Top 8 Corporate Governance Issues

Table of Content

1. Whistle Blowing
2. Whistle Blowing Mechanism
3. Insider Trading
4. Rating Agencies
5. Shareholders’ Activism
6. Class Action
7. Proxy Advising Firms
8. Corporate Governance in PSU

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1. Whistle Blowing

The term whistle blower derives from whistle a referee uses to indicate a foul play and was coined in 1970s by Ralph Nader, a US civic activist to avoid the negative connotations found in other words such as “informers”, “snitches” or “tattler”.

A whistle blower is a person who exposes misconduct, alleged dishonest or illegal activity occurring in an organization. The alleged misconduct may be a violation of a law, rule, regulation and/or fraud, health and safety violations, and corruption. Whistleblowers may make their allegations internally (for example, to other people within the organization) or externally (to regulators, law enforcement agencies, to the media or to groups concerned with the issues).

A whistle blower may be internal or external. Most whistleblowers are internal whistleblowers, who report misconduct on a fellow employee or superior within their company. External whistleblowers report misconduct to outside persons or entities. Whistleblowers may report the misconduct to lawyers, media, regulator or other law enforcement agencies.

What is Whistle Blowing?

Whistle blowing is a term used to describe the disclosure of information that one reasonably believes to be evidence of contravention of any laws or regulation or information that involves mismanagement, corruption or abuse of authority within an organization. ‘It is raising a concern about wrongdoing within an organization or through an independent structure associated with it’¹. In simple words it is speaking out on malpractices, corruption, misconduct or mismanagement.

Whistleblowers have garnered attention due to the worldwide media exposure of accounting scandals in Enron and WorldCom. In 2002, Time magazine named whistleblowers Cynthia Cooper of WorldCom and Sherron Watkins of Enron as its “Persons of the Year.”

Components of a Whistle blower Policy

The key aspects of whistle blower policy are as follows:

• • Define Individuals Covered. A whistle blower policy should cover individuals within the organization as well as external parties who conduct business with the organization.
  • Non-Retaliation Provisions. Whistle blower policy should prevent discrimination or retaliation against employees who report wrong doings. The whistle blowers be given due protection from losing his/her job or being put to any disadvantage otherwise by the affected persons in authority. Policy should also include methods to encourage employees, vendors, customers, and shareholders to report instances of fraudulent activities.
  • Disclaimer. A whistle blower policy should include a disclaimer that anyone filing a claim must have reasonable belief that an issue exists and that he/she is acting in good faith.
  • Confidentiality. Protecting whistle blowers’ confidentiality is an important part of any whistle blower policy. The whistle blowers identity is to be kept confidential. Confidentiality is important because the goal is to create an atmosphere where employees feel comfortable submitting their names with claims of wrong doings to allow for further questioning and investigation. Allowing employees to file anonymous claims may increase the possibility of reporting of claims of mis-doings but it may also increase the possibility of false claims being filed.
  • Process. A whistle blower policy should address the process employees should follow in filing their claims. Organizations may require whistle blowers to direct their claims to a certain person, such as a compliance officer, or, alternatively, to follow a hierarchy until they reach the audit committee or the board of directors. The reporting mechanisms may include telephone or e-mail hotlines, websites, or suggestion boxes.
  • Communication. A whistle blower policy is to be communicated to employees, vendors, customers, and shareholders.

Some of unethical practices/improper activities which are required to be reported or for which whistle should be blown are:

• • Theft
  • Harassment
  • Unethical practices
  • Fraud
  • Dishonesty
  • Discrimination
  • Lack of Independence of Auditors
  • Violation of Regulations and Code of Conduct
  • Insider Trading
  • Corruption and bribery
  • Lack of Work Place Safety Hazards
  • Financial Statement Misrepresentation

2. Whistle Blowing Mechanism

Under US Corporate Governance law, Sarbanes-Oxley Act, 2002 has made it criminal offence, which is punishable by fine and up to 10 years in prison, for taking any action harmful to a person who provides truthful information about a federal offence to a law enforcement officer.

Section 806 of the Sarbanes-Oxley Act, 2002 extends protection to employees of publicly traded companies who report fraud to any federal regulatory or law enforcement agency, any member or committee of Congress, or any person with supervisory authority over the employee. This regulation states that whistle blowers who provide information or assist in an investigation of violations of any federal law relating to fraud against shareholders or any SEC rule or regulation are protected from any form of retaliation by any officer, employee, contractor, sub-contractor, or agent of the company. SOX also requires audit committees to take a role in whistle blowing and reducing corporate fraud. Section 301, compels audit committees to develop reporting mechanisms for the recording, tracking, and acting on information provided by employees anonymously and confidentially.

