SEBI Revises Consent Process

While Rajat Gupta, ex-board member of Goldman Sachs is facing the trial by fire on insider trading charges in US, Stock Exchange Board of India (SEBI) has tightened the screws on the consent process for stock market manipulations and offences.

SEBI last week revised the earlier rules passed in March 2007. Some of the critical features of the revised consent process are:

1. Face the Music

Certain defaults including insider trading, front running, failure to make an open offer, redress investor grievances and respond to the summons issued by SEBI are excluded from the consent process. The defaults falling in the category of fraudulent and unfair trade practices, which in the opinion of SEBI are very serious and/or have caused substantial losses to the investors, shall also not be consented.”

The details are below:-

SEBI shall not settle the defaults listed below:
i. Insider trading i.e. violation of Regulation 3 and 4 of the SEBI (Prohibition of Insider Trading)Regulations, 1992;

ii. Serious fraudulent and unfair trade practices which, in the opinion of the Board, cause substantial losses to investors and/or affects their rights, especially retail investors and small shareholders or have or may have market wide impact, except those defaults where the entity makes good the losses due to the investors;

iii. Failure to make the open offer (except where the entity agrees to make the open offer or if in the opinion of the Board, the open offer is not beneficial to the shareholders and / or the case is referred for adjudication);

iv. Front-running; for the purpose of this circular, front running means usage of non public information to directly or indirectly, buy or sell securities or enter into options or futures contracts, in advance of a substantial order, on an impending transaction, in the same or related securities or futures or options
contracts, in anticipation that when the information becomes public; the price of such securities or contracts may change;

v. Defaults relating to manipulation of net asset value or other mutual funds defaults where the actions of the asset management company (AMC)/ mutual fund (MF)/sponsor, result in substantial losses to the unit holders, except cases where the entity has made good the losses of the unit holders to the satisfaction of the Board;

vi. Failure to redress investor grievances(except cases where the issue involved is only of delayed redressal);

vii. Failure to make such disclosures under the ICDR and Debt Securities Regulations, which in the opinion of the Board, materially affect the right of the investors Non-compliance of summons issued by SEBI;

ix. Non compliance of an order passed by the Adjudicating Officer (AO), Designated Member (DM) or Whole Time Member (WTM);

x. Any other default by an applicant who continues to be non-compliant with any order passed by the (AO) or (DM) or (WTM).”

This means that where SEBI considers breach of law or listing guidelines, the companies, investment managers, brokers etc. won’t be able to pay a fine and get away with it. Previously, on such charges, SEBI allowed them to pay the fine while not admitting guilt and sometimes by voluntarily agreeing to debar from the  from stock markets. Now without being allowed to go through the consent process, the organizations and persons alleged to have committed the above-mentioned acts will have to go through a legal process for criminal offences except in some exceptional cases. SEBI has allowed itself some room for maneuverability for some cases. In regular cases, now an organization can go through the consent process only for small technical breaches.

2. One Time Lucky

No consent application shall be considered, if any violation is committed within a period of two years from the date of any consent order. However, if the applicant has already obtained more than two consent orders, no consent application shall be considered for a period of three years from the date of the last order.”

Hence, this clause allows leeway once only in a couple of years. If an organization has already gone through a consent process, it is not going to get away easily without some criminal charges the next time round. The practice of organizations to claim a mistake has been made every year whenever they get caught will have to stop.

Closing Thoughts

The rules are good. SEBI is finally gearing itself to govern and regulate the stock markets properly. This move in the long-run will build investor confidence and dissuade asset managers, brokers and organizations from indulging in malpractices. Reliance Industries has an ongoing case for insider trading, along with a couple of other banks for front running and stock market manipulations. Reliance has appealed to the Bombay Courts to be allowed to go through the consent order process available before as it’s case is  from 2007.

The method SEBI chooses to deal with the older cases, will decide the fate of many organizations. It appears the organizations are worried, and that for regulators is a good strategy. The last high profile case of consent was of Anil Ambani group in which the group paid a Rs 50 crore (USD 8.93 million ) fine. Hence, in all likelihood the organizations with pending cases will either have to pay high fees or face criminal charges.


  1. Streamlining of Consent Process
  2. Modified Consent Process Circular
  3. Reliance Industries moves Bombay High Court on new consent order rules

Can Compensation Committees in India Decide Executive Pay?

With great power comes great responsibility. However, with the recent protests in US and UK by investors on banks CEO’s pay (RBS, Citi, Barclays), this dictum can be altered to “with great power comes a great salary”. This debate again raised the discussion on role of compensation committees. Are the compensation committees empowered to decide salary of CEOs or is it just a theoretical eye-wash? Let us delve on this topic from an Indian perspective, as till now the investors haven’t raised a hue and cry about it.

1. A Look at the Highest Paid CEOs

Business Today jointly with INSEAD-HBR did a study to identify India’s best CEOs by evaluating their performance from 1995-2011. As per the study Mr. Naveen Jindal, CEO of Jindal Steel & Power ranked first, followed by Mr. A.M.Naik, CEO of Larsen & Turbo and Mr. Y.C. Deveshwar, CEO of ITC. By another study Mr. Jindal is also the highest paid CEO in India with a salary of Rs 69.7 crores. (USD 12.75 million ).

However, the other two CEOs do not come in the top ten list of highest paid CEOs in India, as both are professional CEOs. Mr. Deveshwar’s salary plus perks excluding bonus was Rs 5.52 crores (USD 1.01 million) and he was entitled to a bonus limited to Rs.6.24 crore (USD 1.42 million) for 2011-2012 financial year. Mr. A.M.Naik’s salary including stock options was Rs 14.18 crores (USD 2.59 million) for the same period. Though market capitalization, net profits and growth have been on similar graphs for all the three companies.

Mr. Mukesh Ambai, CEO of Reliance Industries is ranked seventh on the list of best CEOs’. After being on the highest paid CEO list in 2008, he voluntarily decided to restrict his salary to Rs 15 crores ( USD 2.74 million) though he had shareholder approval for Rs 38.82 crores ( USD 7.10 million). However, the amount is peanuts considering his wealth. He is the richest man in India with a net-worth of USD 22.3 billion  and he along with his family are entitled to dividends of Rs 1244.33 crores ( USD 227.73 million) in 2011-12 financial year from Reliance Industries alone.

