Address by Mr. Naresh Chandra, Former Indian Ambassador to USA & Chairman, Special Task Force on Corporate Governance, CII at the "4th Corporate Governance
Summit” organized by CII in partnership with NFCG on February 5, 2009 in Mumbai.
India’s Tryst with Corporate Governance
Mr Naresh Chandra,
Former Indian Ambassador to USA &
Chairman, Special Task Force on Corporate Governance, CII
It is indeed a great honour to be invited to say a few words, in fact, virtually have the last work in such an important conference as that of today.
Mr. YH Malegam and Mr. Manoj Arora, before me have sketched and practically given all the details of the subject of this session. So I would like to say something new. It is generally said that everything that is needed to be said, has been said. So somebody asked this - why this discussion is going on? and somebody replied that the important thing is everyone has not said. So we have to go through this. What I would like to point out is, the way our corporate structure is organized is the main problem that corporate governance and regulators need to address, i.e. is to keep the agency cast out. By agency cast out, I mean the difference in the mis-alignment of objectives between the shareholders who are the principals and management, who are the agents and who act or who are supposed to act on the behalf of the shareholders.
A point, that was unique to the South Asian or South East Asian tradition was very ably brought out by Mr. Malegam is the blurring of lines between owners and management, when it comes to family owned enterprises. I have something to say because I have seen so called highly professional managed enterprises and rest and there are instances when there has been much more mis-management than what happens to this side of the world. But that is a separate issue, I think what has come over the years is that the board of directors and particularly the audit committee has been evolved, which has been described as becoming a sort of intermediary empire to see those who have the fiduciary responsibility to the shareholders, is discharged properly and that is the essence of corporate governance and what the regulator set out to do.
Second aspect is that corporate world is not the entire thing, it is a part of a larger universe that is governance of a country. We offer neglect that if you take the example of organic chemistry, the corporate molecule has a certain valiancy it has bounced to other molecule- some of which are positives and some are negatives, which is intrinsic to corporate molecule itself.
To take 1 or 2 examples, the political molecule, those of you who have the experience of running manufacturing or mining companies and wish to have access to a coal block or iron ore, knows exactly what the expenditure is required to get those licenses and it requires tremendous innovation and creative accounting to finance those kind of arrangements. One can be very brutally frank, but this is not the forum to do so, so I just leave this hanging in the air that there are challenges which management of these companies face. The significant point is IT companies don’t face these challenges and yet that is where the biggest fraud has taken place.
The second aspect is something which can be taken care of by normal functions that is the needs of the shareholders. However the problem comes here when the greed takes over. Every company, every business entity, from the national point of view people look to it to create wealth, to create jobs and to lead to a better level of living for the people, stakeholders, clients and everybody. That is the noble side. The problem arises how to have a system which can regulate, check and maintain a standard when the greed takes over. If I go back to universe which we operate wherein promoters or people have lots of reserves, they don’t want to share with every body. The biggest challenge in India today is the land molecule. The moment you find that funds generated from any business activity have been taken and put into land or land speculation, everybody gets alerted. I have seen that we have this time, despite extreme provocation, provided knee-jerk reaction and I was heartened to see that SEBI chairman said that he will study everything and thereafter finding out the root causes and then he will come to certain reform measures. But one thing which has to be done, is to ask for details about the shares pledged. This is a perfectly valid thing to do. But we have to be bit selective here. Banks routinely ask promoters to pledge shares when they advance more loans for any kind of activity. I think what we have to distinguish is- if it is for the core business of the company or expansion plans and a loan has been taken and a pledge has been insisted upon the banks, it is in a different category altogether. But if shares are being pledged and the money raised, thereby is being used to acquire more and more land in the name of the promoters or family members then there is a problem and that is where we have to check.
We have already covered the difference between just a paper compliance and observing the sprit of corporate governance. I think, what regulator has to do is not to try and be a God of too many small things. If you see the types of compliances which is expected from the secretariat / registrar of companies, it is quite amazing. Notices come for the most minor technical violation and the law is as such that every violation is a criminal offence, because you have to be marched before a magistrate to avoid that right or wrong you immediately compound the case. A whole lot of work and files in the ROC, we discovered are of this type. The result is that the quantity submerges the staff and the quality suffers tremendously. Even today sitting in a board meeting you get reins of papers which are certificates from shop floors coming right at the top through departments, CFO, Secretary, MD. What happens in the board meetings is that very well types certificates are all available. You count them against the check-list and you are satisfied. I think, this is mountain of certified information which comes also acts as a soporific, you have all the compliance certificates in place, you can go to sleep now. The whole thing is whether it is a director, whether it is an auditor, you have to keep your eyes and ears open. There is a world outside of paper, there is a world outside of compliance certificate. That is what has happened. it is not the sophisticated levers or something very subtle which has been maneuvered by the fraudsters at Satyam.
Verification of bank balances is where the fraud has taken place, is at the most elementary basic level and the problem that we find every audit committee tells the external auditor that –‘you are fully authorized to access the bank balances directly from the banks any time’. You gentlemen are fully authorized, so you are fully responsible. To expect that the audit committee after getting toxic papers, will do further forensic research and delve behind the motive of the promoter or the management or the auditor and come up with something great, I think, it is asking for the moon.
