This article has been written by Kumar Rajiv Ranjan, Ex-General Manager (Legal), SECL & Dip. In GCP (Aug ’21 Batch). 

This article has been published by Oishika Banerji.

Corporate governance

The term ‘corporate governance’ is a much used, abused, and at times misused term in the business world today. In layman’s terms, corporate governance refers to the methodology of governing a corporate entity which includes rules, regulations and bye-laws by which a corporate firm is governed, managed, run and controlled. The concept of corporate governance works on the principle of balance of equity, balancing the interest of the company, stakeholders, customers, suppliers, financers, government and shareholders on one hand and the community at large on the other hand. 

The ICSI defines corporate governance as “the application of best management practices, compliance of law in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility, for sustainable development of all stakeholders.”

The Organisation for Economic Cooperation and Development (OECD) in 1999 had framed six (06) principles of corporate governance which were further developed in 2004 and today they are considered as the international benchmark in corporate governance. A brief of the six principles are presented hereunder:

1. The First Principle deals with ensuring the basis for an effective corporate governance framework. It advocates transparency, fair markets as well as effective and efficient allocation  of resources in order to have its impact on overall economic performance, market integrity and market participants with legal and regulatory requirements governing corporate governance being in consonance with the applicable laws.
2. The Second Principle deals with the rights and equitable treatment of shareholders and other key ownership functions. It advocates that the shareholders should have a right to secure methods for ownership registration, right to be sufficiently informed about and have a right to approve and participate in decisions concerning fundamental corporate changes consequent upon changes to statutes, Memorandum or Articles of Association etc.
3. The Third Principle deals with the Ethical principles for Institutional investors, stock market and other intermediaries. It advocates that the institutional investors acting in a fiduciary capacity should be sufficiently transparent in disclosing their corporate governance policies as well as voting policies with respect to investments, and insider trading. It further advocates that zero tolerance towards market manipulation should be adopted and the applicable rules be enforced etc.
4. The Fourth Principle advocates that the role of stakeholders in corporate governance should be like enlightened democratic participants and they should recognize the rights of stakeholders established by law or through mutual agreements and should encourage active cooperation between corporations and stakeholders in creating wealth, jobs and sustainability of financially sound enterprises etc.
5. The Fifth Principle relates to disclosure and transparency mandates. An ideal corporate governance framework should ensure that timely and accurate disclosure is made on all material issues relating to the organization including its financial situation, performance, ownership etc.
6. The Sixth Principle exhaustively sets out various responsibilities of the Board and a few of them are like members to act on a fully informed basis, fair treatment to all shareholders, applicant of high ethical standards, ensure a formal and transparent board nomination and election process, overseeing the process of disclosure and communication etc.

By analysing the above principles and the definition given by ICSI, we can say that the very essence of corporate governance and the corporate governance principles lies in having well defined policies, practices and defined standards of business ethics and moral principles which have been set out internationally and expected to be followed by corporate business houses across the globe.

Corporate governance in the Indian context

With a view to have the highest degree of corporate ethics, fairness and transparency in the business world, the Government of India along with SEBI had set up a number of Committees over a period of time. These committees have submitted a series of recommendations. Some of them, upon acceptance by Govt. of India, have culminated into formal legislations e.g. the Companies Act 2013, SEBI Takeover Regulation, SEBI LODR, SEBI ICDR Regulations, etc. Many other recommendations were adopted as moral principles. Hence, it is pertinent to have a look also at the developments in the field of corporate governance in Indian Context which is being presented herein below:

1. Corporate Governance Code (1998): Developed and designed by Confederation of Indian Industry (CII). The Code has denounced the German system of two tier boards and has also set out some other ethical standards.
2. Kumar Mangalam Birla Committee (1999): It was another committee on corporate governance which was set up by SEBI in 1999. It submitted its recommendations under two heads-mandatory and non-mandatory. Composition of Board of Directors was its mandatory recommendations while role of Chairman, remuneration committee of Board, etc were part of non-mandatory recommendations.
3. Naresh Chandra Committee (2002): It was another committee set up by SEBI which submitted its recommendations in 2002. The Committee’s recommendations were mostly on audit related matters. The Committee also listed a number of activities as prohibited non-audit service like actuarial services, valuation services, auditor’s disclosure of contingent liability etc.
4. Narayan Murthy Committee (2003): In 2003, SEBI constituted another committee under the Chairmanship of Mr N R Narayan Murthy, the then Chairman of Infosys. The Narayan Murthy Committee submitted certain mandatory recommendations for strengthening the Audit Committee, improving the quality of financial disclosure and certain non-mandatory recommendations like evaluation of the performance of the board, instituting a system of training of the Board members etc.
5. CII Task Force (2009): CII Task Force on Corporate Governance was constituted under the Chairmanship of Mr Naresh Chandra. The Task Force also suggested certain voluntary recommendations for adoption by the industry.
6. Voluntary Guidelines on Corporate Governance (2009): While CII had constituted task force for examining corporate governance and suggesting measures for improvement in 2009, in the same year i.e. 2009 itself, Ministry of Corporate Affairs (MCA) issued corporate governance voluntary guidelines which were expected to be followed by industries and corporate houses.
7. CII Task force-II (2009): Another task force was constituted by CII under the chairmanship of Mr Naresh Chandra. This task force also submitted a number of extremely significant and exhaustive recommendations which included having a well functioning nomination committee, having a fixed contractual remuneration to directors, audit committee constitution, separation of the offices of Chairman and Chief Executive Officer, etc.
8. Adi Godrej Committee (2012): It was another committee which was constituted by MCA in 2012 under the Chairmanship of Mr Adi Godrej. The Committee formulated guiding principles for corporate governance which included recommendations on key areas like board composition and diversity, selection process, on boarding process, board evaluation etc.

Various recommendations were finally encapsulated into legislation and the Companies Act, 2013 was born wherein various provisions like provisions on Corporate Social Responsibility (CSR) under Section 135, insider trading, role and responsibility of Audit Committee, etc were incorporated to strengthen corporate governance. Code of Conduct or Ethics Policy was introduced in reference to Section 149(8) and Vigil Mechanism Policy was included in reference to Section 177(8) of the 2013 Act. Accounting standards issued by Institute of Chartered Accountants of India are all parts of corporate governance reforms initiated in India.

Another important legislation towards strengthening corporate governance was enactment of SEBI LODR 2015 and SEBI ICDR 2018 where under various listing requirements were made mandatory.

In 2017, another committee under the Chairmanship of Mr Uday Kotak was constituted which submitted its various comprehensive recommendations on composition and role of board of directors, minimum number of independent directors, board meetings, enhanced monitoring of group entities, disclosure and transparency, accounting and audit related issues etc.

The ground reality of business world : the existence of business frauds

It is thus observed that corporate governance principles or business ethics policies are internationally accepted policies and principles for a noble cause of promoting fairness in business dealings, equitable treatment to all and transparency and accountability in business dealings. A number of reformative actions for strengthening corporate governance were also taken in India. However, on a number of occasions, maintenance of business ethical standards have taken a beating and have fallen prey to human greed and desire to amass wealth at all costs resulting in a number of corporate frauds internationally and also in India. Bank frauds or loan defaults by corporates are grim realities today which put a question mark on practising corporate governance policies or maintenance of ethical standards by the corporate. Our economy is struggling, a number of banks have failed and the share market is highly fluid today. 

People’s confidence in our banking sector has received a big jolt and there are a number of cases where the persons have lost their lifetime earnings and security of future at the hands of faltering and failing banks and NBFC. People’s confidence in our banking sector as a secured mode of investment is at an all time low. To examine what is happening around us,let us took a look at a few cases which had rocked the nation and also the business world during last about 30/40 years are:

1. Harshad Mehta Scam.
2. Failure of Satyam as a corporate giant.
3. YES Bank scam.
4. DUPING BY MEHUL CHAUKSI and NIRAV Modi with active connivance of officials of Punjab National Bank (PNB).
5. Vijay Mallya: The fugitive offender and collapse of United Breweries.
6. VMC Systems Limited Scam which erupted in Aug’2021. In this case also, Punjab National Bank [PNB] is found to be at the central stage.
7. DHFL Fraud Case.
8. Lost investment of Provident Fund money of UP Power Corporation and Coal Mines.
9. Provident Fund Money into the equity shares of DHFL.

With such a huge amount of money getting syphoned out from Indian economy as a result of these scams, there is a very strong need to arrest the slide as well as plight of the Indian economy, and the policymakers of the Country are required to give a deep thought to the subject and they should come out with some preventive, regulatory and also punitive mechanism.

Reserve Bank of India (RBI) is the highest regulatory authority for the banking and NBFC sector and it has also been presenting highly disturbing figures in its different reports. The RBI Annual Report 2019-20 has stated that during Financial Year 2019-20, banking sectors reported 8707 frauds wherein a total sum of Rs 1.85 Trillion was involved. The Report has further stated that during 2017-18,a total of 6799 cases were reported involving a total sum 71543 Crores. 