Most of the highest paid CEOs in India, consist of promoter-owner CEOs, and not professional CEOs. There is a huge disparities in the pay structures.

2. Disparities in Pay Structure of Chairman, Managing Directors and Directors

Looking from the regulatory angle, as per the Companies Bill, a managing director ( CEO in American terms) pay cannot exceed 5% of the net profits of the company. The total remuneration to directors cannot exceed 11% of net profits of the company. However, if approval of higher salary is taken from the shareholders in a general meeting, the limit can be exceeded with the approval of Central Government. Now the question is,  as the CEOs get the highest pay packet and promoter-owner CEOs have controlling stake, can the other directors really have much say, monitor the activities and decide on remuneration?

Coming back to Mr. Jindal’s case, he stated in the Business Today interview, that he spends 20-25% time on business, and most of his time is spent on his constituency as he is a Member of Parliament. Members of Parliament just earn around Rs 50,000/ per month. His mother, Savitri Jindal is the Chairperson of the Jindal group and 56th richest person in the world with the net-worth of USD 13.2 billion in 2011. Therefore, considering all this information, can the success of the company be attributed to him? Moreover, does he deserve this salary? Can the remuneration and compensation committee actually decide his salary independently and objectively?

Now let us look at the compensation of Chairman and Directors. Here are some details from  the India Board Report 2011: 

a) Non-executive director compensation ranged from Rs 1 to 10 lakhs (USD 18,000) in more than half of the companies surveyed. Average compensation rose 20% to Rs 9.9 lakhs in 2009-10 from Rs 8.2 lakhs in 2008-09.

b) The minimum compensation paid to non-executive directors was Rs 15,000 whereas the maximum
was Rs 54 lakhs (USD 100,000) for 2009-10 from among the companies surveyed.

c)  The average compensation paid to non-executive chairmen rose from Rs 15.7 lakhs in 2008-09 to Rs 21.7 lakhs (USD 38,000) in 2009-10, an increase of 38%.

d) Among the companies surveyed, the minimum compensation offered to the non-executive
chairman was Rs 16,000 and the maximum was Rs 13 crores (USD 2.37 million).

Hence, if you see the CEOs pay usually far exceeds Chairperson and Directors pays. There is no parity in their earning capacities and value for time.

3. Questionable Independence of Compensation Committees

In such a scenario, are boards capable of judging remuneration of CEO or other key personnel objectively? Generally, the Nomination and Remuneration Committees are charged with job. As per the Companies Bill in India, the committee should “consist of  three or more non-executive directors out of which not less than one half shall be independent directors.” Hence, the premise is that as there are independent directors, they will be fair. However, the question remains are these directors really independent ? Below are some information nuggets from the India Board Report 2011.

a) On an average in Indian boardrooms, 71% of directors are non-executive and 54% of the directors are independent. Just 16% of the directors are related to promoter or promoter’s spouse.

b) Just 10% of the board members were appointed through search firms. The rest were chosen through personal network of chairperson and managing director.

Therefore, in a way the independent directors appear superficially independent and there are deep relationships existing among them. More so, in family managed business. For instance, ITC has a diverse board room as public sector companies and banks have significant investments in the company. It is a 100 years old company and in last 15 years Mr. Deveshwar was the CEO. Therefore, the compensation committees can be transparent and objective only when they are not under the control of owner-promoter CEOs.

Closing Thoughts

In the western world, CEOs of banks and financial institutions are facing investment ire for unduly rewarding themselves at the expense of the shareholders. In India, the investors generally do not make any noise on pay structure of the owner-promoter CEOs as investors expect them to reward themselves. Although, the owner-promoter pay structures are 3-4 times higher than the professional CEOs. With such a mindset, can we really say corporate governance practices have a chance of succeeding in India? It is a controversial question, nonetheless, let me ask – What should the investors and regulators do to control promoter-owner CEO’s salaries?


  1. Business Today – India’s Best CEOs
  2. India Board Report – Hunt Partners, PWC  and AZB & Partners
  3. Highest paid CEOs in India
  4. Mukesh Ambani’s salary and dividend
  5. Mukesh Ambani’s net-worth as per Forbes
  6. Savitri Jindal’s net-worth
  7. ITC chief Y C Deveshwar Pay Structure
  8. L &T chief A.M.Naik’s Pay Structure

Reflections on New Companies Bill Auditor Rotation Clauses

The New Companies Bill 2011, tabled at the Parliament proposes a few clauses on auditor rotation. According to the new provisions, an auditor will be appointed in the first annual general meeting for a five-year term. Thereafter, the auditor will be changed as per the members’ decisions.

An additional clause for listed companies states that the same individual auditor cannot be appointed for a term exceeding five consecutive years. Secondly, an audit firm cannot be re-appointed for more than two five-year terms. For re-appointment purposes for the individual auditor or audit firm, there has to be a gap of five years. Moreover, for appointment or re-appointment purposes, there should be no common partners between the new firm and old audit firm.

Another interesting clause is that members can resolve to ask the audit firm to rotate the audit partner and team every year.

These clauses will ensure that auditors rotate every five years in the listed companies. As investor confidence is based on independent reporting of the auditors, the thought behind these clauses is that rotation of auditors will ensure independent reporting. The move is good, as economic growth is dependent on investor confidence in financial reporting. These clauses were incorporated in the draft after the Satyam fiasco. However, rotation isn’t a silver bullet that will resolve all auditor independence issues. A few concerns about the clauses are listed below:

1. Appointment of auditors for listed multinational companies.

Similar auditor rotation provision do not exist in other countries. In US, PCAOB recently held discussions on auditor rotation and independence. The general opinion of US auditors was that rotation does not ensure independence and comes with a huge financial cost. Hence, the question comes up whether multinational companies will be open to having different auditors in India, than in their headquarters. For large organizations, consolidation of accounts from different locations is a huge task, and with different auditors the information flow and audit practices may differ. Hence, the head office auditor may find it difficult to rely on the work of a local auditor.

Multinational companies are generally comfortable with big four, hence the audit will continue to rotate between big four. Very few Indian companies have the skill set and bandwidth to audit large multinationals. Therefore, this clause will put some practical challenges for multinational listed companies.

