Introduction of Derivative Contracts on Foreign Stock Indices

SEBI has issued a circular which permit Stock Exchanges to introduce derivative contracts (Futures and Options) on foreign stock indices in the equity derivatives segment. This circular comes into force from today. It is available on SEBI website Click Here: at http://www.sebi.gov.in/circulars/2011/cirdnpd022011.pdf

Eligibility Criteria: The minimum market capitalization mandated is USD 100 billion and the stock exchange may introduce derivatives on a twenty four foreign stock index if the derivatives on that Index is available. Index should be is “broad based”, that is, the Index consists of a minimum of 10 constituent stocks and no single constituent stock has more than 25% of the weight, computed in terms of free float market capitalization, in the Index.

Trading in derivatives on Foreign Stock Indices shall be restricted to residents in India.

EMPOWERMENT OF WHISTLEBLOWERS

In corporate parlance, whistle blowing is a mechanism for employees to raises a concern about wrongdoing occurring in an organization, such as suspected fraud or violation of the company’s code of conduct or ethics policy. In the context of risk management and internal controls, it is a useful management tool which can hunt out information which may or may not surface to the levels where such deviant practices could be flagged, and stopped, thus providing an opportunity for identification and rectification of the problem, without damaging the functioning and/or survival of the corporations.


While the Indian government still has to bring out a comprehensive whistle-blower policy, the Security and Exchange Board of India (SEBI) has set out a model procedure for facilitating whistle blowing in the listed corporations under the Clause 49.

These guidelines are non-mandatory following reservations on the part of several companies, who were apprehensive that the policy could be used to report a number of frivolous cases. However, there are a number of companies who have indeed evolved a whistle blower policy and in some cases; the reporter of misconduct even includes other stakeholders, such as vendors and customers.

Recently, in December 2009, the Ministry of Corporate Affairs (MCA) has issued a Voluntary Guidelines for Corporate Governance, incorporating clause VI for Institution of mechanism for whistle blowing by the companies:

1. 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.

2. 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.

A company’s board and its directors have the responsibility of reducing the damage that any public exposure could bring upon them and as well their companies, their risk management systems should provide for suitable mechanism of facilitation to encourage whistle blowing procedures that would at once encourage adequate confidence in the employees about the confidentiality of the processes and also the fairness and promptitude of follow-up actions on their complaints.

In the US, well published high profile whistle blowing by Sherron Watkins of Enron and Cynthia Cooper of WorldCom, which led to revelation of frauds to the tune of $591 million in Enron and the $3.8 billion in WorldCom.

Aforesaid and other fraud cases, which cost investors billions of dollars when the share prices of affected companies collapsed, shook public confidence in the securities markets, spurred the US administration to pass the Sarbanes-Oxley Act, 2002 (SOX), which provided legal protection to whistleblowers in public companies. Section 806 of SOX, is intended to protect employees of public companies from retaliation for reporting financial misdeeds, and is administered by the Department of Labor’s (DOL) Occupational Safety and Health Administration.

Section 1107, of SOX Act has provision of strong penalties:

“Whoever knowingly, with the intent to retaliate, takes any action harmful to any person, including interference with the lawful employment or livelihood of any person, for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any federal offense, shall be fined under this title, imprisoned not more than 10 years, or both”

Despite a strict ban on various kinds of disciplinary or retaliatory actions against such whistle blowers, such as discharge, demotion, suspension, threats, harassment, blacklisting, etc., the ground realities are quite different and the confidence levels in the systemic protection mechanisms is low.

However, in the recent case, John Kopchinski's six-year legal battle against Pfizer Inc just made him a rich man. Kopchinski and five other whistleblowers have earned more than $102 million in payments from the U.S. government under the False Claims Act through which individuals can reap rewards for exposing corporate wrongdoing. Kopchinski - the Gulf War veteran and former Pfizer sales representative, alone has earned more than $51.5 million as a result of his whistleblower lawsuit against the world's biggest drug maker and the record penalty the company must pay the U.S. government for its massive marketing transgressions. The size of the whistleblower rewards announced is already having an impact worldwide.

