Chapter 5: Other Recommendations

5.01 With the abolition of the office of Controller of Capital Issues (CCI) in the Department of Economic Affairs, the work relating to public issues and regulation of the capital market has been entrusted to SEBI, set up under the Securities And Exchange Board of India Act, 1992.

5.02 The DCA administers the Companies Act, 1956, and provides for the regulation of companies from their birth (registration) to their death (winding up). There are about six lakh companies registered in India. Of these, about 9,000 have accessed the capital market and are, therefore, listed companies, subject to the discipline and the rigours of the SEBI Act and its regulations.

5.03 It has been strongly argued before the Committee that this has caused an increasing overlap, with adverse consequences. First, investors, companies and other stakeholders seem to be falling between the cracks. This was sufficiently demonstrated in the recent stock market investigations, when the suspect companies were inspected by both the DCA and SEBI, but neither was able to take effective action in providing relief to the investors, or quickly punishing the perpetrators. The lack of concerted action against vanishing companies was cited as another example of neither accepting responsibility for the subterfuge that could take place, and the remedial action that did not.

5.04 Secondly, there is considerable duplication. Several examples were placed before the Committee. The Government have set up an Investor Education and Protection Fund (IEPF) and an Investor Education and Protection Committee (IEPC) in accordance with section 205C of the Companies Act, 1956. In parallel, the SEBI has set up an Investor Education and Protection Fund/Committee at the same time. Similarly, section 210A of the Companies Act provides for setting up the National Advisory Committee on Accounting Standards (NACAS), and a national level committee has been accordingly set up. However, the SEBI, too, is prescribing accounting standards as part of its listing agreements under clause 49 of its regulations. Often, different directions are given on the same subject. For instance, the Companies Act allows presentation of accounts in an abridged form, while SEBI’s listing requirements do not permit this.

5.05 While the SEBI should have the power to prescribe additional requirements for listed companies, it seems reasonable to the Committee that SEBI ought not to, in deference to the doctrine of ‘occupied space’, exercise its powers of subordinate legislation in areas where specific legislation exists — as in the Companies Act. It was pointed out to the Committee that section 11A of the SEBI Act is subject to the provisions of the Companies Act, which reinforces the Committee’s view that SEBI may not legislate in matters that have already been legislated upon by Parliament.

5.06 The US Securities Exchanges Commission (SEC) model is often cited, in support of the comprehensive listing requirements being laid down by SEBI. The analogy is not on all fours, because the system in the USA is radically different. Company laws in the US are state subjects, and the state laws control companies. Due to the strong federal character of the American polity, there is a great variance in the administration of companies from state to state. For instance, some states do not even require that company accounts have to be audited by public accountants. As a result, the SEC has had to perform a central unifying legal and regulatory role for companies listed on the stock exchanges. Since, in India, company law is a Central subject, and there is uniformity across the country, it is probably not necessary for SEBI to have all of the powers of the SEC.[1] In any case, the Committee feels that there should be much greater consultations between the SEBI and the DCA prior to crafting materially significant laws and regulations.

Recommendation 5.1: SEBI and Subordinate Legislation

  • SEBI may refrain from exercising powers of subordinate legislation in areas where specific legislation exists as in the Companies Act, 1956.
  • If any additional requirements are sought to be prescribed for listed companies, then, in areas where specific provision exists in the Companies Act, it would be appropriate for SEBI to have the requirement prescribed in the Companies Act itself through a suitable amendment.
  • In recognition of the fact that SEBI regulates activities in dynamic market conditions, the DCA should respond to SEBI’s requirements quickly. In case the changes proposed by SEBI necessitate a change in the Companies Act, the DCA should agree to the requirement being mandated in clause 49 of SEBI regulation until the Act is amended.
  • It would be appropriate for SEBI to use its powers of subordinate legislation, in consultation with the DCA, and vice versa. All committees set up either by SEBI or DCA to consider changes in law, rules or regulations should have representatives of both SEBI and DCA.
  • A formal structure needs to be set up to ensure that the DCA, which regulates all companies, and SEBI, which regulates only listed companies, act in coordination and harmony.