2. Audit firms’ partnerships

Indian audit firms scenario is unique in a way, as Institute of Chartered Accountants of India prohibits foreign audit firms to practice in their own name. Pricewaterhouse is the only one allowed, since it entered the market before these guidelines were passed. Others, for instance, Ernst & Young Indian member firm is S.R.Batliboi and company, and all audits are performed in Indian firm’s name, though partnerships are common. The provision of not having common partners applies in this scenario, as some audit firms are auditing under multiple names. PWC audits under the names of PW and Lovelock & Lewis.

The challenge in this clause is that audit partners move among the group companies. Some firms have organized the partnerships in a way to avoid common partnerships, however work under the same management. It will be a difficult task for companies to identify linkages between various audit firm partnerships. The onus should ideally rest with the audit firm to ensure that there are no common partners.

Another interesting aspect is  audit partners movement among big 4 and other companies. If an audit firm is pursuing an appointment, they now will have to be careful that another firms audit partner is not recruited in their partnership at the same time. This might again result in some fancy footwork to avoid the loss of a client.

3. Independence of the retiring auditor

According to the provisions, audit firm will mandatory be changed after two consecutive five-year terms. In simple words, ten years is maximum period an audit firm can audit a client on a single stretch. Hence, the audit firm knows that it is going to lose the audit client, however, the option to provide non-audit related services opens up. Law prohibits auditors from providing the following services to audit clients:

(a) accounting and book-keeping services;
(b) internal audit;
(c) design and implementation of any financial information system;
(d) actuarial services;
(e) investment advisory services;
(f) investment banking services;
(g) rendering of outsourced financial services;
(h) management services; and
(i) any other kind of services as may be prescribed

These services generally are more lucrative than the audit fees earned. Hence, a retiring auditor may wish to keep good client relationships to obtain future assignments. In such a scenario, one has to view rotation benefit skeptically, as the audit firm may not maintain independent reporting  as desired. Rotation of auditors in such a case may just result in adherence to legal requirement instead of contributing to auditor independence. As such, old Indian business houses have 2-3 audit firms that they use interchangeably in various subsidiaries for audit and other services. The work would just get shared among them.

4. Selection of new audit firm

As mentioned earlier, selecting a new audit firm will be difficult for large organizations. Reason being, besides big four there are just a handful of Indian audit firms who have the capability of conducting audits of multinational organizations. A few of these would already be providing some consulting services to the audit client, hence would not be eligible for appointment as auditors. If the potential of earning from consulting services is more, they might not drop those assignments in favor of audit.

Next aspect is that the provisions have additional clauses for barring a person from becoming an auditor. These relate to the usual clauses of individual, partner or his relative not having in holding or subsidiary companies – securities, directorships, loans, business relationships, managerial positions, or any other conflict of interest.

These clauses result in audit firms and client doing a lot of leg work to ensure that all legal requirements are met. All these aspects limit the choice of selection of new auditor to 3-4 audit firms. Since the audit business is going to circulate among the same set of audit firms, it is doubtful that mere auditor rotation would result in better financial reporting.

Closing thoughts

Auditor independence is a complex subject as it forms the bedrock of investor confidence in financial reporting.  Auditor rotation is a good step to ensure that auditors do not lose their professional skepticism and independence by doing the same audit for decades. However, additional quality monitoring procedures of audit firms and review procedures of financial reports need to be built in the regulatory system in India. India lacks a few aspects of US and other developed countries in this matter, however, that is a discussion for another post. On a positive note, the rotation clauses give an opportunity for medium-sized Indian audit firms to build skill sets to pitch in for business of large organizations.

India Country Risks in 2012

Indian organizations are in for a rocky ride in 2012 as darkening clouds hang over India growth story. In some ways it is a make or break year for India’s continuing successful journey for economic growth and power. The world is watching and India cannot afford to flounder. However, the risks in the economic environment are acting as tsunamis and volcanoes, wiping out past efforts swiftly. This year Indian organizations need to watch out for external risks and triggers carefully, as they can have huge impact on the bottom line of the company.

The prophets of gloom and doom predict that India’s GDP in 2012-2013 financial year will be between 6-7%. In light of prevailing political and economic environment this statement is a conservative realistic assessment. Hence, organizations to sustain and grow in 2012 need to conduct strategic risk assessment of India country risks. I am giving below my top four.

1. Political Paralysis

In 2011, Prime Minster Manmohan Singh’s reputation has nose-dived as the country was engulfed in corruption scandals. His continuance as Prime Minster till the end of term is widely debated in political circles. The Congress party is facing another crises due to Sonia Gandhi’s ill-health. Public is speculating that she has undergone surgery to treat cancer in USA. Hence, rumors are rife about Rahul Gandhi  taking over the reigns of the party. Moreover, senior Congress party leaders are having spats in public.

Last but not the least, Anna Hazare’s fight against corruption has awakened the middle class. Finally, they have lost their apathy and are demanding better governance.

Considering all aspects, there is little likelihood of a strong national party leading India in 2012. Moreover, political commentators are hinting about mid-term polls due to fishers in Congress party and it’s deteriorating credibility. Therefore, large organizations must manage political risks at national and local state level. Keep in mind sensitivities of various political parties otherwise their is a probability of getting caught in a tug of war. Also, adjust the growth plans for government ineffectiveness.

2. Financial Market Turmoil

Indian markets in 2011 have done badly on financial indicators. There is slowdown in growth and in October 2011 industrial output contracted by 5.1%. Fiscal and current deficit are expected to cross 3% and 5% of the GDP respectively in 2011-2012. The GDP growth forecast for the year was reduced to 7.5% on 10 Dec 2011.

Sensex on 16 December 2011 closed at 15,491, a 25 month low. Stock brokers predict that the market is not going to rise in a hurry.

Business Standard reported in its weekly report on 16 December that “The WPI inflation for the month of November came in at 9.11 per cent compared to 9.73 per cent in October. The market was looking at an inflation of below 9 per cent for November. Inflation for November 2010 stood at 8.2%. India’s food inflation eased to 4.35% in the year to December 3 — its lowest reading since late February 2008 — from an annual 6.60% rise in the previous week, government data showed today.

Further, On Thursday, the Indian rupee touched a record low of 54.30 to the US dollar on the back of sustained foreign fund capital outflows in view of the fall in the equity markets, coupled with a stronger dollar in global markets.”

The Finance Minister Pranab Mukherjee recently commented in a meeting – “The present indicators show that both private consumption and investment sentiments have weakened and it is this weakening of sentiments that makes it necessary to shift our focus back to near term issues.