Similar provisions exist in the UK also. The Public Interest Disclosure Act, 1998 which came into force on 2 July, 1999 encourages people to raise concerns about malpractice in the workplace to ensure that organisations respond by:

• • addressing the message rather than the messenger; and
  • resisting the temptation to cover up serious malpractice.

To provide protection to whistle blowers, Public Interest Disclosure and Protection to Persons Making the Disclosures Bill, 2010 was introduced in the Parliament. The Bill passed by the Lok Sabha in 2011 was renamed as the ‘Whistle Blowers Protection Bill, 2011’. The Bill contains provisions to provide adequate safeguards against victimisation of the person making disclosure on any allegation of corruption or wilful misuse of power or wilful misuse of discretion against any public servant. However, the Bill does not address the protection to be provided to whistle blowers in the private sector.

To protect the informers/whistle blowers in absence of any concrete legislation on whistle blower protection, the judiciary has from time to time directed the Indian Government to formulate suitable guidelines/regulations to protect the whistle blowers. In this regard, the Supreme Court while hearing a writ petition regarding the murder of Satendra Dubey, who exposed corruption in NHRI, directed the government to form a suitable machinery for acting on complains from whistle blowers until a suitable legislation is enacted.

The Narayana Murthy Committee appointed by the SEBI in 2002 proposed that a whistle blower policy should be made mandatory for listed companies in India. The recommendations stressed the need for employees of company to have access to the company’s audit committee without necessarily informing the superiors. However, after stiff resistance from the corporate sector, it was made optional. Thus, as per Clause 49 of the Listing Agreement, the Whistle blower Policy is a non-mandatory requirement. As per this policy, every employee is encouraged to come out with their complaints as to any kind of misuse of company’s properties, mismanagement or wrongful conduct prevailing in the company, if any. Whistle blower could be a “present employee” or an “ex-employee” and he has to blow the whistle to the Audit Committee of the company either through phone or through written communication with relevant information without fear of retaliation of any kind. Corporate Governance Voluntary Guidelines, 2009 issued by the Ministry of Corporate Affairs provide:

“The companies should ensure the institution of a mechanism for employees to report concerns about unethical behaviour, actual or suspected fraud, or violation of the company’s code of conduct or ethics policy. The companies should also provide for adequate safeguards against victimization of employees who avail of the mechanism, and also allow direct access to the Chairperson of the Audit Committee in exceptional cases”.

Being non-mandatory, the choice of adoption of the policy on whistle-blowing is left to the listed company to decide. Unfortunately, not many companies have opted for this policy. Fear of abuse of such a mechanism by people to settle scores or personal vendetta seems to be the reasons holding back most of the companies from implementing the policy.

The Companies Act, 2013 has the specific provisions on establishing whistle-blowing mechanism by a listed public company. Section 177 of the Act provides that:

(1)  Every listed company or such class or classes of companies, as may be prescribed, shall establish a vigil mechanism for directors and employees to report genuine concerns in such manner as may be prescribed.

 (2)  The vigil mechanism under shall provide for adequate safeguards against victimisation of persons who use such mechanism and make provision for direct access to the chairperson of the Audit Committee in appropriate or exceptional cases. The details of establishment of such mechanism shall be disclosed by the company on its website, if any, and in the Board’s report.

3. Insider Trading

Meaning

Insider trading refers to purchase or sale of shares by someone on the basis of non-public price sensitive information and using confidential information to make a profit or avoid a loss at the expense of other co-investors.

In various countries insider trading based on inside information is illegal. This is because insider trading is unfair to other investors who do not have access to the information. The rules around insider trading are complex and vary significantly from country to country and enforcement is mixed.

Definition of “insider”

The definition of insider can be very wide and may not only cover insiders in a company but also any person related to them such as brokers, associates and even family members. Any person who becomes aware of non-public information and trades on that basis may be guilty of insider trading.

Corporate insiders are company’s  officers, directors and any beneficial owners of more than 10% of a class of the company’s equity securities. Trades made by these types of insiders in the company’s own stock, based on material non-public information, are considered fraudulent. For example, illegal insider trading would occur if the finance manager of Company A prior to a public announcement of the quarterly results buy shares in Company A anticipating that share price would rise on declaration of high profits.

In many countries “insiders” are not just limited to corporate officials and major shareholders where illegal insider trading is concerned but can include any individual who trades shares based on material non-public information. For example, in cases of where an executive of the company “tips” a friend about non-public information likely to have an effect on the company’s share price, and that person trades on that basis.

However, all trading on information is not illegal insider trading. For example, a person in a restaurant who hears the CEO of Company A at the next table tell the CFO that the company’s profits will be higher than expected and then buys the stock is not guilty of insider trading—unless he has closer connection to the company or company officers.