Strengthening the DCA and ROC Infrastructure

5.07 With the current strength of officers in the Inspection Wing, the DCA is able to carry out only about 200 to 250 inspections per year. Consequently, instead of being a system of regular, random reviews, inspections have become instruments of a complaint-based regime. Naturally, then, there is stigma attached to each inspection carried out by the DCA. Worse, these inspections focus only on the contents of the complaint (often inspired, the Committee was told, by rivals); there is no review of systems, or of practices being followed by companies. There is inadequate feedback on the difficulties that companies are facing in coping with the compliance of laws and practices prescribed by the department, or of the loopholes discovered by the unscrupulous.

5.08 The DCA informed the Committee that outsourcing work to professionals is also being considered. While supporting this proposal, the Committee felt that official manpower will still need to be augmented to do the traditional work more expeditiously, as well as to process the reports received from such professionals for launching remedial action. Given the phenomenal increase in the number of companies in the country, and even after accounting for the efficiencies resulting from the use of IT and selective outsourcing, the Government should consider setting norms for strengthening the inspection wing of DCA — especially by providing for, and encouraging, medium-term contractual appointments of relevant specialists. DCA should be enabled to annually inspect at least 6,000 registered companies, and that the Department would carry out such inspections regularly and on the basis of random selection.

5.09 The Committee also observed that the DCA’s inspecting officers lack adequate transportation or communication facilities necessary for better discharge of their functions. Mobility is essential if DCA’s inspectors are to do a timely and effective job. Perhaps because of the pressure of arrears and limited staff, the DCA has not actively pursued a programme of upgrading the skills of its inspectors. There is hardly any training programme worth the name. In fact, both in terms of their equipment and their skill sets, DCA’s inspectors seem to be caught in a time-warp — trapped, as it were, in a mindset of the 1950s. DCA needs to re-fashion its inspection wing as a crack investigation team, well equipped not only in staff strength, but also in skills and knowledge of the dynamic corporate world in which they must now function.

5.10 Business and industry associations brought to the notice of the Committee that against a collection of about Rs.300 crore, the Government spends (as non-plan revenue expenditure) only about Rs.45 crore on providing services to companies through the DCA. As a result, the ROC and allied offices are ill-organised, ill-equipped, cramped, unfriendly and poorly furnished. Companies representations have stated that fees should not be treated as a source of income — and the quality of services provided should match the income the Government realises from fees and charges.

5.11 It was also brought to the notice of the Committee that most of DCA offices are in cramped rented buildings, often without adequate space for visitors, or for public inspection of documents. This is a permanent Department of the Government, unlikely to be ever wound up. As such, there is a need for the DCA to establish its own buildings, which are modern offices, designed around its functional requirements. The Committee felt that this was as important as computerisation; in fact, to the extent that the DCA does not have its own requirement-defined buildings, the success of the computerisation programme would be diluted.

5.12. The ROC offices are clearly overstretched, as Table 1 below shows. In 1980, there were 3,100 companies per ROC. By 2001, the number of companies per ROC had risen to 28,500 — over a nine-fold increase. Similarly, number of documents being filed with each ROC, on the average, has risen from about 3,00,000 per ROC per year to over 28,00,000 per ROC. This has contributed to the declining standards of service, abysmal standards of maintenance and offices that are bursting at the seams. There is clearly a need to increase the number of ROCs offices to handle such large number of companies. While modernisation and computerisation will ensure that such an increase need not be in direct proportion, one cannot get away from the need to increase the number of ROC offices as well as staffing in each.

Table 1 Increase in workload of ROCs, from 1980 to 2001

Parameters As on 31.3.1980 As on 31.3.1990 As on 13.3.2000 As on 31.3.2001
No. of ROCs 18 19 20 20
No. of companies 56,493 2,02,128 5,42,434 5,69,100
No. of documents @ 5 documents per company 2,82,465 10,10,640 27,12,170 28,45,500
No. of companies per ROC 3,139 10,638 27,122 28,455
No. of documents per ROC 15,693 53,192 1,35,609 1,42,275

5.13 The panacea seems to lie in outsourcing (including random scrutiny, and pre-certification), contractual appointments, computerisation, a continuous increase in staff strength on a normative basis, better transportation and communication facilities, and a regular honing of skills through training. The Committee felt that the Government’s intent to clean up the corporate sector should, first of all, be reflected in cleaner, more efficient, professionally managed and client-friendly Government offices. The Government should lead by example.

