This article has been written by Santosh Kuradi pursuing an Executive Certificate Course in Corporate Governance for Directors and CXOs from Skill Arbitrage.

This article has been edited and published by Shashwat Kaushik.

Introduction

The success of a company depends upon the leaders it possesses, and companies have an abundance of it. However, to make it foolproof, the government of India has made it compulsory to have one-third of a company’s board of directors be independent directors. An independent director should hold unbiased views, be fair and knowledgeable, and act as a watchdog to uphold the interests of its shareholders. Having an experienced, knowledgeable and competent independent director with these qualities is the key to success for corporate governance. For the success of the company, it’s equally important to know other parameters as well.

Role of the board of directors in overseeing a Company’s operation and strategic direction

Good governance in any place is always a key to success, whether in the corporate world, an organisation, or any form of government. And to have good governance, you need to have a team of leaders with enough knowledge, experience, intelligence, and leadership skills to be capable of handling any situation at any given time. They should be willing to work towards a common goal, make decisions impartially, and build and manage the team while upholding the interests of the organisation and the people working for it.

The board members and the directors are the key forces in the corporate world. They are the ones holding the strings of the chariot, and driving in the right direction leads to success. A small decision taken in the boardroom can affect the entire organisation, and every decision taken in the boardroom should be taken with due care and diligence. All decisions taken in board rooms should be thoroughly analysed. 

Of course, it was and always is being done in the same way in every organisation. However, there are still chances of making errors in doing so for many reasons, such as:-

• The company wants to gain more profit in a short period of time.
• Mismanagement of the organisation or poor governance.
• Pilfear in the company.
• Corruption.
• Taking uncalculated risks.
• Failure of prediction.
• No proper checks and balances.
• Delay in taking decisions.
• Unhappy employees.
• Not be able to build trust in shareholders.
• Ignoring the government’s policies.
• Non-cooperation between the board of directors and the team.
• Yes man, team on board of directors.
• Using funds for other purposes than what they are meant for.
• Not adhering to the new technology or upgrading.

Under this situation, there is always room for scams and frauds, and there are many such incidents. Some of the measures against scams and frauds in India and abroad can not be ignored.

Scams in India

The Satyam Computer Services scandal, which unfolded in 2009, was a monumental corporate fraud that shocked the business world. It involved the systematic manipulation of financial records and misrepresentation of company assets by the company’s top executives, led by its founder and chairman, B. Ramalinga Raju.

The scandal came to light when Raju confessed in a letter to the company’s board that the company’s accounts had been falsified over several years. He admitted to inflating profits, overstating revenues, and creating fictitious assets. The revelations sent shockwaves through the Indian corporate landscape and led to a sharp decline in the company’s share price.

Investigations revealed a complex web of deceit and financial irregularities. It was discovered that Raju and his associates had created fake invoices and inflated project values to artificially boost the company’s financial statements. They also engaged in insider trading, using their knowledge of the company’s true financial position to make personal profits.

The scandal not only damaged Satyam’s reputation but also eroded investor confidence in the Indian stock market. It raised serious questions about corporate governance and accountability in India. The Indian government and regulatory authorities launched investigations into the matter, and several criminal charges were filed against Raju and other top executives.

The Satyam scandal served as a wake-up call for businesses and regulators alike. It highlighted the importance of strong internal controls, transparent financial reporting, and ethical leadership. The scandal also led to reforms in the Indian corporate governance framework, including stricter regulations on financial reporting and increased oversight of audit committees.

The Satyam Computer Services scandal stands as a cautionary tale about the dangers of unethical business practices and the importance of maintaining integrity and transparency in corporate operations.

Nirav Modi and Mehul Choksy Scam: The diamond merchants were involved with PNB Bank in attaining a fraudulent letter of  understanding to attain collateral free amount.

On November 9, 1992, the Central Bureau of Investigation (CBI), India’s premier investigating agency, swooped down on the offices and residences of Bombay-based stockbroker Harshad Mehta and his two brothers, Ashwin and Hitesh. The CBI alleged that the Mehta brothers, along with several associates, had been involved in a massive stock market fraud.

The CBI’s investigation revealed that the Mehtas had allegedly misappropriated more than 2.8 million shares of about 90 companies through forged share transfer forms. These shares were worth approximately Rs. 1,300 crores (about US$ 325 million) at the time. The Mehtas allegedly used these shares as collateral to obtain loans from banks and financial institutions.

