“The Business of Business is Business”
Friedman’s fundamentalist theory
The Companies Act or The Act 2013 has been in the making for over ten years now since the time it was drafted by the then government that believed that the current corporate scenario was in dire need of change. The law although only partially implemented is expected to have far reaching effects on the Indian corporate scenario in the years to come. Like everything else, the companies Act 1956 was in need of intervention, having been deemed incapable of keeping up with shifting global market trends and increasing need for protection of stakes in companies. There was a need to “raise the bar on governance”, a step in the right direction which was initiated with the passage of the Act 2013 which as a law is bound to affect each and every one working in Corporates today. Change is coming, although the level of change that may affect your organization may vary and the implications of passing it may differ in scale and complexity.
Passed on 29th August 2013 the Companies Act 2013 has been designed to appreciate the economic environment of India whilst focusing on protection of stake-holders interests and investments in companies. Application of Lean six sigma tools in processes has been seen coming under focus as companies are becoming more process rather than employee oriented, given the high attrition rates in the market today. The act/ law aims at easing administrative burden at several points of a process and is broadening avenues to deal with international market as a direct impact of globalization. With just 470 sections and 7 schedules, the act is much more concise as compared to the 1956 act though it runs hand in hand with more than 300 references to rules in the 1956 act that play an important role in the optimal functionality of the new law, although in my opinion the job of managing the corporate scenario while referring to the companies Act which is actually a co-existence of TCA 1956 and 2013 by the ministry of corporate affairs is commendable.
An act with this much weightage is bound to come with consequences, the following effects in my opinion which everyone part of the corporate scenario today must be aware of:-
Say hello to the rapidly evolving concept of Corporate Reporting!
Corporate reporting framework has been a topic explored vastly even during conception of the Companies act 1956 with introduction of new changes keeping new age objectives in mind like maintenance of consistency and relevance while submitting financial reports, alignment with international protocols and more. Some of the major changes that every corporate has been made aware of and are now in the process of executing are directly affecting the reporting framework internally as well as externally. Every company that exists as a joint venture or has any subsidiaries now has to provide a consolidated financial statement which is considered as the sum total of all financial statements applicable to the firm and its counterparts. Although this order is applicable only to companies listed under SEBI as of now, it will soon apply to all existing companies as a consolidated financial statement is considered to the only general statement capable of conveying the true state of financial affairs within a company as per international protocol.
A number of people seem to have several interpretations of subsidiaries, joint ventures and associate firms. The new Act 2013 has clarified the terms and implications each association brings in crystal clear terms basically indicating that while a subsidiary is a company “controlled” by the parent company due to more than 50% share value in the same. This thing to note is that while several companies will turn to preference shares, this act rules out any significance of the voting power of an enterprise which was not the case in the previous Act. An associate company or a joint venture is one over which the company has significant influence where joint ventures are expected to present a disclosure regarding amounts depending on equity and cannot indulge in joint accounting as per equity method.
Up until now companies were not allowed to revise their financial statements submitted at the end of the annual cycle. In this case any discrepancy from the previous year believed to have occurred due to error, fraud or whatever reason needed to be adjusted in the next cycle as a past year adjustment. The new act however has opened a new gateway which allows companies to revise their financial statements, although the same can be applied only and only under the following circumstances- if there is a genuine doubt on the reliability and authenticity of the financial statements submitted by a company raised to the board either by organizations like SEBI or any person directly concerned with the finances of the company, or voluntary revision or reinstatement ordered by board of directors in the event that they believe the financial statement may not comply with changes in the new act of 2013. The new law expects all companies to adopt a uniform financial year of April 31st to March 1st along with relevant changes to the depreciation regulation and corresponding impact on the cost and recovery regarding useful life of a company or asset.
Don’t keep Calm, The Auditor is here!
Internal financial controls of companies are now under stringent regulation and this can be seen directly through the increase in relevance of and reliance on internal audit programs and reports. Governments have the power to conduct audits at any given time interval while each company is expected to have an internal auditor the band of which post may be decided by the board of directors. While the internal audits are required for all private listed companies and public listed companies with loans amounting more than 25 Cr the act also demands the reports of internal audit controls from Directors with regard to listed companies and auditors for all associated companies on whether the company is compliant and whether it has the funds to sustain.
The new age is seeing changes with respect to the appointment of auditors/ audit companies by companies, breaking the 5 year rotation period of auditing companies and prevention of the concept of staying with the same audit company for more than a two terms of 5 years each. While audit companies catering to partners are out of the running to be considered for appointment the central government continues to have control over the rotation of audit firms as and when they come and go through the standee company. A growing concern is seen regarding non auditor services which although may go unofficially unaudited, yet have seen to benefit the company either through investment banking services or management services. I cannot say I completely agree with prohibition of rendering “non-auditable” services by the auditor to the auditee in strong legal terms as it may include various dimensions of human and economic factors which need not be regulated all the time.