Recommendation 5.2: Improving facilities in the DCA offices

  • The Government should increase the strength of DCA’s offices, and substantially increase the quality and quantity of its physical infrastructure, including computerisation.
  • This should be accompanied by increased outsourcing of work, contractual appointments of specialists and computerisation — all of which will reduce, though not eliminate, the need to increase the officer-level strength of the Department.
  • The inspection–capacity of the Department needs to be increased sharply; inspections should be a regular administrative function, carried out largely on random basis.
  • Officers of the DCA need to go through refresher and training courses regularly. In view of the very dynamic world in which they function, continuous upgrading of their skills is essential

Corporate Serious Fraud Office (CSFO)

5.14 Economic and corporate growth in the country can not be sustained at the desired levels without large-scale public participation in corporate investments. The body of small investors must have adequate confidence in the market, directly, or even better, through the mutual funds. One important element of this faith is the ability of the regulator to quickly investigate frauds and punish the guilty.

5.15 Investigations into the recent stock market ‘scam’ have underscored the limitations of a fragmented approach in our enforcement machinery. Though a number of agencies investigated the highly publicised fraud, none really got the holistic picture of what really happened. The chances of effectively punishing the fraudsters, in such a situation, are very slim.

5.16 Financial frauds in the corporate world are very complex in nature, and can be properly investigated only by a multi-disciplinary team of experts; there are limits to what even gifted amateurs can achieve, especially when they do not have a common platform and different enforcement agencies concerned play a lone hand from their respective turfs. There is a need to provide for a more concerted approach, perhaps by creating an office along the lines of the Serious Fraud Office (SFO) in the United Kingdom.

5.17 The CSFO should consist of several multi-disciplinary teams of investigators – each team being entrusted with one, or a maximum of two investigations at one time. Such team or unit could consist of some, or all of the following, depending on the exigencies of the case:

  • Two experts in company law, (chartered accountants/company secretaries) including one with experience in corporate management.
  • One expert in taxation.
  • One expert, with experience of launching prosecution in the area of economic offences.
  • One expert in the area of overseeing or guiding research into cases of serious corporate malfeasance.
  • One expert in the area of information technology, with ability to conduct IT audits (computer forensics).
  • One expert in the field of criminal investigation.
  • One expert in forensic auditing.
  • One expert on capital markets, with experience in regulation of capital markets and international financing.

5.18 The above posts, wherever suitable serving officials are available, may be filled by inducting officers on transfer/deputation. In other cases, competent persons would need to be inducted from outside the Government on contract. The Committee noted that such persons, especially in the fields of computer or audit forensics, or chartered accountants experienced in investigation of frauds (similar in qualification to the certified fraud examiners [CFE]), are unlikely to be available on government scales of pay. To provide necessary flexibility in this regard, the work of selection/appointment may be entrusted to a committee comprising the following:

  • Cabinet Secretary
  • Finance Secretary
  • Secretary, Department of Company Affairs
  • Secretary, Department of Revenue
  • Secretary Revenue
  • Law Secretary
  • Dy. Governor, RBI
  • Chairman SEBI
  • Director CBI
  • Director CSFO – Member Secretary

Whenever required Chairman CBDT/Chairman CBEC/Director Revenue Intelligence/Director of Enforcement may be invited as special invitees.

5.21 The proposed mechanism should be able to coordinate the efforts required from the various agencies and regulators — which alone can generate the synergy required for achieving results. This committee itself should be empowered to sanction posts and expenditure for the CSFO. The CSFO should have the powers to launch investigation and prosecution under various laws, such as the Income Tax Act, Foreign Exchange Management Act, SEBI Act, etc apart from the Companies Act and the Indian Penal Code in respect of cases entrusted to the CSFO.

5.22 Investigations by the CSFO should be directed to yield the following results

  • a quick unravelling of the fraud or scam, the persons who committed offences or were in the conspiracy, with the intent to bringing them to justice quickly
  • maximum recovery of the gains from the fraud, and the restoration of such assets/moneys to their rightful owners
  • identification of weaknesses in law or monitoring and reporting systems etc. that have allowed the fraud to take place, to enable the Government to take corrective action.