Insider Trading Regulations

The United States has been the leading country in prohibiting insider trading made on the basis of material non-public information. The Securities Act of 1933, the Securities Exchange Act of 1934, and other regulations of the Securities and Exchange Commission (SEC) not only prohibits insider trading but also empower the SEC to conduct investigations in suspected cases of insider trading and prosecute the guilty. Mr. Rajat Gupta, director at Goldman Sachs Group was convicted recently for leaking information to hedge fund manager Raj Rajaratnam.

Similarly, in the UK, the Criminal Justice Act, 1993 and the Financial Services and Markets Act, 2002 contain regulatory provisions on insider trading and other market abuses.

Insider trading is regulated by the SEBI (Prohibition of Insider Trading) Regulation, 1992, which criminalizes insider trading and abusive self-dealing. Anybody in possession of price sensitive information is considered an insider. Price sensitive information must be disclosed to the exchange promptly. In 1995, SEBI directed the stock exchanges to set up surveillance departments. Investor perception of market integrity seems to have improved since. In 2002 the regulations were amended to further fortify the 1992 regulations and to increase the list of persons that are deemed to be connected to the ‘insiders’. Listed companies and other entities are required to frame internal policies and adopt a code of conduct for prevention of insider trading by directors, employees, partners, etc.

Most of the companies in India, in fact have framed a code of conduct for prohibition of insider trading. To what extent these codes are adhered to is difficult to ascertain. Insider trading is reported to be rampant in India but a few cases come to the lime-light because many times it is difficult to flag a trade as a possible case of insider trading.

Difficulties in Detecting Insider Trading

The difficulty in detecting insider trading is that a person with insider information can create fire-walls between himself and the buyer/seller, given the number of intermediaries who operate in the market. An additional factor making surveillance more difficult, are multiple listings. Regulations against insider trading in India are perceived to be soft and wavering. Since insider trading is extremely difficult to detect and prosecute, most countries have given sweeping powers to the regulators to catch the inside trader. For instance, the Securities and Exchange Commission of the US relied heavily on phone tapping and amnesty to informants to won a landmark insider trading case (in 2011) against hedge-fund manager Raj Rajaratnam. SEBI does not have the power of tapping the phone or presenting this as the evidence against the crime. Most of the orders passed by the SEBI have been set aside by higher authorities mainly on account of SEBI’s failure to prove the charges.

4. Rating Agencies

Rating agencies assess the financial strength and creditworthiness of companies particularly their ability to meet the interest and principal payments on their debts and other securities. After assessing the financial strength and terms and conditions of the security to be issued by a company, the rating agency expresses its assessment by way of ‘rating’ for that specific security. The rating for a given security issue reflects the agency’s degree of confidence that the issuer (i.e. the company) will be able to meet its promised payments of interest and principal as scheduled. The rating is technically an ‘opinion’ on the relative degree of risk associated with timely payment of interest and principal on a security instrument.

Thus, rating given by an agency is:

• • An opinion on probability of default on the rated obligation.
  • Forward looking.
  • Specific to the obligation being rated.

It must be noted that a rating is not:

• • A comment on the issuer’s general performance.
  • An indication of the potential price of the issuers’ bonds or equity shares.
  • Indicative of the suitability of the issue to the investor.
  • A recommendation to buy/sell/hold a particular security.
  • A statutory or non-statutory audit of the issuer.
  • An opinion on the associates, affiliates, or group companies, or the promoters, directors, or officers of the issuer.

In India, credit ratings started with the setting up of the Credit Rating Information Services of India (now CRISIL Limited) in 1987. CRISIL was promoted by premier financial institutions like ICICI, HDFC, UTI, SBI, LIC and Asian Development Bank. Now CRISIL is an S&P company with a majority shareholding of the latter. Apart from CRISIL, four more rating agencies have been registered by SEBI in India. These are ICRA, promoted by IFCI and now controlled by Moody’s; CARE promoted by IDBI; Fitch India a 100% subsidiary of Fitch; and Brickworks.

Credit rating agencies in India rate a large number of financial products. These are:

• • Bonds/debentures – [the main product]
  • Commercial paper
  • Structured finance products
  • Bank loans
  • Fixed deposits and bank certificate of deposits
  • Mutual fund debt schemes
  • Initial Public Offers (IPOs)

Functions of Credit Rating Agencies

1. 1. Provide Independent Opinion. Rating agencies provide an unbiased opinion on the relative capability of the issues to meet obligations of the security which are offered to be issued. The agency is independent from the issuer and has no vested interest in the issue.
   2. Provide Professional Assessment. The assessment of the securities made by rating agencies is authentic, reliable and based on the information processed by the highly trained staff.
   3. Provide Easily Understood Information. The assessment provided by rating agencies is expressed in terms of rating symbols which are easily understandable by the intended investors, some of which have no expertise to understand the witty-knotty of the securities.
   4. Provide Basis for Investment. The rating/assessment provided by rating agencies provide a basis for investment by the investors. Investors are provided with the expertise knowledge on the risk and returns associated with the securities. Investors may pick-up the securities for investment as per their risk preferences.
   5. Keep a Discipline on Borrowers. The rating agencies continuously monitor the securities rated by them. It keeps the borrowers under discipline to fulfil their obligations under the securities. The fear of lowering down the ratings keeps the borrowers on their toes.