As per RBI Annual Report 2020-21, the value of the reported fraud was stated to be at Rs 81901 crores. These figures are sufficient to indicate how badly our economy is suffering and if the slide is not arrested, it will collapse sooner than later. How the corporate frauds are taking place and what methodologies are adopted by corporate fraudsters, it would be interesting to examine a few real life cases which have taken place in last around 30-35 years globally and also in India and a few of the landmark cases have been examined as presented hereunder.

Corporate frauds in business world : an analysis

A study of the corporate fraud cases in India and abroad has reflected some common unethical practices in corporate governance field as listed herein below:

1. As far as corporate frauds are concerned, the corporate houses use their guile and professional expertise, at times with the help of their statutory auditors or system auditors or internal auditors who manipulate their financial statements and present a very rosy and inflated figure which is a far cry from truth. The corporate thereafter presented before the banking authorities these manipulated and grossly inflated financial statements to secure finances. They, being big brand names having an established reputation, also exercise their own influence subsequently upon the banking personnel, either by palming the grease of some corrupt bank officials, or by exercising their own political clout or through their planted agents within the banking system. In this way, they get these inflated reports and financial statements accepted by the banking authorities on its face value without much verification. This methodology was adopted in the Satyam case by its CEO B Ramalinga Raju wherein the big accountancy firm Pricewaterhouse Cooper (PwC) as the statutory and independent auditor of the company was no less responsible and their irregular and unethical act of allowing inflating and manipulating the books of account of Satyam Group is still a big blot on corporate governance in India.
2. These inflated financial statements and unreal profit figures are used to obtain from the banks and NBFC loans or finances running into multi-crores of rupees. For obtaining bank finances, the corporate also takes recourse to some other banking instrumentalities. It has been experienced that instrumentalities like BG [Bank Guarantee], LoC [Letter of Credit/Letter of Comforts] etc were extensively used and abused by such Corporate Houses for furthering their business goals.
3. In the recently detected case of VMC Systems Limited, Hyderabad, the modus operandi had remained the same. The Company before the banking authorities had declared their receivables to be at 262 crores by manipulating their books of accounts and financial statement by active connivance of their statutory auditors while in reality, they had pending dues and receivables of Rs 33 Crores only which they were to receive from BSNL and these inflated and manipulated figures were accepted by PNB authorities without proper verification. The Company had also claimed certain receivables from other private companies which were unreal and not true. With the help of these inflated, manipulated and false financial figures, VMC Systems Limited succeeded in securing a loan from a consortium of banks including PNB. Post unearthing of the fraud, the matter is under investigation by CBI and the estimated value of the fraud is above Rs 1700 crores.
4. In the PNB Scam also, Nirav Modi and Mehul Chauksi,the big diamond merchants, exercised their personal clout and succeeded in obtaining fake Letters of Undertaking [LoU] by the Bankers at a small branch of PNB. The Branch of PNB which was involved in this mega financial scam was a small Brady house Branch of PNB which was located at Fort, Mumbai. These LoUs were issued by the officials of PNB working at the Brady House Branch in favour of branches of Indian Banks in overseas destinations for import of pearls and other costlier stones for a period of One Year. Such LoUs for a period of one year were issued despite the fact that the RBI had prescribed a total time period of 90 days only from date of shipment. The duo of Nirav Modi and Mehul Chauksi succeeded in obtaining a total of 1212 LoUs within a period of 74 months from their first fraudulent guarantee obtained by them from PNB on March 10, 2011. Later investigation by CBI revealed that they obtained these LoUs mostly in favour of dummy firms which were operating from the British Virgin Island and the fund received through fraudulent LoUs was transferred into their account.
5. It is also observed that the frauds committed are sooner or later detected and, thereafter, the corporate become defaulters. Soon, they or some operational or financial creditors file insolvency resolution proceedings against them. The courts, thereafter, accept some resolution plans brought before them by some other corporate at a much-discounted rates and in this manner many of big names in the corporate world get themselves absolved of their financial liability. One big example of getting relieved from financial liabilities is the case of Ruchi Soya Industries Limited[RSIL] which had an outstanding loan of over Rs 12000 Crores when insolvency resolution was filed against them but the court accepted resolution plan of Patanjali Udyog Limited for a value of Rs 4350 crores only. As a result, Central PSU Banks like SBI could recover only around 43% of the loan extended. Further, as part of the Resolution Plan, Patanjali Udyog made an upfront payment of Rs 1000 crores only and SBI and other banks extended them a further loan of 3350 Crores. So practically, nothing comes back into the coffers of the Banks through the approved insolvency resolution plan of Ruchi Soya.
6. It has thus been observed that in the Indian corporate sector and business world, the defaulting corporate, in this way, get away with negligible losses but the bigger sufferer has always been the banks and NBFC as financial creditors, retail investors, other secured and unsecured operational creditors. The biggest sufferer has always remained the economy of the country as huge money running into millions of dollars/rupees is taken out from the system.
7. However, in foreign corporate world, major panel actions are also taken whenever corporate frauds of a mega nature have been detected and an exemplary penalty against the defaulters has been also awarded.