5.23 The Committee noted that in the USA, a Corporate Task Force envisaged as a SWAT team has been set up. The Committee feels that a composite task force including relevant experts should be constituted for each case in order to do full justice to the investigation in depth to ferret out full facts of the case.

Recommendation 5.3: Corporate Serious Fraud Office

  • A Corporate Serious Fraud Office (CSFO) should be set up in the Department of Company Affairs with specialists inducted on the basis of transfer/deputation and on special term contracts.
  • This should be in the form of a multi-disciplinary team that not only uncovers the fraud, but is able to direct and supervise prosecutions under various economic legislations through appropriate agencies.
  • There should be a Task Force constituted for each case under a designated team leader.
  • In the interest of adequate control and efficiency, a Committee each, headed by the Cabinet Secretary should directly oversee the appointments to, and functioning of this office, and
    coordinate the work of concerned departments and agencies as described in paragraphs 5.17 and 5.20.
  • Later, a legislative framework, along the lines of the SFO in the UK, should be set up to enable the CSFO to investigate all aspects of the fraud, and direct the prosecution in appropriate courts.

Changes in Law

5.24 Basically, good corporate governance, like honesty, is a matter of personal conviction, and internal creed, rather than of discipline enforced from without. At another level, it is good business because it inspires investor confidence, which is so essential to attracting capital. All the confidence, however, that the good companies build, and the good work that they do over time can be largely undone by a few unscrupulous businessmen, and fly-by-night operators. Vanishing companies are a case in point; in fact, several bad apples have surfaced in the basket of corporate India resulting in frauds and scams on a large scale.

5.25 The Committee has identified various sections in the Companies Act which require strengthening to provide for action and penalties that have adequate deterrent effect. The Committee has noted the inadequacy of penalties in several sections of the Companies Act. A few examples will demonstrate this. Section 77 of the Companies Act places restrictions on the purchase by a company of its own shares or that of its holding company. Companies often indulge in such practice only to exaggerate their volume of trading, and to drive up its share prices. This amounts to misleading the various stakeholders, a case of corporate mis-governance, if not downright fraud. And yet the maximum penalty prescribed in this area is only Rs. 10,000/-. The Committee recommends that the penalty should be linked to the amount of ill-gotten gains involved in the illegal purchase, and prescribed as a percentage of that amount. Sections 370 and 372 of the Companies Act has placed limitations on the loans/guarantees that a company may give, or investments in shares that it may make; or seek the approval of Central Government. In the year 1999, a new section, 372A was inserted in this Act (made effective from 31.10.1998) which effectively did away with the need for Government approval. This was a step in the right direction to give companies more freedom of operation. However, some managements regretfully have misused the provisions of the new section 372A to transfer, indirectly, huge sums of money to the stock market, specifically to entities associated with a particular operator through smaller private limited companies or partnership/proprietorship firms. It is recognized that greater freedom implies greater accountability. The liberalizing intent of section 372A was not to give freedom to the management to play the stock market, and ‘lose’ huge sums of company money on it. The Committee feels that if a company violates or misuses the provisions of section 372A, those responsible should be severely punished. A term of imprisonment be provided as a penalty under this section, and the offence made non- compoundable.

5.26 The above discussion shows that to conceal the actual recipients of the moneys, the company often uses partnership/proprietorship firms as intermediaries and cut-outs. Since the latter are not ‘companies’, the trail, as it were, ends there. Similarly, subsidiaries have been used, merely for intermediate transfers. This is indeed a clever ruse to beating the intent of the law. The Committee, therefore, recommends that the Department of Company Affairs should, find a way to put appropriate checks and balances.

.5.27 The Committee was informed that another committee headed by Shri Shardul Shroff is already examining the issue of rationalization of penalties. Therefore, the Committee is not making any further recommendations on the subject. It hopes that the Shroff Committee would finalize its recommendations, and the Department would act on them, expeditiously.

