Government to Seek Approval of EC to launch FDI

The government has decided to allow Foreign Direct Investment (FDI) in online retail. It will seek the approval of the Election Commission to ensure that the government will not be violating the model code of conduct as the process had been initiated much before the election dates were announced. It is likely that foreign companies will be allowed to own 100% of the Indian entity. 

Currently, global B2C e-commerce firms like Amazon and eBay operate in India as online marketplaces. In this model, these companies do not own any inventory and do not sell any of their own merchandise to Indian shoppers. They offer products from third-party sellers.

Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT)

Securities and Exchange Board of India

CIRCULAR

CIR/MIRSD/1/2014 March 12, 2014

To,

All Intermediaries registered with SEBI (Through the stock exchanges for stock brokers and sub brokers, Depositories for depository participants and AMFI for Asset Management Companies)

Dear Sir/Madam,

Sub: Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) Obligations of Securities Market Intermediaries under the Prevention of Money-laundering Act, 2002 and Rules framed there under

1 Please refer to SEBI Master Circular CIR/ISD/AML/3/2010 dated December 31, 2010 on the captioned subject.

2 In view of the amendments to the Prevention of Money-laundering Act, 2002 (PML Act) and amendments to the Prevention of Money-laundering (Maintenance of Records) Rules, 2005 (PML Rules), it has been decided to make the following consequential modifications and additions to the above referred SEBI Master Circular dated December 31, 2010:

2.1. In clause 5 of Part II, after sub-clause 5.3.1, following sub-clause shall be inserted: 

5.3.2 Risk Assessment

i. Registered intermediaries shall carry out risk assessment to identify, assess and take effective measures to mitigate its money laundering and terrorist financing risk with respect to its clients, countries or geographical areas, nature and volume of transactions, payment methods used by clients, etc. The risk assessment shall also take into account any country specific information that is circulated by the Government of India and SEBI from time to time, as well as, the updated list of individuals and entities who are subjected to sanction measures as required under the various United Nations’ Security Council Resolutions (these can be accessed at

ii. The risk assessment carried out shall consider all the relevant risk factors before determining the level of overall risk and the appropriate level and type of mitigation to be applied. The assessment shall be documented, updated regularly and made available to competent authorities and self-regulating bodies, as and when required.

2.2. In clause 5 of Part II, after sub-clause 5.5, following sub-clause shall be inserted:

5.6 Reliance on third party for carrying out Client Due Diligence (CDD)

i. Registered intermediaries may rely on a third party for the purpose of (a) identification and verification of the identity of a client and (b) determination of whether the client is acting on behalf of a beneficial owner, identification of the beneficial owner and verification of the identity of the beneficial owner. Such third party shall be regulated, supervised or monitored for, and have measures in place for compliance with CDD and record-keeping requirements in line with the obligations under the PML Act.

ii. Such reliance shall be subject to the conditions that are specified in Rule 9

(2) of the PML Rules and shall be in accordance with the regulations and circulars/ guidelines issued by SEBI from time to time. Further, it is clarified that the registered intermediary shall be ultimately responsible for CDD and undertaking enhanced due diligence measures, as applicable.

2.3. Record keeping requirements:

a. In sub-clause 8.1 of Part II regarding maintenance of records pertaining to transactions of clients: The words “for a period of ten years” shall be substituted with “for a period of five years”.

b. In sub-clause 8.2 of Part II regarding maintenance of records pertaining to identity of clients: The words “The records of the identity of clients have to be maintained and preserved for a period of ten years from the date of cessation of transactions between the client and intermediary, i.e. the date of termination of an account or business relationship between the client and intermediary.” shall be substituted with the following:

“Records evidencing the identity of its clients and beneficial owners as well as account files and business correspondence shall be maintained and preserved for a period of five years after the business relationship between a client and intermediary has ended or the account has been closed, whichever is later.”

c. Sub-clause 8.3 (b) of Part II shall be substituted with the following:

“Registered intermediaries shall maintain and preserve the record of documents evidencing the identity of its clients and beneficial owners (e.g., copies or records of official identification documents like passports, identity cards, driving licenses or similar documents) as well as account files and business correspondence for a period of five years after the business relationship between a client and intermediary has ended or the account has been closed, whichever is later.”

d. In sub-clause 9.2 of Part II regarding monitoring of transactions: The words “preserved for ten years” shall be substituted with “maintained and preserved for a period of five years from the date of transaction between the client and intermediary”.

e. In clause 8 of Part II, after sub-clause 8.4, following sub-clause shall be inserted -

8.5 Records of information reported to the Director, Financial Intelligence Unit – India (FIU-IND): Registered intermediaries shall maintain and preserve the record of information related to transactions, whether attempted or executed, which are reported to the Director, FIU-IND, as required under Rules 7 & 8 of the PML Rules, for a period of five years from the date of the transaction between the client and the intermediary.