Moreover, Moody’s in November 2011, “downgraded the entire Indian banking system’s rating outlook from “stable” to “negative,” citing the likely deterioration in asset quality in the months ahead.” Additionally, aviation, telecom, commercial real estate and power utilities industries collectively owe banks Rs 5 lakh crore. These industries are most affected by the slow down.

The financial market situation is unlikely to improve in the short run. India will most probably not see a double-digit growth in GDP in 2012-2013. Companies need to risk adjust the financial growth numbers keeping in mind the prevailing situation. . Conservative estimates and cost control will steer the organizations in safe waters. Maintain good liquidity throughout the year as banks are not going to save organizations in a crunch.

3. Future Regulatory Reforms

The regulatory reforms came to a standstill in 2011. The business leaders came out strongly criticizing the political parties for hampering economic growth. The unhappiness of corporate world is evident that investments – domestic and foreign – are at an all time low.

The government in December 2011 parliament session had a list of 50 Bills for approval. Some of the Bills presented were Companies Bill 2011, Banking Laws Amendment Bill 2011,Prevention of Money Laundering (Amendment) Bill,  Direct Taxes Code Bill, 2010, Forward Contracts (Regulation) Amendment Bill, 2010; Pension Fund Regulatory and Development Authority Bill, 2011, Securities and Exchange Board of India (Amendment) Bill 2009; Insurance Laws (Amendment) Bill, 2008 and Regulation of Factor (Assignment of Receivables) Bill, 2011, among others.

This shows the pending backlog of bills requiring approval in the parliament. Business leaders are likely to lobby for approval of these bills in 2012. Hence, risk managers need to be geared to manage numerous regulatory changes in 2012.

4. Skyrocketing Corruption & Bribery

In light of various scams – telecom, mining, land, etc, – the corruption perception index in 2011 has fallen to 3.1 from 2010’s 3.3. India’s world ranking in corruption has gone lower to 95 from a total of 183 countries assessed. This is not surprising as Indian’s in 2011 saw well known politicians and business owners implicated in scam cases.

The recently released report of Global Financial Integrity – Illicit Financial Flows from Developing Countries Over the Decade Ending 2009 – states that trade mis-pricing accounts over 80% of the illicit financial flows in Asia. India in the last decade lost US $104 billions in illicit flows and is ranked 15th highest among developing countries with China topping at US $ 2467 billion. Though in comparison to China, India doesn’t appear to be doing badly, but that is distorted reality. A couple of activists and whistle blowers lost their lives during the year for uncovering corruption cases.

In 2011, Anna Hazare initiated public rallies to force government to pass Lok Pal Bill. Although, parliament is expected to pass it in December 2011 winter session, the implementation will take some time. The government’s sincerity in eradicating corruption is questionable as the various anti-graft bills are being used to play political football. The UPA government to counteract Hazare’s war cry has presented three additional anti-graft namely –  Judicial Accountability Bill,  Public Interest Disclosure Bill (Protection to Whistleblowers Bill) and the Citizens’ Charter – in the parliament in December 2011. A step in the right direction but the road ahead is tough. Passing bills and implementing them are different ball games.

In light of the fraud cases, high-level prosecutions and political games, the Indian corporate world has become vary. In 2012, organizations must focus on implementing a code of conduct for employees and provide training to them on business ethics. The legal and reputation risks will be extremely high if these aspects are ignored.  The situation becomes more tricky for US and UK multinationals as they are governed by FCPA of their respective countries.

Closing Thoughts

Political deadlock, inflation and corruption have taken the air out of India’s growth story. 2012 will be the decisive year in assessing whether India can surmount these obstacles and accelerate economic growth or  go on a downward spiral. Organizations must maintain a balance between growth and risks. The downside risks can cost heavily and there may be no quick ways to turn around numbers. Hence, doing proper planning, implementation and cost effective operational execution are key for success.


  1. Illicit Financial Flows from Developing Countries Over the Decade Ending 2009 – By Global Financial Integrity
  2. Corruption Perception Index
  3. Weekly Report: Sensex, Nifty hit 2-yr lows on growth woes – Business Standard

Corporate Governance in Private Limited Companies

Transparency is often just as effective as a rigidly applied rule book and is usually more flexible and less expensive to administer. – By Gary Hamel

 Corporate governance in private limited companies is an often-ignored topic as it is not mandatory by law. The Companies Act and SEBI Listing Agreement focus on corporate governance aspects of public listed companies. The reason for excluding private limited companies is that they do not have numerous shareholders hence the risk is minimal. I beg to differ. Corporate governance encompasses much more than shareholder rights. Corporate governance includes rights of investors, financial institutions, customers, suppliers, employees and society.  

Let us first cover the backdrop of the problem briefly. In India, 90% of the companies are either unlisted public companies or private limited companies Private limited companies fall under three groups – 1) private companies belonging to business families; 2) private companies as subsidiaries of listed Indian public companies; and 3) private companies as subsidiaries of foreign companies.  

The corporate governance is limited in 1st and 3rd categories as in the 2nd category the provisions of listed companies apply to quite an extent. In the second category, it is dependent on the owners to take the initiative. The biggest challenge is for 3rd category as holding companies provisions may not be applicable in India. However, they are applicable in the country of the holding company. If the holding company is listed then corporate governance aspects apply of the relevant country. Though, quite frequently the focus in the subsidiary company is not the same as holding company. These companies sometimes have turnover and employees more than the listed organizations. Still these are not covered in the regulatory ambit.

The Institute of Companies Secretary of India has issued recommendatory guidelines for it. The Companies Bill, presently awaiting parliamentary approval does cover the same. This definitely is a step in the right direction. Organizations must take first mover advantage to incorporate the provisions in their governance, risk management and compliance programs.  I am giving below five areas that they can focus on:

1.     Corporate Social Responsibility

In 2009, Ministry of Corporate Affairs (MCA) issued voluntary guidelines for Corporate Social Responsibility (CSR). The guidelines discuss key aspects of governance practices that business organizations need to focus on. The policy covers six aspects- 1) Care of all stakeholders; 2) Ethical functioning; 3) Respect for workers’ rights and welfare; 4) Respect for human rights; 5) Respect for environment; and 6) Activities of social and inclusive development. The policy requires that business entities should provide an implementation strategy covering projects, timelines, resource allocation etc.