5.28 Section 274(1)(g), inserted in the Companies Act in December, 2000, now provides for disqualification of directors in certain circumstances. This is clearly an attempt to improve corporate governance. However, the disqualification, at present, is attracted only if annual accounts/returns are not filed or if there is failure in the repayment of deposit or interest thereon. The Committee feels that conditions attracting disqualification should be widened to include repayment on debentures, or interest thereon, or serious offences such as those covered under sections 77 and 372A of the Act. The Committee, therefore, recommends that the Department should further amend section 274(1)(g) so that disqualification is also attracted by directors of companies which indulge in what the Department considers serious offences of betrayal of fiduciary responsibilities. However, only willful defaults should be covered, to distinguish from defaults arising from genuine business failures. Further, institutional investors need not be protected from default, through this section, as they should be able to protect their own interests.

5.29 However, in doing so, the Department also needs to re-examine the extent to which it would want the disqualification to apply to independent directors. The Committee was informed that institutional directors had already been exempted by the department from the rigours of this section; similar exemption needs to be given in case of independent directors.

5.30 It was brought to the notice of the Committee that when large advances were routed, by listed public companies such transfers were often disguised as ‘trade advances’, or advances for purchase of particular shares. It is not clear to the Committee as to why any company should return to do so in totally unrelated areas. It seems this is just a ploy to either fund the purchase of its own shares, or to play the stock market. This is established from the facts that tens of crores of rupees were ‘lent’ by listed public companies recently to entities having very small paid up capital, and that these smaller companies transferred the moneys to the stock-brokers within hours of receiving it. The Committee feels that managements/boards should not be able to misapply shareholders funds in this manner. Above a certain limit, companies should need to immediately disclose such transfers to a prescribed authority.

5.31 The Committee would like to make several recommendations in this regard. First, any company that buys or sells shares, a stock-broking company, should be subject to a different, stricter regime, especially with regard to laws that govern borrowing or lending of funds by companies. Secondly, loans or deposits to such a company should be limited to a proportion/multiple of its paid-up capital and share reserves; conversely, a company should not be able to borrow more than a proportion/multiple of its paid-up capital and free reserves. This is justified also on the ground that companies need to maintain a rational debt to equity ratio. Thirdly, the unanimous resolution under section 372-A of the Companies Act should in fact be signed by all the directors, and not merely approved by those present and voting. Finally, this resolution should state unambiguously that no part of such moneys shall be used, directly or indirectly, for a purpose other than that stated in the resolution, or for earning interest in private limited companies, or for the purpose of playing the stock market. This additional responsibility is a concomitant of the liberalized provisions of section 372A.

5.32 Judicial delays in this area are well known. The Committee was not surprised to learn that prosecutions are pending in Courts for years together, it is, astonishing nevertheless that DCA have perhaps been unable to secure a jail term in even a single case in the last five decades. The Committee noted that prosecutions once filed are followed up by an officer designated for the task. Often, this post remains vacant, with the result that this important aspect is looked after by another officer in addition to his regular work. The Committee would like to make two recommendations in this regard. First, the prosecution wing in the DCA needs to be strengthened by increasing the strength of personnel in the wing, and supplementing it by hiring better advocates, perhaps on a retainer basis, instead of relying only on the over-worked government advocates. Secondly, the Department should examine the possibility of introducing shortened procedures, along the lines of the recent amendment to the Code of Civil Procedure e.g. recording evidence through commissioners.

5.33 A major issue confronting the regulators today is the absence of special law that would permit disgorgement, from the perpetrators, of the proceeds of frauds or illegally earned proceeds, or its return to rightful owners such as the shareholders. Vanishing companies are a case in point. Prosecuting promoters may lead to imposition of fines, perhaps even imprisonment. But the money that the investors have been cheated of is out of reach, as per the provisions of the existing law. From the point of view of the investors, prosecution of such promoters is a case of locking the barn after the horse has bolted. The Committee noted that the SEBI Act has been recently amended to give it certain pre-emptive powers, such as attachment of bank accounts, so that the ill-gotten gains do not disappear. The Committee recommends that similar provisions be made in the Companies Act, subject to the necessary safeguards, such as approval of the Company Law Board, or its successor body (when formed).