2.4. In clause 14 of Part II, after sub-clause 14.1, following sub-clause shall be inserted: 

14.2 Appointment of a Designated Director

i. In addition to the existing requirement of designation of a Principal Officer, the registered intermediaries shall also designate a person as a ‘Designated Director’. In terms of Rule 2 (ba) of the PML Rules, the definition of a Designated Director reads as under:

“Designated Director means a person designated by the reporting entity to ensure overall compliance with the obligations imposed under chapter IV of the Act and the Rules and includes —

(i) the Managing Director or a Whole-time Director duly authorized by the Board of Directors if the reporting entity is a company,

(ii) the managing partner if the reporting entity is a partnership firm,

(iii) the proprietor if the reporting entity is a proprietorship concern,

(iv) the managing trustee if the reporting entity is a trust,

(v) a person or individual, as the case may be, who controls and manages the affairs of the reporting entity if the reporting entity is an unincorporated association or a body of individuals, and

(vi) such other person or class of persons as may be notified by the Government if the reporting entity does not fall in any of the categories above.”

ii. In terms of Section 13 (2) of the PML Act (as amended by the Prevention of Money-laundering (Amendment) Act, 2012), the Director, FIU-IND can take appropriate action, including levying monetary penalty, on the Designated Director for failure of the intermediary to comply with any of its AML/CFT obligations.

iii. Registered intermediaries shall communicate the details of the Designated Director, such as, name, designation and address to the Office of the Director, FIU-IND.

3. Registered intermediaries are directed to review their AML/CFT policies and procedures and make changes to the same accordingly. The other provisions specified in the SEBI Master Circular dated December 31, 2010 remain the same.

4. The Stock Exchanges and Depositories are directed to:

a. bring the provisions of this Circular to the notice of the Stock Brokers and Depository Participants, as the case may be, and also disseminate the same on their websites;

b. make amendments to the relevant bye-laws, rules and regulations for the implementation of the above decision in co-ordination with one another, as considered necessary;

c. monitor the compliance of this Circular through half-yearly internal audits and inspections; and

d. communicate to SEBI, the status of the implementation of the provisions of this Circular.

5.  In case of Mutual Funds, compliance of this Circular shall be monitored by the Boards of the Asset Management Companies and the Trustees and in case of other intermediaries, by their Board of Directors.

6.  This Circular is being issued in exercise of powers conferred under Section 11 (1) of the Securities and Exchange Board of India Act, 1992 and the Prevention of Money-laundering (Maintenance of Records) Rules, 2005 to protect the interests of investors in securities and to promote the development of, and to regulate the securities market.

7. This Circular is available on the SEBI website (www.sebi.gov.in) under the section

SEBI Home > Legal Framework > Circulars. 

Yours faithfully,

Krishnanand Raghavan General Manager

Notifications issued by the MCA on Corporate Social Responsibility

The Ministry of Corporate Affairs (MCA) with a view to roll out the requirements of Corporate Social Responsibility (CSR) from the beginning of the new financial year 2014-15 as proposed by the Hon’ble Minister of Corporate Affairs have come out with three notifications on February 27,2014 which are as under:

1) Vide the first notification which has been  issued by virtue of the powers conferred u/s 1(3) of the Companies Act,2013(“The Act”),the appointed date for the operation of section 135 in the Act and Schedule VII there under have been fixed as April 1,2014.It is pertinent to note that under the above provision, which was incidentally notified on September 12,2013 ,the Central Govt. is empowered to appoint different dates for the coming into force of the different provisions of the Act.

2) In exercise of the powers conferred under Section 467(1) of the Act, amendments have been made to Schedule VII of the Act and the activities encompassing  CSR have been enlarged. Under Section 467(1), the Central Govt. has the authority to alter by notification any of the regulations contained in   any of the Schedules to the Act. It is  however , necessary as ordainedby Section 467(3) that  the alterations so made are laid before both Houses of Parliament while it is in session for a period of thirty days either entirely in one session or in two or more successive sessions .Both Houses shall be authorized to make such changes to the regulations to the Schedule as deemed appropriate. The modification or annulment so made shall not, in any way, vitiate the validity of any action taken on the basis of the regulations in the  Schedule  that existed prior to the modification or annulment.

3)      By   virtue of the third notification   which has been issued conjointly under the aegis of Section 135 and section 469(2) of the Act, the Central Govt. have issued the Rules called “Companies (Corporate Social Responsibility Policy ) Rules 2014.These Rules will substitute the draft  Rules  which were circulated in the public domain previously for debate and the final version of the Rules do take into consideration suggestions received from various stakeholders. It may be noted that the above Rules have been framed in line with the authority bestowed upon the Govt. to make rules   in respect of all or  any  matters  which under the Act are to be administered by the issuance of appropriate Rules.

It is significant to note that Section 469(3) provides that any rule that is prescribed by the Govt. under sub-section (1) ibid may contain the stipulation that any contravention thereof may entail a penalty by way of fine which may extend to Rupees five thousand and if the contravention is of a continuing nature there may be a further fine of Rupees Five Hundred for every day after the first during which the contravention continues. From a plain reading of the CSR Rules above it is seen that the Rules do not contain the penalty clause as contemplated in Section 469(3).