The importance of reporting fraud, sticking to auditing standards and have been highlighted but the main point to be noted which exhibits how seriously the government is combating corporate crime and fraud is by establishment of the NFRA [National Financial Reporting Association] which not only has the power to guide and advise the central government with respect to laws and strategies for Audit control but also enjoys judicial power with the capabilities to investigate frauds on account of wither companies or individuals.
Organization Restructuring- Control Vs Commitment
The main objective of this in my opinion is to make the process of mergers and acquisitions efficient, easier and compliant with limited timelines. The judicial power and sanctioning authority for re-structuring of companies not lies at the seat of the NCLT [National Company Law Tribunal] and the goal is to maintain transparency regarding the real owners of a company by prohibiting a company from making more than a two level investment in a subsidiary. Restructuring transactions include compromise or agreements, amalgamations, demergers while the valuation of each of these transactions must necessarily be carried out by a registered valuer. The concept of minority buy out is great as this removes the complications that arise from minority stakeholders in the company as the ownership moves back to the parent units although this amendment is also subject to several terms and conditions applicable at the time of the movement.
Cross border mergers are now allowed and encouraged, fast track mergers are available for small units amalgamating while dormant companies which can be proved to be potentially and productively active in the future are now recognized. Pros of this amendment include recognition of small scale companies, limit on number of members in partnership firms, relaxed provision for BOD meetings in smaller companies and so on.
A few good men! Increased corporate responsibility at the Managerial level
Increasing the cap on number of Directors that a company can have, laying down rules for a director to have experienced India for at least 182 days before being appointed and provision for women directors are a few changes which can be expected. Mandatory committees to be involved in the removal or appointment of a director, role of central government in exercising control over unlisted public companies by appointment of leaders, protection of independent director rights, differentiation between nominee and independent directors, managerial responsibilities on part of auditing firm directors and stringent punishment for non-compliance when it comes to inside trading are welcome changes which only go to show how much India is advancing and growing and realizing the need to set some ground rules. However, in my opinion inside trading when performed in defined limits may not always be as harmful as is deemed. Either ways, the new era will see added responsibilities and more importantly, accountability on the part of corporate leaders aiming at creating an atmosphere of transparency.
Corporate social responsibility- The way to Go!
As per the new act, companies over a specified net worth of 500 Cr are expected to spend 2% of their net revenue on CSR activity [Section 135]. CSR committees per qualifying company are mandatory, required to plan the CSR activity for the company along with the budget of expenditure for the same, whilst also monitoring the activity returns and performance. The CSR committee is crucial to regulate and approve of CSR policies, ensure 2% spend on the program and draft a report on the success of the same while presenting to the board. CSR activity can be anything that deals with Environment sustainability, social business enhancement, women empowerment, infant and women health protection, poverty reduction, socio- economic development, education and so on! Companies can pool together in order to perform CSR and CSR projects or programs may also integrate into existing business models of the company, a recent example being of General Electric Healthcare where the CSR activity focusing on education and eradication of unemployment grew into an economic structure integrating with the existing business models of GE India and is today a separate entity belonging to GE Healthcare called GE HC Education.
Now, accounting statements will represent more than just numbers- the growing focus on Investor Protection!
This is a focus thought discussed at length in the new Act of 2013. The transactions of companies with related parties which may not be in the order of ordinary business are now to be sanctioned by board of directors and privy to strict compliance standards. Income tax regulations on national and international transactions, provisions to do with caps in inter-corporate loans as well as fraud rick mitigation by defining fraud in clear terms and placing more responsibility on directors, management leaders and auditors has increased accountability and clarity in terms of corporate investment protection. The Investor Education and Protection fund is also established to engage in reimbursement of funds to investors who may have suffered losses due to fraud. Investor protection is not only given utmost importance but also happens to be the section of the new act with most number of amendments in consideration with growing markets, globalization and increase in corporate fraud with establishment of the Serious Fraud Investigation office [SFIO] and increased responsibility on part of directors through direct reporting, auditing and investment management.
The Company Act, 2013 arrives in turbulent markets and during a time of integration, globalization and strained economic variations. It is determined to inculcate transparency, penalties and governance that can surely not be taken for granted anymore. While most changes are welcome and eventual like the encouragement of Start-ups, lower registration fees for smaller companies, reduction of time wastage on administrative and procedural issues, protection of confidentiality of board decisions and resolutions, one wonders if the extreme fraud penalties are necessary considering the dynamically changing markets and rupee value consideration, especially when it comes to transacting with international entities. Alternatively, CSR which used to be a voluntary activity taken up by companies in good faith, to boost employee morale, make a visible difference to the world, one wonders if making it mandatory loses the basic foundation of the concept. Changing auditor rotation schemes is also something I have my doubts about, as this way one loses the historical expertise that comes with past company rotations. Like I have maintained earlier we are all surviving in turbulent times where one sees a changing India every day in one way or another. Whether we are talking about genetically modified organisms, biotech crops, food labeling or other social, environmental, economic, political or corporate issues, all that matters today is taking responsibility and keeping in mind that this may be a step forward in the right direction, the direction being the betterment of India’s economic investment climate. Only time will tell.
References: KPMG 2013 , E&Y LLP, Translegalllc, The Economic Times