Organizations to communicate their commitment to CSR can put the policy on their website with each locations implementation strategy. This will help communicate organizations ethical stance to all third parties wishing to do business with it.

2.    Appointment of Board of Directors

In public listed companies, independent board of directors is appointed to ensure better governance. Family owned listed companies and private limited companies are remarkably cagey about appointment of external independent directors as they consider it as interference and sharing of power.

The private companies owned by foreign companies generally appoint directors from within the subsidiary organization. Friends and colleagues are appointed and they form a coterie. Although, this is legal it does influence governance as Chairman/ CEO lose the benefit of independent viewpoints and unbiased opinions. Boards have two purposes – 1) Act as trustees for the organization 2) Provide strategic insight to CEO. However, CEOs of private limited companies are disadvantageous position in comparison to listed companies CEOs

In such cases, it is a good practice to appoint directors from other group organizations. Secondly, if the holding company management permits, appoint exceptionally qualified independent directors. Here, management gurus, ethics leaders, financial experts and other professionals can be appointed. A right balance must be maintained to have an effective board.

3.    Rules and Performance of Board of Directors

 Unfortunately, the board meetings in private limited companies are sometimes held for namesake. It is more to complete the paperwork to meet the regulatory requirements can have an engaged discussion and chart out business strategies.

To ensure the board members are engaged the first step is to formulate and implement rules for the directors and define their area of responsibility.  Roles and responsibilities should be given according the qualifications and skill sets of the member. If the board skills are not sufficiently diversified, additional members must be appointed. Board members should commit sufficient time to the company. On a periodic basis, their performance against the targets should be evaluated by other board members. The mandate must be to add business value to the organization. It is a good practice to early audit the participation of board members in meetings and their respective performance.

4.    Risk Management & Internal Controls

 Indian Company Law mandates all companies private and public limited, over specified turnovers and capital to have proper internal control systems. The external auditors are required to report on the status of internal controls.

However, it does not mandate audit committees or risk committees for private limited companies at board level. It is a good practice to formulate one and ensure it provides relevant information to the audit. Financial and risk management experts can be appointed from within the organization or outside to give an independent view.

 5.    Appointment of Auditors

 Auditors in family owned companies are sometimes appointed based on old business relationships. This practice in India, significantly affects the independence of the auditors.

In respect to subsidiary companies, Indian and foreign companies, auditors are chosen by the holding company’s management. In most cases, the holding company’s auditors are appointed for confidence in consolidation of financial statements. Although this is a good practice, in Indian context there is a small snag. Local relationships with the auditors might circumvent the independence. Hence, if local management is involved in frauds, the auditors may compromise in ethical reporting. It is a good practice to frequently call on the holding companies audit partner and advise him/her on the issues. Direct relationships with international partners put a check on local auditors.

 Closing thoughts

In India, corporate governance practices are just a little over a decade old and mostly focused on listed public companies. In private limited companies, it is still in nascent stage. Organizations however can voluntarily take the initiative to adopt best practices. This improves confidence of third parties and brand reputation. It also benefits if the organization in a few years is planning to turn public limited or plans to sell the company.



Ministry of Corporate Affairs (MCA) – Corporate Social Responsibility (CSR)  Voluntary Guidelines.


SEBI Circular on Blogs giving Stock Market Advice

Securities & Exchange Board of India (SEBI) on 23 March 2011 issued a circular regarding stock tips and information published by brokers and sub-brokers. The circular  was issued after Anil Ambani complained to SEBI that false rumors circulated in the stock market have negatively affected his group companies stock prices. Now, though I consider the issue of the circular as a good move, I have my doubts on the effectiveness of the same. Let me discuss the reasons below.

First, rumormongering alone cannot change market sentiment about an established business group. Where there is smoke, there usually is a fire. Anil Ambani’s ADA Group has recently been in news for all the wrong reasons. The negative sentiment in the market can be a culmination of these incidents. It started with SEBI charging Anil Ambani and  few senior officials of the group for insider trading. The group didn’t accept the charge however, paid a penalty of Rs 50 crore. Secondly, Anil Ambani’s interrogation by CBI and PAC in respect to 2G telecom license scam investigation has acted as a red-alert to investors. Last but not the least, ADAG projects relating to power plants haven’t taken off and are behind schedule. Overall, these issues have raised questions on Anil Ambani’s leadership and delivery skills.  Obviously,  Anil Ambani is piqued, and is grumbling over the turn of events.

Hence, my first question is  – Did SEBI use the right reasons for issuing the circular?

Next, coming to the contents of the circular, points 1 and 3 are on interest.

Point 1 below highlights the problem.  Brokers and sub-brokers are giving unauthenticated views on shares on blogs, chat-forums and other internet mediums.

“1. It has been observed by SEBI that unauthenticated news related to various scrips are circulated in blogs/chat forums/e-mail etc. by employees of Broking Houses/Other Intermediaries without adequate caution as mandated in the Code of Conduct for Stock Brokers and respective Regulations of various intermediaries registered with SEBI.”

In all probability with my skepticism intact, I would say SEBI’s allegation is true. My question is that – Is SEBI saying that the information floated by merchant bankers, investment analysts, brokers and sub-brokers in media is authentic. I have my doubts on this. In the beginning of my career I had worked in primary markets division of a merchant bank. I can honestly vouch for the fact, that merchant bankers and brokers had access to authentic and inauthentic information, and the real facts were hardly ever available in detail in newspapers. A small individual investor would rarely have access to reliable information.

To accentuate my point, see the cases of Enron and Parmalat. In both cases, the investment analysts and bankers suspected wrongdoing but ignored the red flags for personal benefit. It is a well-known fact that in some cases owners and senior management have resorted to providing false information in press releases to play the stock market and book profits. Yes, the argument is that SEBI has guidelines to contract these fraudulent activities, but have they been effective?

With such a history, is it right to hold the internet community responsible for providing inaccurate information? Is this just the bloggers-these-days lament?

The point 3 of the circular discusses the internal controls stockbrokers need to implement in respect of their employees activities. Read below and tell me whether these can are effective measures to curtail rumors?