I was with a group of independent directors, some of them much more experienced than me, and they were saying do the people really expect us to do all this. It is a great to be honoured when tasks are being assigned that an independent directors will do this and this. If you think independent directors, attending four meetings in a year, will be able to perform the type of task that has been given? We have to revise and tune up the system of work- the way the independent director is appointed or remunerated. A reference has been made to the UK combined code and I would recommend it adoption here. When a person is appointed an independent director, he gets a very detailed complete letter of appointment, saying these are your duties, these are your responsibilities, these are your liabilities under various Acts and default is punishable. Then he is also told that there is an insurance cover that if you get caught or if you involved in a litigation, then that insurance company would look after you. It is really a paper cover. The list of exceptions are so many that I wonder that any body gets any assistance out of it, but it is a moral booster. Then it says, this is your term, 3 years or 5 years subject to approval at the AGM and this is your remuneration. It cannot be altered because it is signed as a contract. What happens in India? - It is 1% of the commission. When my committee was doing a study in 2002, we found that one company out of 20 gives commission. These are profit-making companies. With few honourable exceptions, the amounts are not generous at all. These are not in proportion to the responsibilities that are entrusted on these worthy gentlemen, who are supposed to be super monitors and superior to the auditors. Then you reduce so called independent directors to the board’s decision in relation to what should be the remuneration for the year at the end. Now boards decision is a euphemism, it is actually the will of the controlling shareholders. How is this guy independent? I think, my committee missed, we made some recommendations in this regard, but we should have been more specific. If you have a system of regular annual remuneration, it would ensure that you get the right type of people and that the remuneration is not dependent upon the whim of the promoter shareholders.
The second aspect is that how does tax authorities treat the independent directors. At many places, the directors have got notice from the service tax commissioner, that you are just a consultant or an adviser. SEBI things that we are the part of the controlling executives fully responsible. The tax guys feel that we are an adviser / a consultant so whatever you get, you have to pay service tax. So the different wing of the government have totally different kind of conceptions of what a country director is and this is something that needs to be seen. Very important point was made that we must have the regulatory system in place, which does not dilute managerial initiatives and the spirit of innovation. We had the same fear. In fact, when the report was submitted it was very quickly announced that is accepted, it was December 2002 and people were going overboard towards Sarbanes-Oxley. So I came to know that something to be said in the budget speech, I went and met the then Finance Minister and told him that it is going to send a wrong signal. I must say, if you see his budget speech delivered on the last day of February 2003, there are two lines, which are very important- ‘We will follow these recommendations, bring about improvement but ensure that business enterprise and managerial initiative is not inhibit’. I hope that that will continue to be one of the principal in Government of India’s policy on this matter.
Finally, in Satyam has happened, it has been rightly said, it is not a failure of system, it is failure that system was not followed. I believe, in an earlier session, a question was asked that if Mr. Raju had not confessed- when we would have found out? It is a very pertinent question because that shows that how a small group of people were able to fool a large number of people- auditors, directors for so long and for so vast fund of money. Here the thing is, I have a feeling that this game has been going on for so long.
Second, that diversion has taken place and siphoned money has been used to create a kind of network, which had become self-sustaining. The best secrets are kept by partners in crime. Once you are a part of a network, you have no option but to be loyal to each other and maintain secret, but it is something, which needs to be investigated. I feel, what is required today is very quick investigation. People are asking questions, why did it take so long for the system to provide an opportunity to officers of SEBI to interrogate these people. I was discussing with a SEBI officials in the day and it is amazing how it has been done. It has been done by using the machinery of justice to trump everything else. And it is amazing string of things, when the SEBI officers reach there and they were told that they would be meeting the next day. The people go to the DGP get arrested, get produced before the Magistrate and goes straight to the judicial custody. It is absolutely extra ordinary. I have never heard of such a thing.
Here are people accused of 120B, 420, 477A- criminal breach of trust, criminal conspiracy and the police do not get the custody even for 2 days. If police had custody and centre state relationship being what they are, the SEBI would have had access to them. But sending them to judicial custody gives them a cover of needing court permission and that court permission was delayed. The permission was not given on one technical ground or the other, till the matter had to reach the Supreme Court. This brings out a defect in the system.
I think, government will have to apply its mind that SFIU which was recommended and which I believe is in place then why SFIU and SEBI were not quick enough in their action, why did the ministry had to wait for the report of the ROC. There was a confessional statement by different persons. I believe, some very clever lawyer must have seen all these that ‘you cannot obstruct the course of investigation by confining yourself to executive agencies’. Thus the only method of blocking investigation was to go to the court and judicial custody, which is the lacuna in the system, which people have to study and see how to plug it.
Thank you very much once again.
Edited transcript of the Address by Mr. Naresh Chandra, Former Indian Ambassador to USA & Chairman, Special Task Force on Corporate Governance,
CII at the "4th Corporate Governance Summit” organized by CII in partnership with NFCG on February 5, 2009 in Mumbai.