The CBI also alleged that the Mehtas had manipulated the prices of shares through collusive trading and other illegal means. This resulted in artificial inflation in the stock market, leading to massive losses for investors when the bubble burst in 1992.

The Mehta brothers were arrested and charged with various offenses, including criminal conspiracy, cheating, forgery, and violation of the Securities and Exchange Board of India (SEBI) regulations. The trial in the case lasted for several years, and the Mehtas were eventually convicted and sentenced to prison.

The Harshad Mehta scam, as it came to be known, was one of the biggest financial scandals in India’s history. It shook the confidence of investors in the Indian stock market and led to the introduction of stricter regulations to prevent such frauds in the future.

KLA was another corporate fraud that was the first of its kind in the airline industry, which ultimately led to the fall of the empire of the King of Good Times. The airline was launched by flamboyant Vijay Mallya, well known as the King of Good Times. Over a short period of time, KLA established a reputation as the finest private airline in the country, with high quality service standards and was enjoying second highest market share after Jet Airways.

The Sahara India scam, one of the biggest financial scandals in Indian history, involved two Sahara group companies: Sahara India Real Estate Corporation Ltd. (SIRECL) and Sahara Housing Investment Corporation Ltd. (SHICL). These companies lured millions of investors, primarily from rural and semi-urban areas, into investing in their Optionally Fully Convertible Debentures (OFCDs), promising high returns and guaranteed buybacks.

However, the companies operated in a fraudulent manner, flouting regulatory norms and failing to comply with the guidelines set by the Securities and Exchange Board of India (SEBI). They raised funds from investors without registering their OFCD schemes with SEBI, effectively bypassing the regulatory oversight that is essential for protecting investors’ interests.

The Sahara group companies used aggressive marketing tactics and employed a network of agents and brokers to solicit investments from unsuspecting individuals. They made false and misleading claims about the safety and profitability of their OFCDs, exploiting the financial aspirations of people who were often unaware of the risks involved.

The scam came to light when investors began facing difficulties in redeeming their OFCDs and receiving promised returns. As the magnitude of the fraud became apparent, SEBI launched an investigation and ordered the Sahara group companies to refund investors’ money. However, the companies failed to comply with SEBI’s directives, leading to legal proceedings and a prolonged battle between the regulator and the Sahara group.

The Sahara India scam not only caused financial losses to millions of investors but also eroded trust in the financial system. It highlighted the need for stricter regulations and enforcement measures to prevent such fraudulent practices in the future. The case serves as a cautionary tale, underscoring the importance of investor education, due diligence, and regulatory vigilance in safeguarding the interests of investors.

The Infrastructure Leasing & Financial Services (IL&FS) financial scandal sent shockwaves through India’s financial sector. IL&FS, a major infrastructure development and finance company, was found to have concealed its financial stress and defaulted on various debt obligations, amounting to over $12 billion.

Scams abroad

One of the most notorious cases of corporate fraud is the Enron scandal. At its height, Enron, a major energy company, was raking in billions upon billions in profits. However, when the company began to face declining revenues and debt troubles, company executives hid the facts through massive accounting fraud.

All frauds are similar in nature, including manipulation in financial transactions and utilisation of funds in inappropriate ways.

There might have been some frauds and scams that were never reported and kept unexposed to the normal public, kept secret or else the intricacies never been solved. 

This is where the government of India laid the policy to have an outsider as an independent director who speaks his mind, has professional scepticism, and has the skills to identify a red flag and question any abnormal financial parameter. An independent director must have technical knowledge, including a deep understanding of the financial statements, economy and industries in which the company operates. Having such independent directors will definitely lead the company to success.

Government rules for appointment of independent director

The appointment of independent directors in India is governed by Section 149 of the Companies Act 2013, along with Rules and Regulations. Here’s a breakdown of which companies must or can appoint independent directors:

Public listed companies (mandatory)

 All publicly listed companies must have at least one-third of the total number of directors as independent directors. It is a mandatory requirement to ensure that publicly listed companies have a significant presence of independent directors to enhance corporate governance.

Other classes of public companies (prescribed by the federal government)

The Union government has the authority to prescribe the minimum number of independent directors for other classes or classes of public companies and the government can extend the requirement of appointing independent directors to specific categories of public companies beyond the mandatory provision for listed companies.