“3. In view of the above facts, SEBI Registered Market Intermediaries are directed that:

  •  Proper internal code of conduct and controls should be put in place.
  • Employees/temporary staff/voluntary workers etc. employed/working in the Offices of market intermediaries do not encourage or circulate rumors or unverified information obtained from client, industry, any trade or any other sources without verification.
  • Either access to Blogs/Chat forums/Messenger sites etc. should be restricted under supervision or access should not be allowed.
  • Logs for any usage of such Blogs/Chat forums/Messenger sites (called by any nomenclature) shall be treated as records and the same should be maintained as specified by the respective Regulations which govern the concerned intermediary.
  • Employees should be directed that any market related news received by them either in their official mail/personal mail/blog or in any other manner, should be forwarded only after the same has been seen and approved by the concerned Intermediary’s Compliance Officer. If an employee fails to do so, he/she shall be deemed to have violated the various provisions contained in SEBI Act/Rules/Regulations etc. and shall be liable for actions.”

 I appreciate the idea of Intermediary Compliance Officer whetting the information before it is published in an organization’s blog. Secondly, the concept of maintaining access rights logs definitely provides evidence to trap the guilty.

However, my point is what if the stock broking organization employee  has malafide intentions s/he doesn’t need to use the company blog. All the employee needs is a client list and maintain his/ her personal blog to share information. The clients and others can be requested to subscribe to the blog. With appropriate clauses in blog policy, the blogger cannot be held responsible for providing incorrect business advice and influencing the market.

Will the next step of SEBI be to issue guidance notes on personal blogging or should the stock broking organizations have internal policies on the same? This in my mind is an open issue, and I think we will see some more action in this space. Let us see how things take shape.


A Review of KPMG Report -Risk Management, A Driver of Enterprise Value in the Emerging Environment

KPMG this week released a report titled Risk Management, A Driver of Enterprise Value in the Emerging Environment”. The survey on Enterprise Risk Management (ERM) covered Europe, Middle East, Africa and India. The survey highlights the major issues Indian risk managers are grappling with as 57% of the respondents were from India.

 I  found the report good as it identifies a number of problems relating to risk management in India. The same ones which I have ranted about on this blog for nearly a year. Spare sometime this weekend to read the report; it will give you a good grasp on the challenges in risk management. Below are some excerpts from the report that I consider crucial for improving risk management within Indian organizations.

1.    Meet CEO/Board Risk Management Requirements

 The Indian risk managers are perpetually complaining that they have little visibility at board and CEO level. The risk managers’ views are that CEOs do not give attention to their audit reports. My contention is that risk managers are focused on dealing with risks at micro level and do not cater to the risk management requirements of the CEO and Board of Directors. Hence, their work and concerns do not appear on the CEO radar as from a CEO’s perspective they are immaterial.

The KMPG report states that Both CEOs and Board members consider Risk Management to be equally important. CEOs/business leaders would like to see more focus on reputation risk, political risk and the impact of corporate restructuring and M & A on business performance. CEOs view Risk Management through an opportunity lens whereas others view it with a “keep us out of trouble” lens.” Let me ask a basic question to risk managers – how many have attempted to address strategic business risks of mergers & acquisitions, new product development and competitive disadvantages? If not, do we have a right to complain?  Hence, risk managers start focusing on addressing CEO and Board’s concerns on risk management to be effective.

 2.    Integrate Governance, Risk Management & Compliance (GRC) functions

The other challenge from Indian perspective is that risk management is equated to internal audit. If internal audits are done, the presumption is that all organization risks are managed. It is a ticking the box compliance mentality of risk managers which is killing the organization.

The second issue is that though Indian organizations size and turnover has increased, the GRC departments are still ill equipped to handle the task. Various GRC functions are spread across different departments under different heads. These department heads neither are risk management specialists nor are risk management performance indicators a priority to them. I haven’t seen a patient willing to get a surgery done from a physician instead of a specialized surgeon. However, where organizations are concerned, generalists lead risk management functions. Very few organizations have a Chief Risk Officer (CRO) or Head of Risk Management with all GRC functions reporting to him/her at local and global level. Most Chief Risk Officers are not reporting to the CEO. Hence, the disjointed department structures and disintegrated reporting patterns limit risk managers’ capability in giving relevant information to CEO and Board.

KPMG report states that –“two-thirds of the respondents believe that having a CRO will bring about a perceptible change to the quality of Risk Management practices prevalent in their organizations “  Secondly, the report says – “Nearly two thirds of the respondents in our survey indicated that their organizations developed risk responses at an individual risk/process level rather than at a portfolio level. This is partly fallout of the challenges that organizations are facing in risk aggregation/quantification at the organizational-level.” These two responses clearly bring out a need to integrate GRC functions under one department head, develop processes, and deploy tools to improve the functioning.

3.    Focus on Developing a Risk Culture 

I have always harped that Indian organizations are not focused on developing a risk culture. The impact on internal controls due to a negative organization culture is significant. If the tone at the top, psychology and attitude is not geared towards risk prevention and mitigation, the organization will face significant reputation, legal and competitive disadvantage. For example, in the last one year Tata group have faced significant reputation damage. Tata first faced Tata Indica fire issue, then the Niira Radia tapes leak and now is under investigation for bribery in 2G-telecom scam. Similarly, ADAG group first dealt with SEBI charges for insider trading and now is under investigation for 2G-telecom scam. Impeccable reputations are destroyed and questions are being raised on integrity of the industrialists.

Due to high-level corruption in the country,  the mindset is that risk exposures can be managed by greasing the hands of right people. Thus, the tone at the top contributes to slipshod risk management efforts within the organization. If senior management is not walking the talk all communication from risk managers about risk mitigation and business ethics, become paper policies.

Secondly, there is no proper assessment regarding risk appetite of the organization. KMPG report states – Only 20 percent of the Indian respondents have suggested that their company has formally articulated a risk appetite that is approved by the CEO and the Board covering all business units and function.” With such a low percentage of organizations focusing on risk at an organization level can one disagree with KPMG’s statement that – “Embedding a strong risk culture is still in its infancy”

 The above are my takeaways from the report. Share your opinion here. What are your top concerns about risk management in India?

SEBI’s proposal on accounts restatement

A proposal is pending approval with the board of Securities Exchange Board of India (SEBI) regarding restatement of accounts of listed companies. A panel appointed by SEBI has proposed that stock exchanges can call for restatement of financial statements if the audit report has serious qualifications. Interestingly, the CEO and/or CFO of the organization will bear the cost of fresh audit. The shareholders will not have to pay for the audit fees. SEBI is holding the CEO and/ or CFO responsible for the misstatement and is allowing the final say on the financial statements to the auditors. As per the proposal, SEBI will discuss the seriousness of the qualifications with the Institute of Chartered Accountants of India before suggesting restatement of accounts to the company. You can read the full article here on Economic times.