According to a recent Fraud Survey 2009 conducted by KPMG, nearly two–third (65%) of the senior executives viewed fraud and misconduct to be significant risks within their industry. These senior executive were most concerned of potential loss of public trust, potential legal fines/ sanctions, and loss of new or existing customers due to frauds.

In an another survey data based on actual fraud cases from the Association of Certified Fraud Examiners, responders opined that frauds were more likely to come to light through whistleblower tips than through audits, controls, or any other means. In addition, employees, who responded to KPMG Forensic’s 2008–2009 Integrity Survey cited Internal Audit as among the least likely channels to which they would feel comfortable reporting misconduct.

The whistle blowing, as an internal control mechanism is yet to come of age in our country. Whistle blowing, in India, still continues to be perceived by many as acts; which are not constructive, a matter of personal vendetta or revenge, intention to embarrass the organization, and so on so forth. On the other hand, the whistleblowers have often faced reprisal, greatly suffered and endured, often for many years, after the complaints have gone unheeded. One of the reasons attributable to this is poor levels of confidence in the ability of the legal and regulatory environment to ensure promised protection against retaliation.

For developing a better corporate governance practices in the country, it is imperative to empower the whistle blowers, the policy concerning them need to be made mandatory, with clear guidelines for prosecuting intimidation of or retaliation against the complainants, including imposition of fines/ penalties for frivolous or mischievous complaints and fast-track disposal of cases along the lines of the Sarbanes-Oxley Act (SOX).

Satyam Lessons and Corporate Governance Reforms

“The directors (managers) of such companies, however, being managers of other people’s money than their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private co-partnery frequently watch over their own… Negligence and profusion, therefore, must always prevail more or less in the management of the affairs of such a company.”

• Adam Smith - An Inquiry into “The Nature and Causes of The Wealth of Nations”, p.31.


INTRODUCTION

The Corporate Governance, has never ever, since the Satyam Episode, become such a household word. A confessional letter of 7th January 2009 from Mr. Ramalinga Raju, founder Chairman of Satyam, divulged the accounting scam of the order of US $ 1.6 billion, and shook the whole country with tremors felt throughout the globe. Mr. Ramalinga Raju can be credited as the only corporate fraudster to have admitted his misdemeanors – fudging of accounts, inflated revenues, non-existing profits, and the fraudulent bank deposits and audaciously sustaining it for seven long years. The Mr. Ramalinga Raju’s misdeeds, unfortunately had given negative publicity of India Inc so far a positive story. The fraud has undermined the trust in the government, companies, and markets alike. In India, nobody had ever imagined anything to go wrong at Satyam, one of India’s best known IT companies, which ironically had received the Golden Peacock Award for Corporate Governance in 2008.

This episode has led to debates in India, about some of inadequacies in the corporate governance norms. Questions have been raised about the performance/ effectiveness of board of directors, roles of auditors, the impact of regulations, disclosures, etc. However, the silver lining to this whole episode was the proactive role played first time ever in India by the shareholder activists in opposing the unanimously approved board’s resolution of December 16, 2008, in acquiring a property of companies (Matyas Properties and Maytas Infra) owned by the son of Mr. Ramalinga Raju, which led to revelation of frauds being committed by promoter behind the scene. If a large company like Satyam could do it for years, what’s the guarantee more are not doing it? It is therefore, important that the Satyam fraud needs to investigated and sentence the fraudsters swiftly and harshly to increase 'deterrent aspects’.

The frauds of such magnitudes provide a good opportunity for introspection. These times also expose the shortcomings and vulnerabilities of the system. Conflicts always have hidden solutions. There are lessons to be learnt from Satyam’s nemesis too. It is one such great opportunity to reassess some of the existing framework on corporate governance, systems for better enforcements of regulations; effective roles and duties of directors, executives, regulators; ethics in businesses and empowerment of minority shareholders.