Benefits of Rating Agencies to the Investors

1. 1. Facilitate Investment Decisions. With the ratings on the securities, investors can take quick decisions about the investment to be made. Investors may quickly assess the risk level and rate of returns of the rated security. Rating also facilitates choice among the many alternative investments available.
   2. Facilitate Review of Investments. As the rating agency reviews continuously the ratings given to the instruments/securities, the investors in those securities can decide whether to keep the investment or to sell it off. For example, in case a rating being downgraded, investors may think of selling the instrument/security.
   3. Safeguard against Bankruptcy. Rating agencies give an idea to the prospective investors about the degree of financial strength and creditworthiness of the issuer. High rating given to a security gives an assurance of safety and minimum risk of bankruptcy.
   4. Saving in Cost and Efforts. Investors in securities need not take advice of stockbrokers, merchant bankers or the security analysts while making investment decisions. This reduces the efforts of the investors in taking investment decisions. Investors may save their time in collecting and analysing the information on the creditworthiness of the issuer.

Benefits to the Issuers/Companies

1. 1. Improves Corporate Image. High credit rating creates confidence and trust of the investors about the company. This in turn enhances corporate image.
   2. Lower Cost of Borrowing. Companies/Issuers that have high credit ratings for their instruments get funds at lower cost from the market. Investors tend to accept the securities having less risk at low interest rates.
   3. Market for Debts. Credit rating creates market for debts securities. Issuers can price their issues as per the ratings and reach out to the new investors.
   4. Easy to Raise Funds for Closely-held Companies. Closely held companies and lesser known companies may find investors for its securities in case of high ratings for their instruments/securities.
   5. Aid Growth and Expansion. Credit rating agencies create market for debts and facilitate the companies to get finance easily for growth and expansion.

Dubious Role of Credit Agencies

Credit rating agencies provide a check and balance on companies seeking to raise debts from the market. The credit rating agencies assess the creditworthiness and financial strength of the companies and express opinion to meet the interest and principal obligations of the issuers. In most countries of the world including India, it is a statutory requirement for every issue of debts securities to be rated by one of the agencies. As a result of this, the role of credit rating agencies has become very important.

Unfortunately, in many instances, the role of rating agencies has been found to be dubious. For example, in case of collapse of Vivendi Universal in France, Moody’s Investors Services and S&P did not downgrade the rating of the company despite huge losses and heavy debts. Similarly, S&P until 10 days before the collapse of Parmalat in Italy kept its “investment grade” ratings on the firm.

Financial Crisis Inquiry Commission reported in January 2011 that credit rating agencies were enablers of the financial meltdown in the US in 2008. The mortgage related securities which fueled the financial crisis could not have been marketed without the ratings given by rating agencies. Ratings helped the sub-prime securities to soar the market which ultimately collapsed.

The following are the factors/reasons behind the dubious role of credit rating agencies.

1. 1. Competitive Pressure. Rating agencies often compete with each other in providing rating services to the securities issued by companies. These pressures may lead to lowering of the rating standards as was indicated in the case of Enron and sub-prime crisis of 2008.
   2. Conflict of Interest. Business model of rating agencies involves income realisation from the companies being rated by them. This gives rise to conflict of interest as the pressure always exists on the rating agencies to grow its profits. Many times, rating agencies also provide ancillary services to the companies which give rise to more conflicted interest.

Suggestions

1. 1. Rating agencies must keep their sales and research functions completed segregated by the Chinese Walls like structures, so that income received by the agencies from their clients does not affect the ratings being assigned by them.
   2. The rating agencies must be debarred from rendering non-rating services to their clients.
   3. The rating fees received by the agencies must be adequately disclosed.
   4. There should be closer monitoring of rating agencies by the market regulators.
   5. Corporate governance of rating agencies must be improved to enhance accountability and transparency in the functioning.

5. Shareholders Activism

Shareholder activism is a way in which shareholders can influence a corporation’s behaviour by exercising their rights as owners. There are numerous ways in which shareholders may influence the board of directors and management ranging from dialogue with management to voice their concerns about a particular issue to formal proposals that are voted on by all shareholders at a company’s annual meetings².

Engagement of shareholders in corporate governance is capturing the attention of policymakers and corporate governance activists, albeit slowly. Retail shareholders or individual shareholders, although contribute to the equity capital of companies, they have a little influence and power in the functioning of companies. The legal framework and policy initiatives of the regulators are geared towards the protection of the interest of investors including minority shareholders. A recent positive phenomenon is that of the institutional investors who have started voicing their voice and concerns, in many cases forcing reversal of the resolutions adopted by companies.