The stated objective for the new proposal is to give more power to SEBI and auditors to ensure financial statements integrity and built a robustness in the reporting system. My personal doubt is whether this proposal will really be effective. There are two scenarios were financial statements lack integrity:

1)  CEO/ CFO force auditors to write auditors report in their favor and/or 

2)   Auditors compromise ethics and give an unqualified auditor’s report an incorrect financial statement.

In both these scenarios the proposal is not saying much. Hence, I suspect that in this case auditors may become more pressurised into submitting unqualified reports. Rather than give independence to auditors, this guideline may become a deterrent to writing qualifications in the auditors report.

Additionally, there has to be some clarification on who will bear the cost of restatement if an honest mistake is made and a material fraud or error is discovered after submission of the audited financial statements?

What do you think of this proposal ? Do you think it is a move in the right direction or is it going to make it more difficult for auditors to give qualifications ?

Fraud Symptom 3 – Board’s failure to exercise judgment

The board performance and effectiveness differentiates between success and failure of the organization. Before, I mention the details; I am giving a brief background of the Indian corporate sector and relevant laws. Ministry of Corporate Affairs Annual Report 2009 states that there were 821,212 companies limited by shares registered in India. Of these 83,010 were public limited companies and 738,202 were private limited companies. There were 2903 foreign companies operating in India as of 31 December 2009.

Now the question is how this data is relevant. SEBI’s Listing Agreement Clause 49 defines the corporate governance requirements for publicly listed companies in India. That means it is applicable to less than one-tenth of Indian companies.

The clause mentions requirements for independent directors, formation and working of audit committee, corporate governance norms and disclosures, code of conduct etc. The Indian Company Law’s various sections define the requirement for true and fair financial statements, audit committee and corporate governance requirements. However, most of the sections provisions are applicable to public companies and deemed to be public companies. The SEBI guidelines and Company Law requirements on corporate governance are not applicable to private limited companies. Hence, from a fraud symptom perspective, the issues are different and I am dealing with them below separately.

 The most renowned case of boards’ failure to exercise judgment in India is of Satyam. So let me cover that briefly. Satyam’s board consisted of well-known business personalities, namely Mr. Krishna G. Palepu a professor in Harvard Business School and Mr. Vinod Dham known as Father of Pentium. The Central Bureau of Investigation report stated (as given in Top News) –

 “The members of the Board of Directors had acted as “rubber stamps”, unwilling to oppose the fraud. Not a single vote of dissent has been recorded in the minutes of the Board meetings.”

This clearly raises questions on the effectiveness and role of independent directors. Four independent directors of Satyam resigned within a short span after the fraud disclosure. This issue which was brought into focus was “should independent directors be held responsible for the fraud?” The impact was felt across corporate India. The research paper Independent Directors and Firm Value: Evidence from an Emerging Market” mentions that in January 2009 at the time of disclosure of Satyam fraud there was a substantial peak in number of resignations of director. 197 directors voluntarily resigned though their term had not ended. The number consisted of 109 independent directors, 40 insider directors and 32 gray directors. There are certain challenges, which independent directors face in India that may not be applicable to developed countries. I will provide details after covering the SKS Microfinance case that also highlights boards’ failure in business ethics though not in fraud.

SKS Microfinance case came into light when the CEO Suresh Gurmani was unceremoniously fired by the board of directors. There were no performance or fraud issues. Eight of the ten directors voted in favor of his termination, the other two were absent. It is being said that this was done because the founder chairperson Vikram Aluka had some disagreement with the CEO.  Two of its reputed directors are Pramod Bhasin, President and CEO of Genpact and Chandra Shekran, Former Executive Director, SIDBI. This event brought focus to the internal operations of SKS Microfinance. The organization was formed as part of social entrepreneurship to give rural poor and farmers small value loans. It is said that the organization was charging an astronomical 28% interest and was coercing village women and farmers for recovery. A number of farmer suicide incidents were reported to police holding SKS responsible. Andra Pradesh government passed a revised law about microfinance lending which in the last three months has severely affected the microfinance industry. The question here is what was the board doing? Did the directors not question the excessive profits of the company whose objective was social entrepreneurship? Did they ask for information regarding operations? Shouldn’t the board of directors question business ethics of the organization?

The main reasons for failure of independent directors in India are that most of the public listed companies’ shareholding is structured differently. The family or founders bring in their relatives and friends as board of directors and control the organization. The independent directors do not receive insider information of the organization, as senior management is loyal to the founder / family. Hence, all effort is made to protect the family/ founders authority and control, rather than interest of the public shareholders. Therefore, though the qualifications of the directors are good and relevant they have little impact. The directors are appointed more to add prestige to the board and company, a men’s club is formed and nobody bothers to ask the right questions. For the directors it is a status symbol to be on the board, along with the director’s fee, free travel and various indirect privileges. In such a scenario, the board’s independence is lost and there is hardly any focus on curtailing fraudulent activities.  

Next issue to discuss is about private companies. As such, since the number of shareholders is less than 50, in most cases of fraud the financial impact is felt by a small group. The problem arises when the private limited company is a subsidiary of a public limited company or a multinational. According to SEBI Listing agreement  a subsidiary company having a turnover or net worth of 20% of the holding company or has a significant transaction which is more than 10% of its turnover, assets or liability with the holding company has to comply with certain requirements of independent director, audit committee and review by holding company board of directors. However, through multi-layered structuring of private companies, these rules can be circumvented.

As most of the multinationals operating in India have a business process outsourcing or information technology outfit, I am taking an ITES company example to explain how multi-layered structure increases management’s propensity for fraudulent activities. Suppose company “A” is a public listed company in US. A separate private limited company “B” is formed in US with a common founders or board members. Now a separate private limited company “C” is formed in India. Now company A enters into an agreement with company B for providing software development and call center services. Company B enters into an agreement with company C in India for providing the same services. Now let us say majority of the back-office operations are performed by company C in India. Some senior managers maybe reporting to company A and B senior managers. However, now because of the autonomy available to company C and then company B senior managers, the full information does not flow to company A’s board of directors. Hence, the board of directors of company A, whose funds have been used to setup company B and C, would have very little visibility of actual operations. With such minimal control and high autonomy, company B and C senior managers separately or in collision can undertake fraudulent activities without detection.      