5.34 Corporate mis-governance, with or without breach of the law, is often about managements/promoters taking the minority shareholders for a ride. Yet, the offence lies on the company itself; thus, if a heavy monetary penalty is imposed then, in a way, the minority shareholders are being penalised for the ride that they were taken on. Worse, expensive advocates are hired, air journeys undertaken and hotel accommodation paid for, with the money of the shareholders, to defend the management/promoter who has cheated them in the first place. This double jeopardy needs to be removed, if necessary, by inserting a new section in the Companies Act. The manager/promoter held guilty should be asked to pay the legal cost after proven guilty , after disposal of appeal, if any.

5.35 With regard to subsidiaries, another point needs to be made. Investments in, returns from and dealings with subsidiaries should be known to the shareholders of the parent company, in easily understandable formats. For this reason, consolidated financial statements (CFS) have come to be internationally accepted. The ICAI has also prescribed accounting standards for CFS. The Committee recommends that CFS be expeditiously provided for in the Companies Act.

Recommendation 5.4

  • Penalties ought to be rationalized, and related to the sums involved in the offence. Fees, especially late fees, can be related to the size of the company in terms of its paid-up capital and free reserves, or turnover, or both.
  • Disqualification under section 274(1)(g) of the Companies Act, 1956 should be triggered for certain other serious offences than just non-payment of debt. However, independent directors need to be treated on a different footing and exempted as in the case of nominee directors representing financial institutions.
  • A stricter regime should be prescribed for companies registered as brokers with SEBI. Greater accountability should be provided for with respect to transfer of money by way of Inter Corporate Deposits, or advances of any kind, from listed companies to any other company, as a necessary concomitant of the liberalisation that section 372A of the Companies Act, 1956 provides.
  • DCA’s prosecution wing needs to be considerably strengthened. Streamlined procedures be prescribed in the Companies Act, on the lines of the recent amendments to the Code of Civil Procedure.
  • To ensure that proceeds from illegal acts and frauds do not escape recovery, Companies Act needs to be amended to give DCA the powers of attachment of bank accounts etc., on the lines of the powers recently given to SEBI. Ill-gotten gains must be disgorged.
  • Managers/promoters should be held personally liable when found guilty of offences. In such cases, the legal fees and other charges should be recovered from the officers in default, especially if the offences pertain to betrayal of shareholder’s trust, or oppression of minority shareholders. It is patently unfair that the shareholder is penalised twice, once when mulcted, and again to have to incur the legal expenses to defend the fraudster.
  • Consolidated Financial Statements should be made mandatory for companies having subsidiaries.

Compliance Audit

5.36 An important element of good corporate governance is transparency; hence the provisions for disclosures and filing of accounts which can be inspected. The Committee noted that there is insufficient compliance of even these basic requirements, as Table 2 below would show:

Table 2 Compliance rate in filing of documents

Year Companies Annual returns filed Compliance Rate (%) Balance sheet / P&L account filed Compliance Rate (%)
1994-95 353292 219705 62.19 221832 62.79
1995-96 409142 220318 53.85 201275 49.19
1996-97 450950 247423 54.87 267335 59.28
1997-98 484500 274814 56.72 277000 57.17
1998-99 511990 260530 50.89 270961 52.92

5.37 This unsatisfactory situation is aggravated by the fact that the ROC offices are able to take only half of the documents filed on record. The documents not taken on record are not available for inspection. This further brings down the effective compliance rate as Table 3 below would show:

Table 3 Net Compliance rate

Year Compliance in filing(Annual Returns) age of documents taken on record Effective compliance rate
1994-95 62.19 50.04 31.12
1995-96 53.85 46.47 25.02
1996-97 54.87 47.22 25.91
1997-98 56.72 54.57 30.95
1998-99 50.89 58.79 29.92

5.38 It was argued before the Committee that the Government is partly to blame for not ensuring these compliances so basic to good corporate governance. One answer in increasing the strength and facilities of ROC offices, in normative fashion, in proportion to the increase in the number of companies, as discussed in paragraph 5.09 above. The Committee, however, feels that the Government should explore two other avenues. First, since a large number of documents are not taken on record because they are defective, a system of ’pre-certification’, by company secretaries, can be introduced. The system would replace the current pre-scrutiny that the Department attempts to do, with only a mixed degree of success. Monetary and other penalties should be prescribed for company secretaries who incorrectly certify that the documents being filed are as required by law. Secondly, the Government could consider introducing in the Companies Act a provision which empowers it to order a ’compliance audit’, much in the same manner as the special audit that it can, at present, order under section 233-A of the Companies Act. The Committee would also recommend, from the point of view of not adding to the compliance costs, that this power be used rarely and sparingly. A natural concomitant of this added responsibility would be the responsibility, on the company secretaries issuing compliance certificates, to report to DCA any violations of the Companies Act that the company has willfully, or otherwise, committed.