Shareholders activism is getting manifested through the following:

Institutional Investors

The institutional investors are an important force to monitor the controlling groups to ensure that the company is run for the interest of all the investors. Institutional investors especially the mutual funds can influence corporate governance since they hold substantial shares in companies. In developed countries, institutional investors get CEO’s changed, blocked mega mergers, practices changed, accounting practices re-examined, stock-options changed. The institutional investors are ‘as good as regulators’. Many leading institutional investors in the U.S.A. and U.K. publish their own corporate governance codes, which set out what they expect of the board of the companies in which they invest. For example, TIAA-CREF in the U.S.A., Hermes in the U.K. has brought out its policy statement on corporate governance. Council of Institutional Investors (CII) representing the institutions investing in the US public companies has also published standards for voluntary practices.

Most corporate codes worldwide including the OECD Principles of Corporate Governance advise the institutional investors to intervene, state their voting policies and exercise voting power at the general meetings of the companies. The U.K. Combined Code (2008), for example, recommends that the institutional shareholders should enter into a dialogue with companies based on the mutual understanding of objectives. The Code cast a responsibility on the institutional investors to make considered use of their votes. The Malaysian Code also provides ‘institutional shareholders have a responsibility to make considered use of their votes. Institutional investors should encourage direct contact with companies, including constructive communication with both senior management and board members about performance, corporate governance, and other matters affecting shareholders’ interest.’

Presently, the role of institutional investors in corporate governance is minuscule in India compared to the developed nations. To protect the interest of the investors, the mutual fund houses must disclose their participation and voting in the companies where they have parked a large chunk of their funds raised from a number of investors. They must inform the investors on an urgent basis of their support or opposition to some key business decisions of the firms. Such an act would force companies to follow best corporate governance practices in their businesses benefiting entire investors class. For the first time in India, the institutional investors in the Satyam fiasco questioned the propriety of using the software company’s cash pile to buy the family firms linked to the disgraced chairman of the company. Under pressure from the furious institutional investors, the deal had to be aborted. In March 2010, SEBI issued a circular asking all Asset Management Companies (AMCs) to formulate guidelines for exercising voting rights held by them by virtue of their shareholding in the companies. In practice, however, mutual funds and other institutional investors don’t believe in questioning or confronting the company managements as they prefer ‘voting with their feet’ i.e. selling the shares and walking away in case of ‘smell’ of governance or other major problem.

Shareholders’ Associations

In the developed countries where shareholders associations and unions are very strong and are known to have blocked certain proposals which they perceived to be against their interests. For example, the Australian Shareholders Association (ASA) is a not-for-profit organisation established in 1960 to protect and advance the interests of investors. It does this by advancing the interests of retail shareholders with government, industry, the markets and individual companies, monitoring companies with the aim of improving both financial performance and corporate governance and providing information and education to shareholders. The UK Shareholders’ Association (UKSA) is the leading independent organisation which represents the interests of private shareholders in the United Kingdom. Apart from helping to invest more wisely, UKSA campaigns to protect the rights of shareholder in public companies and promote improved standards of corporate governance. In India, currently, there are about two dozen SEBI-recognised investor associations in India, out of which almost half-a-dozen are inactive. These associations are finding it difficult to operate in the current environment being wholly dependent on the grants of the government and find solace in organizing investors meet or conferences occasionally. The retail investors in India being scattered, ill-informed, and un-organized usually suffer out of the mis-management of companies. They have no means to sense the governance problems in companies. By the time antics of promoters are leaked, it becomes too late to quit the company. The result is obvious.

Companies Act, 2013

The Indian Companies Act confers several rights to the shareholders. Broadly, these are:

(1)  Right of access to Documents and Books. Members of a company has the right to obtain copies of Memorandum of Association; Articles of Association; Annual Report including Director’ Report; Balance Sheet and Profit and Loss Account. Members have been given right by the Companies Act to inspect Register of Members; Register of Debenture-holders; Register of Charges; Register of Investments; Minute Books of general meetings; Proxies lodged for the general meeting; and all returns filed by the company. Shareholders may inspect the minutes of the Annual General Meeting (AGM).

(2)  Right to make Fundamental Corporate Decisions. Certain fundamental corporate decisions are the exclusive power of the meetings of the members of the company wherein decisions are made by the members by passing of resolution (ordinary or special as the case may be): changing registered office; authorizing capital increases; waiving preemptive rights; buying back shares; amending articles of association; delisting; acquisitions, disposals, mergers and takeovers; changes to company business or objectives; making loans and investments beyond prescribed limits; authorizing the board to: sell or lease major assets; borrow money in excess of paid-up capital and free reserves, and appoint sole selling agents and apply to the court for the winding up of the company.

