Tightening Internal control through companies Act, 2013 An Overview

Navneet Singal

The Companies Bill 2012/ 2013 got its assent in the Lok Sabha on December 18, 2012 and the Rajya Sabha on August 8, 2013. Later on august 29, 2013 it got consent from the President of India and has become the much awaited Companies Act, 2013 (2013 Act).

Companies act, 2013 made an attempt to reduce the content of the substantive portion of the related law in comparison to the Companies Act, 1956 (1956 Act).

The Companies Act, 2013, envisages significant changes in the provisions related to governance, e-management, compliance and enforcement, disclosure norms, auditors and mergers. It also includes several new concepts like one Person Company, small companies, dormant company, class action suits, registered valuers and corporate social responsibility etc.

The changes in the 2013 Act have great far reaching implications and are all set to significantly change the manner in which corporates operate in India.

This paper will emphasize that how the internal control will improve after the enactment of the new Companies Act. It will provide more power in the hands of the shareholder and the government. It is an attempt to focus on the Tightening of the Internal Controls thru the measures below:

• Self-Regulation
• New Mechanism and organizations
• Transparency and disclosures

Implementation of Internal control via Self-Regulation

Widening the definition of Key Managerial Personnel Sec. 2 (51)

The definition of the KMP has been widened with the Companies Act, 2013. “KMP” in relation   to a company means:–

• The Chief Executive Officer or the
• Managing Director or the Manager;
• The Company Secretary;
• The Whole Time Director;
• The Chief Financial Officer; and
• Such other officer as may be prescribed.

KMP’s are largely responsible for majorcorporate actions and consequently liable topenalty or punishment in the event of defaultas an “officer who is in default”.

Inclusion of the definition of Independent Directors (IDs) Sec. 149

Every listed public company shall have at least 1/3rd of the total number of directors as IDs.

• The Central Govt. may prescribe minimum no. of IDs in any class(es) of public companies.
• ID is a director other than MD, WTD or ND.
• ID should, in opinion of Board, be a person of integrity with relevant expertise & experience.
• Must possess other prescribed qualifications.

Class Action

The Companies Act,2013 provides for class‐action lawsuits, which can allow a large number of people with common interest in a matter to sue or be sued as a group. Sections 245 and 246 of the Act contain these provisions. Under these, class‐action suits may be filed by investors if they are of the opinion that the affairs of the company are being conducted in a manner prejudicial to the interest of the company, its shareholders or depositors.

Appointment of Small shareholder’s Director

Listed Companies may have one director elected by small shareholders i.e. shareholders holding shares of nominal value of not more than Rs. 20,000/-.

Establishment of new mechanism/organizations to control over fraud

Whistle Blowing Sec. 177(9)

Every listed/ prescribed class of companies shall establish a vigil mechanism for directors and employees to report genuine concerns.

The vigil mechanism shall provide for adequate safeguards against victimization of persons who use such mechanism and for direct access to the chairperson of the Audit Committee inappropriate/exceptional cases.

Details of such mechanism shall be disclosed on company’s website and Board’s Report. It is an important provision to upgrade Indian legislative framework to global best governance practice and will make the corporate managements’ more accountable.

Establishment of the Serious Fraud Investigation Office (‘SFIO’)

The Central Government (CG) shall establish an office to be called SFIO to investigate frauds relating to a Company.

The CG refers matter to SFIO on receipt of:-

• Report of Registrar; or
• Special resolution from the company; or
• In public interest; or
• On request from Central/State Government.

The SFIO shall be headed by a Director and consist of experts in the fields of corporate affairs, capital market, law, taxation, etc.

The Company Secretaries have an opportunity of occupying prestigious position as experts in SFIO and play vital role in important investigations.

Constitution of National Financial Reporting Authority (‘NFIO’)

The Central Government (CG) may constitute a NFRAto provide for matters relating to accounting/auditing standards which shall:-

a) Make recommendations to CG on the formulation ofaccounting and auditing policies and standards for cos. / Auditors.

b) Monitor and enforce compliance with accounting and auditing standards.

c) Oversee the quality of service of professionals.

d) Perform such others functions as may be prescribed.

NFRA shall have power to investigate into matters of professional or other misconduct committed by any member or firm of CAs.

Where professional or other misconduct is proved, NFRA shall have the power to make order for imposing penalty of not less than ₹10 lacs but which may extend to 10 times of the fees received in case of firms.

Higher transparency and more disclosures

Directors’ Responsibility Statement:

Internal financial controls have been laid:

• Compliance of all applicable laws and that system are adequate.
• Risk management policy of Company.
• Composition of Audit Committee / Recommendations
• Details about the policy developed and implemented on corporate social responsibility initiatives taken.
• Composition of the Corporate Social Responsibility (‘CSR’) Committee.
• Approval of Financial Statements and Board’s report.

If a Company contravenes the provisions –

• the Company shall be punishable with fine which shall not be less than fifty thousand rupees but extend to twenty-five lakh rupees; and
• every officer who is in default shall be in imprisonment which may extend to 3 years or with fine which shall not be less than Rs. 50,000/- or with both.

E-Governance

E-Governance has been proposed for various company processes like maintenance and inspection of documents in electronic form, option of keeping of books of accounts in electronic form, financial statements to be placed on company’s website, holding of board meetings through video conferencing/other electronic mode, voting through electronic means etc.

Online services will be able to reduce the need of hard copy and have a positive impact in the direction of saving environment.

It will substantially improve the standards of disclosure and transparency, involve more stakeholders in the company processes and provide real time information and service to the shareholders and other stakeholders.

Audit & Auditors

Audit Committee / Board to consider Auditor on the basis of qualification and experience.

The auditor cannot provide the following services to the Company:

Auditor not to render certain services accounting and book keeping services;

• internal audit;
• design and implementation of any financial information system; actuarial services, management services.
• investment advisory services;
• investment banking services; or
• rendering of outsourced financial services.

Auditors Liability has been increased:

• Concept of class-action lawsuit introduced. Shareholders and depositors can now claim damages and compensation from auditors for negligence. The liability shall be of the firm as well as of each partner who was involved in making any improper or misleading statement of particulars in the audit report.
• Auditors may have to take indemnity insurance cover against third party liability which might be expensive.
• Audit firms will have to increase the support staff to do a more rigorous checking of the accounts.
• Auditors are more likely to become conservative and ask for more details of expenses and statements from managements.

Penalty:

• Normal punishment with a fine of Rs.25,000 and Rs.5 lakh.
• Other punishment will be imprisonment upto 1 years or fine between Rs.1 lakh to Rs.25 lakh.

Secretarial Audit (SA) Sec. 204

Every listed and every public company having a paid-up share capital of ₹ 100 Cr or more shall annex with its Board’s Report, a SA Report given by a practiced company secretary (‘PCS’)

Secretarial Audit Sec. 143(12),(15) & 204

If a PCS conducting SA, has reason to believe that an offence involving fraud is being or has been committed against the company by its officers/employees, he shall immediately report the matter to the Central Government.

If a PCS does not comply with the above provision, he shall be punishable with fine of minimum ₹1 lac and may extend to ₹25 lac.

(Author may be contacted at navneet.singal@gmail.com )