a limited amount for debts of a company. Unlike proprietorships and partnerships, in a limited liability company the liability of the members in respect of the company’s debts is limited. In other words, the liability of the members of a company is limited only to the extent of the face value of shares taken up by them. Therefore, where a company is limited by shares, the liability of the members on a winding-up is limited to the amount unpaid on their shares.

Borrowing Capacity

A company enjoys better avenues for borrowing of funds. It can issue debentures, secured as well as unsecured and can also accept deposits from the public, etc. Even banking and financial institutions prefer to render large financial assistance to a company rather than partnership firms or proprietary concerns.

Dual Relationship

In the company form of organization it is possible for a company to make a valid and effective contract with any of its members. It is also possible for a person to be in control of a company and at the same time be in its employment. Thus, a person can at the same time be a shareholder, creditor, director and also an employee of the company.

Capacity to sue and be sued

To sue means to institute legal proceedings against or to bring a suit in a court of law. Just as one person can bring a legal action in his/her own name against another in that person’s name, a company being an independent legal entity can sue and also be sued in its own name.

Limitations

No valuation of investment:

Shares of a private company are not listed on stock ex­change. There are no regular dealings in these shares. A shareholder cannot, therefore, know the real value of his investment in a private company.

Lack of public confidence:

Public has little confidence in a private company because its affairs are unknown and it is not subject to strict control under the law.

Smaller resources:

A private company cannot have more than fifty members. Its credit standing is lower than that of a public company. Therefore, the financial and managerial resources of a private company are comparatively limited.

Poor protection to members:

A private company enjoys several exemptions from various provisions of the Companies Act. Minority members may suffer at the hands of the majority members. Dissatisfied members cannot cut off their connection with the company except at a loss.

Lack of transferability of shares:

There are restrictions on the transfer of shares in a private company. As a result a shareholder cannot leave a private company easily and quickly.