(3)  Right of participation in General Meeting. Members have the right to receive the notice of the general meetings specifying the meeting place and time and the agenda of the meeting. They have the right to attend the general meeting in person or through proxy. Members can speak at the meeting, vote by show of hands or demand a poll. They have the right to vote in case of voting by poll. The Companies Act gives right of postal voting for certain fundamental decisions.

Any member may apply to the Company Law Board (CLB) to call an AGM if the company has defaulted in conducting an AGM. Shareholders may also demand calling of Extraordinary General Meeting (EGM) for discussing any emergent item. The requisition for an EGM must be signed by shareholders holding at least 10 per cent of the paid up voting capital.

(4)  Right to appoint Directors. Members have the right to appoint the directors (at least two third of directors of a public company is required to be appointed by members of the company). They also have the right to remove the director(s).

(5)  Right as to Accounts and Audit. Members have the right to appoint the auditor and fix his remuneration. Auditors can be removed by the members of the company by passing a resolution at the general meeting. The annual accounts of the company are required to be passed at the annual general meeting of the company.

(6)  Right to participate in the profits of the company. The dividend to be paid is required to be approved by the members of the company at the annual general meeting of the company. Members have the right to receive the dividend within 30 days of the declaration.

(7)  Shareholding Rights. Members have the right to receive share certificate (in case shares are held in physical form); to transfer shares; to receive right offer of shares (in case of a public company); and to receive bonus share.

There are many provisions in the Indian Companies Act which are directed at protection of the interest of minority or retail shareholders. Some of these are:

1. 1. Appointment of the Small Shareholders’ Director. The Companies Act provides for election of a small shareholders’ director from amongst small shareholders (“Small Shareholder” means a shareholder holding shares of nominal value of twenty thousand rupees or less in a public company) in a listed public companies. Such a director may be appointed suo motu by a company or upon the notice of at least one thousand small shareholders or one tenth small shareholders of total small shareholders.
   2. Protection against Oppression and mis–management. The Companies Act confers rights to shareholders in matters of oppression by the majority or mismanagement. The lesser of 100 shareholders or those holding 10 per cent of voting rights can apply to the Tribunal for redress. The Tribunal can terminate or modify agreements entered into by the company or remove/appoint directors to the board. Members can ask for investigation in the affairs of the company. They can also file petition to the Tribunal for winding up of the company.
   3. Appointment of Directors by Proportional Representation. The Companies Act gives option to the companies to adopt system of proportional representation for the appointment of directors, either by a single transferable vote or by a system of cumulative voting. In such a system minority shareholders may also be in a position to get representation on the board of directors of company different from the straight majority of votes system where a majority holding 51 per cent or more paid-up share capital can elect all the directors and the shareholders having even 49 per cent of the total voting power are unable to elect any director.
   4. Class Action Suit. Class action suit is the instrument to empower small and minority shareholders to fight for their rights collectively by bringing a claim to court for the losses by the actions of a company.

6. Class Action

A class action or class suit is a lawsuit that allows a large number of persons with a common cause in a matter to sue as a group. In this suit a group of persons is represented collectively by a member of that group. This differs from a traditional lawsuit, where one party sues another party for redress of a wrong, and all of the parties are present in court. Class actions are most common where the allegations involve a large number of people who have been injured by the same defendant in the same way. Instead of each damaged person bringing his or her own lawsuit, the class action allows all the claims of all class members to be resolved in a single lawsuit.

Class action suits for company law cases, a well established principle in western countries, originated in the US. In class action suit, one can sue the company, the directors, the auditors, the promoters and other key managerial personnel of the company who were party to the fraud. In India, the need for class action suit arose after the Satyam scam wherein the investors in the US successfully won damages but those in India had no legal recourse for the damages which they suffered owing to the fraud and manipulations.

The Indian Companies Act, 2013 introduced class action suits for the first time to provide protection to the investors by enabling them to file suit for claiming damages from the unscrupulous promoters and directors of companies. Section 245 of the Act provides:

(a)  Such number of member or members, depositor or depositors or any class of them, if they are of the opinion that the management or conduct of the affairs of the company are being conducted in a manner prejudicial to the interests of the company or its members or depositors, file an application before the Tribunal on behalf of the members or depositors for seeking all or any of the following orders, namely:

1. 1. to restrain the company from committing an act which is ultra vires the articles or memorandum of the company;
   2. to restrain the company from committing breach of any provision of the company’s memorandum or articles;
   3. to declare a resolution altering the memorandum or articles of the company as void if the resolution was passed by suppression of material facts or obtained by mis-statement to the members or depositors;
   4. to restrain the company and its directors from acting on such resolution;
   5. to restrain the company from doing an act which is contrary to the provisions of this Act or any other law for the time being in force;
   6. to restrain the company from taking action contrary to any resolution passed by the members;
   7. to claim damages or compensation or demand any other suitable action from or against-