Public companies with certain criteria (mandatory)

Criteria: Public companies meeting the following criteria must have at least two independent directors:

• Paid-up share capital of INR 100 million or more.
• Turnover of INR 1 billion or more.
• Aggregate outstanding loans, debentures, borrowings, and deposits exceeding INR 500 million.

Exceptions: However, there are exceptions to these criteria, including:

• Joint ventures
• Wholly-owned subsidiaries
• Dormant companies, as defined under the Act

Qualification of the independent director

• The independent director should not be an employee of the company or hold any position in the company.
• The Independent Director should not be holding shares or any business in the company.
• No relatives of independent directors should be directors or in any key managerial post.
• The independent director should have sufficient knowledge of the company and be able to understand the balance sheet and red flags where required.

Role of independent director

The role of an independent director is to actively participate in board meetings, give valuable suggestions for the betterment and progress of the company, work as a watchdog, understand the situation of the company, check on all financial transactions, keep track of all the progress ongoing in the company, and give timely remarks if any. Be impartial in your dealings, and always uphold the interests of the shareholder, company and government.

The Independent Director is required to keep himself updated with recent technologies, government regulations, economic conditions, and the competitors’ strategies from time to time so that he can contribute to the well-being of the company and uphold the interests of the shareholders.

The director is required to be available to attend the board room meeting whenever the requirement arrives.

The independent directors are independent of their views and can bring any wrongdoings immediately to the attention of the public. With their experience, they can give valuable suggestions and bring considerable progress to the company.

They should be fair in dealings and always uphold the prestige of the company by helping them to abide by all the rules and regulations. They should protect the legitimate interests of the company, shareholders, and employees while acting within their authority.

Independent directors should maintain confidentiality and ensure the company has a functional vigil mechanism to address concerns.

Challenges and concerns related to independent directors

The challenges and concerns of an independent director are not limited, just as the objectives of the company are not limited. An independent director may be experienced and have sufficient knowledge in his own field. When it comes to acting as an independent director, one needs to acquire and learn about the prospects of the company, use their expertise, and give valuable input.

The independent directors are required to get updated from time to time so that they act as watchdogs to hold the interest of shareholders.

Independent directors need to be innovative, logical and pragmatic in their approach.

Though they are not responsible for the progress of the company, they are members of it, and the success of the body depends upon the functioning of its members. Hence, the success of the company depends on the directors they have.

Conclusion

The Indian market is expected to grow rapidly due to factors like an increased educated population, the availability of the internet, demand for technological support from other countries, the availability of vast land features, the opportunity to provide manufacturing services to the country and the rest of the world, motivation for a young entrepreneur to establish new startup and government policies to support these ventures. There is a room for an exponential increase in the number of well established companies in the country.

The measure hurdle or obstruction for the progress of India is always the eruption of unprecedented scams and frauds in India taking place, and again, the hard earned money of the public is wasted, and the same is seen in the form of subdevelopment in India. If the so-far reported scams had been avoided well in time, then the progress of India would have been far more than what we are experiencing today.

With the increase in the number of companies functioning, the need for the functioning of these companies in a well organized manner is the main crucial requirement for the economic growth of India. No government organisation can get involved in each and every company’s dealings and have checks and balances at each and every stage.

Having an independent director in the prescribed manner as laid out by the government of India is definitely going to be a great success for the well-being of the company and its shareholders. Not only shareholders and the company, but the economy of India will also bloom well since India is moving towards a developed country and is expected to be the third largest economy in the world. With a well trained faculty preparing independent directors in India, the world can always have access to the support of these trained independent  directors for their companies as well.

     In essence, the role of independent directors transcends the confines of regulatory compliance. They are the architects of ethical leadership, the stewards of effective governance, and the mentors shaping the future leaders of the organisation. As India’s corporate landscape evolves, recognising and harnessing the full potential of independent directors becomes not just a regulatory requirement but a strategic imperative for sustained success.

References

• http://www.lawstreetindia.com/experts/column?sid=488
• https://www.idfy.com/blog/unmasking-corporate-frauds-in-india/
• https://www.linkedin.com/pulse/importance-independent-directors-indias-corporate-landscape-nelson-o8def/
• https://ca2013.com/appointment-of-auditors/india-briefing.com/news/understanding-the-role-of-independent-directors-in-indian-companies-29426.html/#:~:text=Independent%20directors%20play%20a%20pivotal,and%20monitoring%20the%20company’s%20operations.