Considering the above-mentioned factors, one needs to assess the intent of board of directors. If the intent is wrong, there will definitely be laxity and ineffectiveness.


The board’s independence and critical thinking is necessary for effective corporate governance and preventing large-scale fraud within organizations. The following recommendations are useful from Indian perspective:

1)    Ministry of Corporate Affairs should focus on providing a structure for corporate governance. Applying similar provisions as developed countries is useful, however if similar support structure is unavailable, the provisions become ineffective.

2)    SEBI should delve deeper into appointments of independent directors to ensure that public shareholdings interests are protected.

3)    Reputed professionals who are appointed as directors should fulfill their obligations in true spirit and sincerity. Directorships shouldn’t be just treated as status symbols.

4)    Organizations while forming a multi-layered structure of companies should build processes to ensure transparency and accountability. Procedures for corporate governance should be implemented across the group uniformly.


  1. Ministry of Corporate Affairs Annual Report (
  2. SEBI Listing Agreement (
  3. Satyam CBI Report (
  4. Satyam Board of Directors Resignation ( )
  5. SKS Microfinance ( )
  6. Independent Directors and Firm Value: Evidence from an Emerging Market (authored by: Rajesh Chakrabarti, Krishnamurthy Subramanin and Frederic Tung)

To read the full list of Fraud Symptoms, click here.

Rs.300 Crore Citibank Fraud


Shivraj Puri

Last week Citibank India filed a police complaint stating that Mr. Shivraj Puri, an employee of Gurgoan branch had siphoned of money from 20 high net-worth investors (HNI) amounting to Rs 300 crore (USD 67 million). Media updates of police investigation show that police are having some success in cracking the case. I thought let me provide the case details and the implications of the case to Citibank and other related parties.


Case Facts 

Here is a summary of case published to date. Mr. Shivraj Puri is a Senior Relationship Manager in Citibank Gurgoan branch. He used a forged notification of Securities & Exchange Board of India (SEBI) stating that few select clients would earn higher returns (18% to 20%) if they invested in his suggested schemes.  He invested the money obtained from HNI in the stock market in his personal capacity over a period of few months. Presently, information of the period of fraudulent activity is not available.

Up to now the main client affected by the fraud is Hero Honda group and the amount diverted is to the tune of Rs 200 crore (USD 44.67 million). Mr. Sanjay Gupta, Assistant Vice President in the accounts office of Hero Corporate Services was arrested yesterday. Mr. Sanjay Gupta is purported to have formed two finance companies BG Finance and G2S Consultancy and diverted Hero group promoter funds in these two companies. These funds were then fraudulently invested by Mr. Shivraj Puri of Citibank. Mr. Sanjay Gupta has allegedly taken Rs 20 crore (USD 4.46 million) as commission from Mr. Shivraj Puri for diverting these funds.  It is suspected that Mr. Sanjay Gupta was aware of the forged SEBI letter but recommended the investment to a number of people.

Other details reveal that funds were transferred to Mr. Puri’s wife, other relatives account and some benami (fictitious accounts). Mr. Shivraj Puri used Religare and Bonanza brokerage firms for investing the money in stock market. Religare stated the Mr. Puri has been a client since December 2009.

SEBI investigators have commenced investigating Mr. Puri. RBI has demanded a fraud report and impact from Citi and may take an independent review of Citi operations.

 An Analysis of Issues

Impact on Profits: As per the audited financial statements as on March 2010 the net profit of Citibank India was Rs. 860 crore (USD 192 million). If Citibank has to absorb the loss of the fraud and payback to the clients, its profitability for the year will be impacted negatively. Presently, since the main loss is of Hero Honda group, and its employee is involved in the fraud, the whole burden may not be on Citi. The second aspect being stated is that the shares held in various demat accounts by Mr. Puri will be identified and the accounts frozen (19 accounts have been frozen till date). This will enable partial recovery of the estimated fraud loss.

Segregation of Duty: The Relationship Manager of Citibank as per the details available on Citi website is a “one point contact with the Bank”. The Relationship Manager is “backed by a team of experts in the fields of investments, insurance, treasury and foreign exchange services”. There appears to be lack of controls and supervision on the activities of the Relationship Manager. From the looks of it, the Relationship Manager is selling the investment concept, obtaining funds, investing them and monitoring the accounts. This shows that there is no segregation of duty for the different functions. SEBI and RBI could both question the investment management department functioning.

Know Your Customer (KYC): Both SEBI and RBI have issued guidelines for Know Your Customer. KYC procedures mandate that asset management companies should review cases of clients “where the source of the funds is not clear or not in keeping with clients apparent standing /business activity”. If in this case, funds from Citi customer accounts were being diverted to accounts in Citi (for example, Mr. Puri’s relatives or other fictitious accounts) then there should have been checks in place to question the business validity of the transactions. On the other hand, the brokerage firms, Religare and Bonanza should have questioned the source of funds of Mr. Puri as he is a salaried employee. Although, they are stating that KYC procedures were followed.

Suspicious Transaction Monitoring: According to RBI and SEBI guidelines, a bank is required to have systems in place to monitor suspicious transactions and there is special emphasis on high net-worth investors (HNI). For HNI the nature of activity of the customer should be monitored by the bank and suspicious transactions reported to RBI if money laundering is suspected. In this case, questions can be raised on the nature of systems and procedures in place to monitor suspicious transactions. SEBI and RBI could raise questions on the accuracy and validity of suspicious transactions monitoring reports submitted by the bank.

Functioning of Risk Management Departments:  RBI guidelines specify that banks should have proper fraud monitoring, compliance and risk management functions. The responsibility for establishing and maintaining the fraud risk function rests with the CEO. In this case, the fraud was perpetuated over a few months (specific dates not available) and the fraud department was alerted by the customer complaints. This raises questions on fraud detection and monitoring procedures implemented at the bank. The bank could face some tough questions from RBI regarding the fraud and compliance department functioning.

Citi definitely is in a soup and as the investigation unfolds, we will know the full story. I am expecting a few more skeletons to topple out. Will definitely keep you updated on the happenings. Share your opinion about the case here.