• • • the company or its directors for any fraudulent, unlawful or wrongful act or omission or conduct or any likely act or omission or conduct on its or their part;
    • the auditor including audit firm of the company for any improper or misleading statement of particulars made in his audit report or for any fraudulent, unlawful or wrongful act or conduct; or
    • any expert or advisor or consultant or any other person for any incorrect or misleading statement made to the company or for any fraudulent, unlawful or wrongful act or conduct or any likely act or conduct on his part;
    • to seek any other remedy as the Tribunal may deem fit.

(b)  The requisite number of members shall be:

• • in the case of a company having a share capital, not less than one hundred members of the company or not less than one-tenth of the total number of its members, whichever is less, or any member or members holding not less than ten percentage of the issued share capital of the company, subject to the condition that the applicant or applicants has or have paid all calls and other sums due on his or their shares;
  • in the case of a company not having a share capital, not less than one-fifth of the total number of its members.

7. Proxy Advisory Firms

‘Proxy advisor’ refers to any individual or any organization that prepares recommendations and gives advice for the institutional investors or shareholders so as to aid them in the casting of their vote in respect of any policy issues or a public offer [Regulation 2(1)(p) of SEBI (Research Analyst) Regulations, 2014]

Proxy advisory firms are the independent research outfits which provide voting recommendations for their clients after weighing all the pros and cons of any proposal. Some shareholders particularly institutional investors and high net worth individuals need an independent analyst to evaluate the decision taken by the company and here the proxy advisory firms act as a helping hand and provide recommendations to shareholders according to which they can cast their vote on issues such as executive compensation, corporate governance, etc. Proxy advisory firms provide institutional investors with research, data, and recommendations on management and shareholder proxy proposals that are voted on at a company’s annual meeting. A proxy firm (also known as proxy advisor, proxy voting agency, vote service provider or shareholder voting research provider) provides services to shareholders (in most cases an institutional investor of some type) to vote their shares at shareholder meetings of, usually, quoted companies.

The proxy advisory firms have been quite prevalent in the USA since 1980. The need for these firms was felt when the Satyam scam took place in early 2010. SEBI incorporated the SEBI (Mutual Funds) (Amendment) Regulations in 2010 requiring more transparency in the voting and disclosure of the norms by the institutional investors. This gave rise of emergence of proxy advisory firms in India. The ‘In Govern Research Services’ was the first proxy advisory firm of India started in June 2010. Since then several firms like the Institutional Investors Advisory Services (IIAS), Stakeholders Empowerment Services (SES) have been established.

Functions of Proxy Advisory Firms

• • The major function of these firms is advising on the matters come up for voting at the general meetings and other meetings of companies.
  • These firms aid shareholders in exercising their voting rights in the company in significant decisions like the appointment of the directors, changes in the policies of the company, etc.
  • Proxy advisory firms also provide a report or rating on the corporate governance of the entity.
  • These firms also monitor risks of the companies to provide timely advise to the investors with a view to protect the interests of the investors.

Role of Proxy Advisory Firms

The enhanced corporate governance standards as laid down by the Indian Companies Act, 2013 and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, has made the role of proxy advisors very significant. The proxy firms act as the driving force for the companies in complying with the stringent corporate governance norms. The proxy firms assist the to understand the agendas of the company, to provide them with analysis of different proposals and voting decisions of the company. There are several examples where the proxy advisors’ recommendations helped in the administration of better governance policies in the companies.

The recommendations of proxy advisors help the companies to build their reputation and trust among the shareholders. If the report showcases a positive report of the company regarding their decisions and legal compliance, then this would attract investor’s confidence in the company. This helps in more investments in the company. Thus, companies tend to follow good governance policies so that the recommendations drafted by the proxy advisors favour them. Generally, it is seen that shareholders like to invest in the companies that fall under the jurisdiction of these advisory firms because they could access insider information and the status of the company which would otherwise not have been available for the investors.

Proxy advisor firms act as the watchdog for the companies by keeping a check on companies whether they are adhering to the rules and regulations and working in the interest of shareholders. In the absence of such advisories, investors generally acted as passive members in the companies as they were not able to analyze the pros and cons of the decisions or proposed decisions of the companies.