8. The cases of World Com Inc and Enron Corporation are two of the biggest corporate scandals in the corporate and business world of the USA. In the WorldCom fraud or in the other case of The Enron Scandal, the modus operandi was similar, that of playing with and manipulating the books of account wherein their statutory auditor and external Auditor Arthur Anderson actively connived. In the case of WorldCom Inc, the Company with active connivance of its Auditor had overstated its assets by over USD 11 Billion. When the fraud was unearthed, it was the largest accounting fraud in American history which was just recovering from the shock of another mega Enron Scandal. It was a slap on the corporate governance principles and business ethics policies . Its external auditor Arthur Anderson lost its credibility permanently as it was found to have indulged itself in similar manipulation of books of accounts in the Enron case also. WorldCom filed for bankruptcy on 21st July, 2002. Criminal cases were instituted against officials of World Con Inc and conclusion of criminal proceedings resulted in conviction of Bernard Ebbers, its Founder President and CEO on nine counts of securities fraud. He was sentenced to 25 years of prison in 2005.
9. The Enron Scandal had just preceded the World Com Inc Case. In this case, Mr. Andrew Fastow as CFO of the Company, had also manipulated the books of account of the Company and, in a like manner, had engineered and developed a financial accountancy fraudulent plan through which he was able to show in the books of the company that Enron was having a very sound financial health despite the fact that many of its subsidiaries were struggling and losing the money but this fact was suppressed from the investors and Wall Street regulators through manipulation of accounts.
10. For the purpose of hiding the financial realities from the Investors and other stakeholders, Fastow &amp, others at Enron engineered a scheme to use off-balance-sheet special purpose vehicles (SPVs) or special purposes entities (SPEs), with the sole intention to hide the debts figures and toxic assets of Enron from investors and creditors as well as Stock Market regulators. These SPVs were engineered exclusively for the purpose of hiding accounting realities and were not aimed at any operating results. Fastow and his team were simply transferring some of Enron’s rapidly rising stock to the SPV in exchange for cash or a note. The SPVs were subsequently using the stock to hedge an asset listed on Enron’s balance sheet. In return, Enron was giving guarantee to the SPVs the value to reduce apparent counterparty risks.
11. Sadly in this notorious accounting fraud, they were joined by their external auditors, one of the most reputed and trusted accounting firms in Arthur Anderson LLP, who were according to their stamp of approval despite extremely poor and at times suspicious accounting practices of Enron. The inflated bubble of Enron was ultimately deflated and the dubious accounting procedures practised throughout the 1990s by Enron in active connivance with its auditor Arthur Anderson were unearthed which rocked the entire business world. Wall Street was shaken, the share price of Enron dipped to an all time low and finally Enron was forced to file bankruptcy on 2nd December 2001. Its share prices doomed to pennies from a high of USD 90.56 during the summer of 2000.
12. The Enron Scandal was the biggest corporate scandal in the USA (until the WorldCom scam unearthed in 2002) resulting in USD 11 Billion losses to the shareholders. The Wall Street Darling crumbled beyond imagination. A number of criminal cases were filed and Arthur Anderson as the Auditing firm became one of the biggest casualties resulting from the fall of Enron Empire. A number of criminal charges were filed against them also. With the WorldCom scandal following in 2002, their credibility has suffered such an irreparable damage from which they have never recovered. They were disgraced beyond imagination. A group of former partners bought the name in 2014 and created a new accounting firm by name Anderson Global and thereby trying to rebuild themselves.
13. Further, criminal cases were instituted against most of Enron’s executives. They were charged with conspiracy, insider trading and securities fraud. Mr Kenneth Lay, founder of Enron as well as its former CEO, was convicted on six counts of fraud and conspiracy and four counts of banks fraud. However, before sentencing, he had a heart attack and finally died in Colorado. Its Star CFO Andrew Fastow also pleaded guilty for two counts of wire fraud and securities fraud for facilitating Enron’s corrupt business practices. He was sentenced to imprisonment and he spent more than five years in prison. The uproar following the Enron Case and Worldcom Inc case was huge.The collapse of Wall Street, dwindling faith of investors, falling business etc forced the US government to intervene to regain the confidence of the people and the investors. In July 2002, the Sarbanes-Oxley Act was enacted after its signing into law by the then President Mr George Bush. The Act introduced strict regulatory norms and punitive measures as it also prescribed the consequences for destroying, altering or fabricating financial statements and for trying to defraud the shareholders. Additionally, the Financial Accounting Standard Board (FASB) raised its level by several notches as far as ethical conduct is concerned.
14. The Enron case and the following WorldCom Inc case impacted Indian market also and Indian Government finally rose from a state of slumber and in the year 2002, the Govt. of India appointed Naresh Chandra Committee with a mandate to principally examine and recommend inter alia amendments to the existing laws involving the auditor-client relationships. The Committee was also asked to examine the role of independent directors and submit its recommendation. Significant developments took place thereafter as a number of Committees were constituted to examine corporate governance in India and to submit reports/recommendations to strengthen it. The reports and recommendations submitted by these Committees finally found its reflection in the Companies Act, 2013, SEBI LODR Regulations 2015 etc thereby bringing more accountability in the corporate world.