OVERVIEW OF INDIAN CORPORATE GOVERNANCE

India’s corporate governance codes are on par with the best in the world, the importance of continuing to assess it against international best practice, to suit to the Indian ethos & culture with utmost sincerity and keenness in enforcement has been highlighted by the recent fraud at Satyam.

The Indian corporate would appreciate the fact that the corporate governance in India has not been forced upon them by the government, but it was a voluntary and path-breaking initiative from the Indian industries association - Confederation of Indian Industry (CII). It was necessitated, for the fact that India Inc was to move forward and globalize itself towards international standards in terms of disclosure of information by the corporate sector and, through all of this, to develop a high level of public confidence in business and industry in the process of building large global conglomerates. CII had vigorously lobbied and pressurized the government of India for its implementation.

Corporate governance initiatives in India began in 1998 with the “Desirable Code of Corporate Governance” – a voluntary code published by the CII, and the first formal regulatory framework for listed companies specifically for corporate governance, established by the SEBI, widely known as Clause 49 of the Listing Agreement – Aimed at improving corporate governance in the country. The latter was implemented in February 2000, following the recommendations of the Kumarmangalam Birla Committee Report.

Legal reforms has been ongoing, with SEBI in 2003 revised the Clause 49, as per the recommendations put forward by the committee and public comments received. Subsequently, the SEBI received a number of feedbacks/ representations, which were deliberated once again by the Narayana Murthy Committee and post discussion, SEBI directed further amendment to the Clause 49 in October, 2004. The amendment to Clause 49 of the Listing Agreement has been the topic of elaborate deliberations and discussions in the Indian corporate scene. The difficulties in achieving compliance prompted many apex chambers of commerce to appeal for an extension of the extended deadline of 31 December 2005, without success. The ease with which SEBI introduced mandatory corporate governance standards in India is unparallel.

The Companies Act, 1956 was undoubtedly a significant landmark in the development of Company Law in India. It consisted of 658 sections and fourteen schedules. The Act was enacted with the object of amending and consolidating the law relating to Companies and certain other associations. The main object of the Act was to provide protection to investors, creditors and public at large and at the same time leaving management free to utilize its resources and energies for the optimum output. However, the working of the Companies Act brought to light several lacunae and defects in its provisions. Therefore, the Act was amended from time to time. But despite extensive changes the principal Act still suffers from certain serious defects. Moreover, after liberalization, the increasing number of options and avenues for international business, trade and capital flows had necessitated modernization of the regulatory structure for the corporate sector in a comprehensive manner.

In 2004, the Indian Government took up a comprehensive review of the Companies Act, 1956. The aim was to strengthen compliance norms and to provide a governance structure for unlisted firms. The new Companies Bill has been based on best international practices and fosters entrepreneurship. As a result the Union Cabinet on 29th August 2008 gave its approval for introduction of the Companies Bill, 2008 in the Parliament to replace the Companies Act, 1956, the existing statute for regulation of companies in the country and considered to be in need of comprehensive revision in view of the changing economic and commercial environment nationally as well as internationally. The bill had lapsed with the dissolution of the house in December 2008 and it has now been re-introduced on 3rd August, 2009. The Companies Bill seeks to enable the corporate sector in India to operate in a regulatory environment of best international practices. The provisions of Companies Bill are broadly considered to be suitable for addressing various contemporary issues relating to corporate governance, including those recently noticed during the investigation into the affairs of erstwhile Satyam.

The bill has now been re-christened as Companies Bill 2009, and will be forwarded to a Parliamentary Standing Committee for recommendations. With the standing committee set with no time frame for giving its recommendations, the passage of the new law is likely to take over a year. It is quite sad that the amendment of the Company Act 1956 has been languishing for so many years now. It is earnestly hoped that speedy passage of the Companies Bill will now be ensured.