SEBI Norms on Proxy Advisory Firms

Proxy advisory firms affect the voting by the shareholders in the companies. To minimise conflict of interest and faulty recommendations by these firms, the SEBI issued guidelines for regularising the powers of proxy firms on August 3, 2020, which came into force on January 1, 2021. The following norms are required to be followed by proxy firms:

1. 1. All proxy firms are required to be registered with the SEBI.
   2. These firms are required to disclose all the recommendations of voting and these are to be reviewed every year. The report/recommendation issued should be shared simultaneously with the company and investors and if there are any clarifications or comments that the company wants to suggest, the same could be sent by the company to proxy advisors within the timeline decided beforehand and the needful changes can be made in the report.
   3. If the opinion of the company varies from that of the proxy advisor’s report and it could not be justified by minor amendments then the those changes can be done by issuing additional reports or adding an addendum depending on the issue.
   4. If there are any discrepancies, false information, or material revisions are required to be done, the same should be disclosed to clients within 24 hours of realizing such an error.
   5. Proper records are to be maintained by these firms regarding the recommendations that are being given by them. The methodologies, procedures, and sources that were being referred to or followed, to formulate the report should also be disclosed to the clients.
   6. A proper framework is to be established by these firms to look after the internal functioning and to handle and resolve any conflict of interest that arises during the ancillary course of service like if they provide consultancy service in addition to the advisory which could lead to a biased point of view and the same should be disclosed to the clients also.
   7. A code of conduct is required to be followed encompassing eight principles like honesty, good faith, confidentiality, etc.

8. Corporate Governance in Public Sector Undertakings

There are three forms of public sector undertakings in India, firstly, the Departmental Undertakings, such as, railways, postal department etc. which are under the control of a ministry of the Government and financed and controlled directly by the Government.

Secondly, the Statutory Public Corporations which are created by the Parliament or State Legislature by passing an Act which defines the powers, functions, management, organisational and administrative structures of such corporations, such as the Food Corporation of India, Life Insurance Corporation of India, etc.

Thirdly, the Government Companies which are registered under the Companies Act and wherein the Government holds 51 per cent or more of it’s paid up capital. For example, Hindustan Machine Tools Limited, Steel Authority of India Limited, etc.

The Central Public Sector Enterprises (CPSEs) have to comply with the corporate governance rules made from time to time by the Department of Public Enterprises (DPE) under the Ministry of Heavy Industries and Public Enterprises, New Delhi. Department of Public Enterprises (DPE) is constantly endeavouring to make efforts to improve corporate governance practices in Central Public Sector Enterprises (CPSE). In June 2007, DPE issued guidelines on corporate governance for CPSE on experimental basis which was adopted by CPSEs on voluntary basis in 2008-09. In May 2010 these guidelines are adopted on mandatory basis. The aim of these guidelines is to protect the interest of shareholders and relevant stakeholders.

These guidelines on corporate governance are applicable to both listed and unlisted CPSEs. These cover issues like—

• • Composition of Board of Directors,
  • Setting up of Audit Committees,
  • Role and powers of Audit Committees,
  • Setting up of Remuneration Committee,
  • Issues relating to subsidiary companies,
  • Disclosures, accounting standards, and risk management,
  • Report, compliance and schedule of implementation.

In addition to the corporate governance guidelines issued by the Department of Public Enterprises, public sector undertakings registered under the Companies Act have to follow the provisions of the Act (Except those provisions which are explicitly notified to be not applicable). The listed public sector enterprises are required to comply with various SEBI regulations including Clause 49 of the listing agreement. Besides these, CPSEs are also regulated by their respective Acts, regulations of the Comptroller and Auditor General of India (CAG), Central Vigilance Commission (CVC), Administrative Ministry and other model Ministries. The Parliament of India and various Parliamentary Committees exercise the power of oversight and overall control over the CPSEs.

The peculiar features of corporate governance in public sector enterprises include:

• • Appointment of directors, managing director and chairman through a prescribed procedure;
  • Appointment of Statutory Auditor by the Comptroller and Auditor General of India;
  • Remuneration of directors and employees on the basis of recommendations of the Pay Committee constituted by the Government;
  • Annual Report on both the Houses of the Parliament;
  • Scrutiny of the working by the Parliamentary Committees.

The Guidelines on Corporate Governance for CPSEs

Applicability of Guidelines

For the purpose of evolving Guidelines on Corporate Governance, CPSEs have been categorised into two groups:

• • those listed on the Stock Exchanges;
  • those not listed on the Stock Exchanges.

The listed CPSEs have to follow the SEBI Guidelines on Corporate Governance. In addition, they shall follow those provisions in these Guidelines which do not exist in the SEBI Guidelines and also do not contradict any of the provisions of the SEBI Guidelines.

Non-listed CPSEs should strive to institutionalize good corporate governance practices broadly in conformity with the SEBI Guidelines. The listing of the non-listed CPSEs on the stock exchanges may also be considered within a reasonable time frame to be set by the Administrative Ministry concerned in consultation with the CPSEs concerned. The non-listed CPSEs shall follow the Guidelines on Corporate Governance, which are mandatory.