Recommendation 5.5

  • DCA should consider reducing workload at offices of ROCs by providing for a system of ’pre-certification’ by company secretaries; the system should provide for monetary and other penalties on company secretaries who certify incorrectly, even through error or oversight
  • The Companies Act be amended to enable the DCA to order a ’compliance audit’, much in the same manner as it can order special audits under section 233-A of the Companies Act.


5.39 It was brought to the notice of the Committee that in the UK, auditors are required to certify the company they are auditing as a “going concern”. Apparently, inherent in the certification is the guarantee that the company would last for at least one more financial year. In the background of our own “vanishing companies”, the Committee found such a proposition rather attractive. It therefore recommends that, in addition, auditors could be requested to bring to the notice of the concerned stakeholders if there is a default in re-payment of debt or interest, or failure in the redemption of debentures, or payment of interest thereon, or a disqualification of director/s. In fact, in the case of debentures, auditors must report non-creation of security where there is such a failure. The Committee felt that these requirements should form part of the Manufacturing and Other Companies Auditors’ Report Order (MAOCARO) that is under revision currently. The Committee also felt that the provisions of section 293(1) (a) of the Companies Act should be strengthened to prevent any unnatural stripping of assets by the company, or any notable divestment of shares by the promoters or directors.

5.40 The Department currently carries out, as pointed out above, a technical scrutiny of documents filed by them. Due to pressure of work, inadequate training, and other reasons, this has been reduced to being a scrutiny pro forma rather than one of content. It was argued before the Committee that there should be a professional examination of the accounts filed by companies. It was equally forcefully argued , on the other hand, that merely going through the audited accounts of a company is not likely to add any value, as a correct picture can only emerge, if at all, when professionals look at the books of accounts, and a duplication of the entire audit process was not what was needed. The Committee feels that a review, by professionals, of the accounts filed with ROCs could reveal, prima facie, errors of commission or omission. When noticed, these could lead to a fuller investigation/inquiry, including the possibility of a full-fledged supplementary audit. The Committee is aware that a large number of issues such as confidentiality, independence of those auditing audit, genuine differences of interpretation etc. would be involved in examining a proposal such as this. The Committee would therefore like to recommend, in principle, the concept of random scrutiny of accounts. However, the concept and its implementation needs to be more fully delineated by an independent group charged with the responsibility of examining only this proposal.

5.41 In presenting, to the various stakeholders, a true and fair view of their company, the quality and professionalism of chartered accountants is crucial. A professional is as good as his training. It is, therefore, essential that those who join the profession are trained with the best assisting professionals. However, the ICAI prescribes the maximum number of articles that a firm can train. The Committee feels that this limitation is tantamount to denying the opportunity to a large number from joining the better firms. It was brought to the notice of the Committee that when there was no limit, some unscrupulous members of the Institute had issued false certificates of training. The Committee, however, felt that “capacity to train” of an accounting firm could easily be determined by the Quality Review Board being proposed in this report. It, therefore, recommends that this limit should be withdrawn as it promotes mediocrity rather than excellence. The ICAI, it was mentioned, is attending to this.

5.42 It was repeatedly stated before the Committee that corporate ethics are more about the culture, or the state of mind of the organization, rather than an outcome of legal provisions. Thus, healthy internal systems and practices are more important than legal limitations from without. Therefore, the Committee recommends, as has been done in the SOX Act that each company be asked to establish an internal code of conduct, and that the company’s performance be measured against the stated code.

5.43 The Committee noted the lack of research-based discourse on the impact of good corporate governance on economic performance. This is essential if companies are to be convinced that good governance makes for good business. Academic research will be of immense help to the DCA by bringing to its notice the shortcomings in the law and the suitable prescriptions. The Committee proposes that a part of the Investor Education and Protection Fund be earmarked for carrying out research in the area of corporate governance.