LESSONS FROM SATYAM EPISODE

The Satyam board on December 16, 2008, had unanimously approved a proposal to acquire 100 percent of closely held Maytas Properties for Rs 6,240 crore ($ 1.3 billion) and 51 percent of Maytas Infra for Rs 1440 crore ($300 million). The latter acquisition was proposed to be done in two stages: first, Satyam would acquire 31 percent from the promoters at Rs 475 a share, and in the second, it would buy another 20 percent from the market through an open offer at Rs 525. The two acquisitions would have totals expenditures of Rs 7680 crore ($1.6 million).

The immediate reaction of institutional shareholders and investment analyst, as soon as the information become public the next day, was that it was daylight robbery and the promoters were siphoning money out of Satyam. They further vehemently reacted and said that they would to go to any length to prevent this from happening. Mr. Ramalinga Raju was left with no option to abandon the plan at the first place, but also had to put in his papers, confessing cooking of the books for several years, on 7th January 2009, sending shockwave all throughout the corporate board. However, the silver lining to this whole episode was the ascendancy of the Shareholders Activism, one of the first times ever in India. But for the proactive role played by the shareholders and the institutional investors, the nefarious activities committed clandestinely by promoters would not have seen the light of the day.

In the Indian context, it is well known that the many of the companies are controlled by the families and would like these to be handed over to their sons and daughters. The promoters may pursue interests that are not necessarily desirable from the point of view of the commercial success of the company. The promoters are all powerful making even the academically well qualified Independent Directors, as in the case of Satyam having people like; Vinod K Dham, Mendu Rammohan Rao, Krishna G Palepu, Mangalam Srinivasan…, appear dwarfs and not of independence. This has brought to attention once again the role of the independent directors.

As a consequence of the fallout, all the independent directors resigned one after another. These included Mangalam Srinivasan, Vinod K Dham, Krishna G Palepu, T R Prasad, Prof. V S Raju and M Rammohan Rao.

It is one thing to have elaborate codes, but quite another for companies to follow them in letter and spirit. Yet another is the question of enforcement if companies do not adhere to the standards. Weakness of enforcement in India is a real issue. The unraveling of these events at Satyam has once again put spotlight on some of the corporate governance practices and has exposed the following weaknesses:

1. Lax Regulatory systems
2. The imperious and Machiavellians promoters/ CEOs and their unbridled greed
3. Connivance and collusion of Auditors and poor auditing practices
4. Timid and acquiescent independent directors
5. Shareholders activism and Empowerment of minority shareholders
6. Empowerment of Whistle blowers

We ought to refrain from taking quick-fix regulatory measures. It would be worthwhile to search for holistic solutions to these issues; which are relevant in the Indian context. The choice of changes in the regulatory frame work should be compatible with the country’s own values and legal system. The system adopted should be agile enough to fore warn the early signals of a brewing crisis and take corrective measures. The system should encourage “proactiveness” rather than be a "reactionary", otherwise status will not change. With the present day state of art computer technologies, this is not impossible.

One must, however, understand that no matter how strong a regulatory system is, it cannot always prevent frauds. Despite the enormous increase of disclosures and stringent risk management systems in US post the Sarbanes Oxley Act, inability of the system to read the early sign of impending recent Subprime crisis, Madoff's Ponzi scheme, and willingness to take corrective action is one such example. Moreover, strong measures often lead to expensive regulations and defiance. There are limits to legislations as a lot depends on the integrity and ethical values of various corporate players such as directors, promoters, executives and shareholders. The key lies in management decisions and its commitment to establish and follow rigorous governance systems. The implementation must be in the letter and spirit, and one should recognize the responsibility of the company towards its stakeholders.

Record number of fraud cases in first half of 2009

Over 160 cases of serious fraud with charges in excess of £100,000 came to UK courts in the first half of this year, according to KPMG Forensic – the highest number of cases in a six month period in the 21 year history of its Fraud Barometer.
The cases had a total value of £636m which, if replicated in the second half of the year, would also lead to the highest value of fraud in the Barometer’s history (currently £1.2bn in 1995). Professional gangs were the most active perpetrators of fraud,..

To read the full article by KPMG Click Here.