With the renewed focus on corporate governance under Companies Act, 2013, the spotlight is on the Board of Directors. The Act entrusts greater responsibility on the Board, empowering it while at the same time making it more accountable. The role of directors becomes even more crucial as economies today compete to attract capital, and good governance is a decisive factor in investment decisions.
To delve further into the evolved role of directors, we need to understand the impact of the new disclosures mandated in the directors’ report. In the case of listed companies, the Directors’ Responsibility Statement shall declare that adequate internal financial controls have been laid down and they are operating effectively.
The term ‘internal financial controls’ has been defined and goes far beyond financial controls to include the policies and procedures adopted by the company for efficient conduct of business. It includes aspects like adherence to company policies, safeguarding assets, prevention and detection of frauds and errors, and so on.
This is far more significant than the certification of internal financial controls currently made by the CEO/CFO to the Board under clause 49 of the listing agreement. The directors’ report is a public document and there are severe penal consequences for false disclosures.
Under the new regime, the Board’s responsibility is not limited to setting up adequate controls, and extends to ensuring their operating effectiveness. This assumes greater significance in the light of the additional reporting obligation cast on the statutory auditor with regard to the operating effectiveness of internal financial controls. Given the penal consequences under the new regime, the auditors would like to do detailed testing of controls. The Board, management and statutory auditors would have to align their approaches while evaluating and testing the operating effectiveness of internal financial controls.
Statutory compliance and risk management: The Directors’ Responsibility Statement should now state that the directors have devised proper systems to ensure compliance with law and these are operating effectively. The directors’ report should also indicate the development and implementation of a risk management policy, including the identification of risk elements that, in their opinion, may threaten the company’s existence
The impact of disclosure in the new regime is much greater. Currently applicable only to listed companies under clause 49, going forward all companies — unlisted public as well as private — will be impacted.
Related-party transactions: Details of contracts with related parties, along with their justification, would form a part of the directors’ report. While the need for obtaining central government approval has been removed, the penalties have become stricter — contravention in the case of a listed company could lead to imprisonment.
Board evaluation: For listed and large public companies, directors should report the manner in which the Board has formally evaluated its annual performance and those of its committees and individual directors.
Participation in meetings: There is tremendous emphasis on participation in board meetings. Every director has to attend at least one board meeting during a 12-month period, failing which there could be vacation of office. The provision of escaping vacation of office through leave of absence has been removed.
The mandatory code of conduct for independent directors stipulates constructive participation in board meetings, besides providing for one exclusive meeting of independent directors to evaluate the performance of the Board as a whole and of the Chairperson.
Further, independent directors have to ensure that related-party transactions are adequately deliberated before they are approved.
From the Act it is clear that a number of disclosures hitherto mandated elsewhere have been brought under the ambit of the directors’ report. The underlying objective is to bring to the notice of the directors and senior management those important governance issues that get relegated to the periphery, only to later resurface as a crisis.
A huge positive is the requirement for directors to implement robust internal processes before making mandatory disclosures. This, in turn, will improve corporate governance and pre-empt unpleasant surprises. To illustrate, the law of the land will apply to all companies. A compliance framework mandated by the Act is only a tool to help Boards discharge their statutory responsibility.
Another heartening aspect of the new Act is that the duties of directors have moved beyond the company and shareholders to a larger stakeholder community. The duties of directors have been defined and they are mandated to act in the best interest of the community and environment. This intent is reflected in the new set of CSR (corporate social responsibilities) guidelines.
The clock has already started ticking with the notification of some sections of the new Act. It is, therefore, vital for directors to evaluate the current level of governance, and equip themselves to meet the new demands.
Satyavati Berera is Executive Director and Pankaj Tewari is Senior Manager — Risk Advisory Services, PwC India