Recommendation 5.6

  • MAOCARO should be amended to provide that auditors report certain violations, such as those listed in paragraph 5.39.
  • Section 293(1)(a) should be strengthened to prevent any unnatural stripping of assets, or sale of shares by management/promoters
  • To reduce workload in ROC offices, as well as to improve auditing standards, the government should consider introducing a system of ’random scrutiny’ of audited accounts, in the same way as is done by the Accountancy Foundation in the UK, or is proposed to be done by the Public Oversight Board in the USA. However, this recommendation should be implemented only if, and after, DCA can take care of concerns such as the genuineness of randomness, client confidentiality etc., and is confident of its own manpower strengths and skills
  • ICAI should re-consider the limits it has set on the number of articles that a partner can train; something that has the unintended consequence of denying young prospective accountants the chance to train with the best in the profession.
  • Companies should be required to establish, and publish, an “Internal Code of Ethics”.
  • DCA should sponsor, and financially support, from the IEPF, research on corporate governance and allied subjects that have a bearing on investor/shareholder well- being.

5.44 Better quality of auditing would contribute to better corporate governance. Better professionals are likely to be produced when audit firms make higher investments in training, technology and human resource development. This is not possible if audit firms are small, as they cannot, and do not, have the wherewithal of bigger firms. In India, audit firms continue to remain chronically small. The country has as many as 43,000 audit firms, of which as many as three-fourths are single person proprietary firms. Less than 200 firms (0.5%) have more than 10 partners. Several reasons were advanced for this phenomenon. Some felt it was the regulatory regime set out by ICAI that discourages consolidation. Others felt that the small size of Indian audit firms was but a reflection of the small size of Indian businesses; that the audit firms were cast, as it were, in the image of their clients. Several other theories, including some very outlandish (cultural) ones, were advanced.

5.45 Whatever be the reasons, the adverse consequences for the profession are obvious. First, they are unable to compete with international firms in the lucrative consultancy/advisory and non-statutory work markets. Secondly, the profession seems to be in the constant fear of being swamped by international firms through the ‘back door’. Thirdly, council decisions could be driven by the requirement of satisfying this very large constituency of small firms. This can catch the profession in a vicious circle of taking decisions that will keep them small for all times to come. Finally, perhaps not enough is being spent on, or done for, top class professional development. Consequently, arguably the best accountancy brains in the world are not being shaped into world class accountants.

5.46 That being so, the Committee feels that professionals in India need to consolidate and grow. Consolidation will, in fact, create a virtuous circle, allowing them to grow and consolidate further. If they do so, they can compete with the best and the biggest in the world. There was a view that in the west consolidation had perhaps gone too far; it was stated that regulators there were now looking for ways to create options to the limited number of dominant firms. However, it was felt that here the profession was so fractured, that it was too early to worry about ‘over-consolidation’. The Committee felt that, for the present, a beginning should be made by the ICAI, and the government, by setting in place a regulatory regime that will foster, rather than hinder, this growth.

5.47 Related issues regarding the maximum number of partners, number of audits per partner etc. were discussed and reviewed by the Committee. Whilst the Committee received suggestions, both in favour and against these limits it felt that these issues are for the Institute of Chartered Accountants of India to decide after careful consideration of what is good in the long-term interests of the profession. However, the Committee accepted the suggestion of introducing the concept of ‘limited liability’, as per prevalent international norms, in India for partnership firms of professionals. This would encourage quality talent to be attracted to the profession, and allow for faster growth and consolidation of firms, by reducing the fear of unlimited liability for all partners The Committee therefore recommends that necessary changes in the law be made to allow for the incorporation/conversion of partnership firms to ‘limited liability’ firms.

Recommendation 5.7

  • ICAI should propose to the Government a regime and a regulatory framework that encourages the consolidation and growth of Indian firms, in view of the international competition they face, especially with regard to non-audit services.
  • The Government should consider amending the Partnership Act to provide for partnerships with limited liability, especially for professions which do not allow their members to provide services as a corporate body.

[1] There are variations across different regulatory jurisdictions. For instance, the Financial Services Authority in the UK does not lay down accounting standards.