Conclusions and suggestions

Corporate governance is essentially about how the organisations and corporations are directed, managed, controlled and held accountable to all the stakeholders. Accountability, transparency, security and responsibility are its pillars particularly in the era of globalisation and liberalisation but like in foreign countries, India has also witnessed some mega financial scams viz. Harshad Mehta Scandal, Satyam case etc. thereby throwing open the question of managing financial risks and ensuring corporate governance. The recent Tata- Mistry feud has yet again raised debates on protecting interest of minority shareholders and role of independent Directors and for many, in this case also, ethical business practices took a beating as reflected in the manner in which Mr Mistry was exited from the Board of Tata Sons. For many observers, it reflected an autocratic style of functioning of Mr Ratan Tata under the garb of corporate democracy. Questions of ethics have been also repeatedly raised when big companies and established names do allot preference shares to their promoters at heavily discounted rates.

Clause-49 Listing Agreement by SEBI and enactment of Companies Act, 2013 repealing the old act followed by enactment of SEBI LODR 2015 were some of the major developments towards transparency and ethical corporate governance. Some other steps like strict following of integrity pact in business contracts, zero tolerance on corruption, prioritising risk management, evaluation of Board performance biannually and placement of reports in AGMs etc, if taken, shall lead us towards productive ethical and transparent governance. Clause 29 A of the Insolvency and Bankruptcy Code, 2016 should be strictly followed to ensure fairness and accountability in the insolvency procedure as also repeatedly urged by Apex Court. Timely disclosure of accurate information on financial matters, performance etc has to be the key for ethical and transparent governance.

However, the biggest threat today is the corporate banking frauds and NPAs(Non performing assets) which are practically unrecoverable. The tentacles of such frauds are menacing, impacting our economy in a much bigger way in consideration of the fact that a single banking fraud is seen to be valued around Rs 1000 Crores or even more. In 2021 alone, as per a written reply tendered by Union Minister for Finance before Rajya Sabha [Upper House], 13 bank frauds, each of a value of more than 500 Crores, have been reported by the State Runs Banks for the period up to June’21. Such an astonishing figure for the first quarter of the Financial

Year 2021-22 is an admitted fact by the Government of India. It was further stated by the Minister in the reply tendered before the Upper House that such types of cases were79 in 2019-20 and 73 during 2020-21. In all these frauds, almost similar methodology is adopted. The Fraudsters Corporate are using forged financial statements, forged instruments, manipulated books of accounts, borrowing of funds against fictitious accounts, unauthorised credit facilities, fraudulent foreign exchange transactions and they are further assisted by managerial failures at the stage of credit sanctions/disbursement.

In consideration of all the above facts, some preventive measures as well as punitive measures, tightening of administrative set up, enactment of new rules etc would be essentially required and in this nefarious game, sadly some big names in the world of Accountancy and Auditing firms have also been found to be involved which is also an area of grave concern. 

To curb and control the menace of corporate frauds is a big challenge today and it is happening principally due to non-practicing of ethical practices in business as well as non-adherence to corporate governance principles which are fast eating up into our economy. This slide is required to be at once arrested. If it is allowed to continue unabated and suitable

preventive and punitive measures are not taken, the business sector and economy may collapse due to cash crunch and absence of financial liquidity sooner than later and one of the principal contributory factors for such happening shall be the non-adherence of corporate

governance principles and ethical business practices and a stage of anarchy and hooliganism shall result as we are witnessing in Srilanka today.

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