It is also important to note that Section 469(4) ordains that   the Rules notified be placed before parliament   exactly on the lines stated in Section 467(3) as enumerated above.

Analysis of the CSR Rules

Against the above backdrop, it would be meaningful to analyze   as under   the contents of the CSR Rules.

CSR defined

Rule 2( c) provides a definition to the term ”CSR”. Readers may recall that   under the draft CSR Rules circulated earlier, Rule 3(b) provided that CSR   means CSR as defined in Section 135 of the Act. Ironically Section 135 does not contain any definition of CSR. Thus the  drafting aberration that existed  in the draft Rule 3(b) now stands obliterated by the appropriate definition of CSR as provided by Rule 2(c ).

Net Profit defined- Is the definition legally tenable

Rule 2(f) provides that “Net profit” shall mean the net profit of a company as per its financial statements prepared in accordance with the   applicable provisions of the Act but shall not include the following:

i) Any profit  arising from any overseas branch or branches   of the company, whether operated as a separate company or otherwise and

ii) any dividend received from other  companies in India which are covered under and complying with the provisions of section 135 of the Act.

It would be appropriate at this juncture to look at the Explanation contained in Section 135 which states that “for the purposes of this section “average net profit” shall be calculated in accordance with the provisions of Section 198.”

Section 198 contains a list of items against which credit hall not be given/items which are not deductible while computing the net profits of for the purposes of Section 197.Although the Section does not specify that the formula provided therein can be extended for the purposes of any other provision of the Act, in as much as section 135 contains the Explanation quoted above, it willy-nilly follows that   the formula prescribed by section 198 has to be necessarily applied for the purposes of Section 135.

It is pertinent to note that Section 198 does not consider the exclusions carved out by Rule 3(f) as reproduced partially above. Having said this, the important question that arises is whether the contours of any provision in the mother Act   can be extended through sub-ordinate legislation. The two items of exclusion provided in Rule 3(f) do not figure in Section 198.It can therefore be stated that Rule 2(f) contains provisions which are inconsistent with the provisions of the Act.  It is   a   settled judicial principle that sub-ordinate legislation cannot override the provisions of the statute and if so does, it is to be  deemed  unconscionable. There exist a catena of judicial pronouncements to support the view that sub-ordinate legislation by way of Rules cannot override the provisions of the   Statute under which they are made. The following citations   can be quoted in support of the above postulate.

i)Assistant  CIT Vs. Tusnial Trading (61 ITTJ)(Gau.700)

ii)Rallis India Ltd.Vs.State of Andhra Pradesh (1980 AIR 749)

iii)Shish Chand and others Vs .Bhagwan Pershad (ILR1973 Delhi 698)

In the light of the above, it is submitted humbly that Rule 2(f) to the CSR Rules may not stand the test of judicial scrutiny if subjected to challenge before an appropriate forum.

We would also submit that the exclusions provided in Rule 2(f) ought to have been inserted through a statutory amendment to section 198 of the Act which of course could be done only through parliamentary procedure and   sanction .

Assuming but not admitting that Rule 2 (f) is tenable, we would  state that the  proviso to the above Rule stipulates that the net profits for the  relevant financial years determined in accordance with the provisions of the Companies Act,1956 need not be  re-computed in accordance with the provisions of the Act.

The second proviso to Rule 2(f) clarifies that in the case of a foreign company which comes within the CSR requirements its net profits will have to be computed in accordance with Section 381 (1)(a) read conjointly with Section 198 of the Act. It is interesting to note that neither Section 198 nor section 381 have   been notified yet for operation.

CSR Compliances are company specific

Rule 3(1) which has inadvertently been numberd as Rule 8   makes it abundantly clear that the CSR requirements are to be complied  with   by every company which satisfies the criteria laid down in section 135(1) on a standalone basis. The Rules will apply to the Holding company as also to its subsidiary. There will therefore be no aggregative approach for CSR spends in the context of a group of companies. A foreign company which has either a branch office or project office in India will have to comply with CSR requirements subject to the company meeting the prescribed criteria.

Rule 3(2) lays down the exemption clause, so to say, where it comes to compliance. Any company which drops short of the criteria provided in section 135(1) for a consecutive period of three financial years will be exonerated from the requirement of constituting a CSR committee as also from  ensuring other compliances contemplated u/s 135 for the period it does not meet with the criteria in section 135(1).

Rule 5 –CSR Committees-Does Rule 5(1) override   the statutory provisions in section 135(1) of the Act

Rule 5(1)provides that an unlisted public company or a private company which is covered u/s 135(1) which is not required to  appoint an Independent director pursuant to sub-section(4)of section 149 of the Act can have a CSR Committee without an Independent director.

Readers are aware that CSR requirements are to be complied   by every company including a private company which meets the prescribed criteria. Section 135(1) provides that every such   company should set up a CSR Committee of the Board which should consist of at least one Independent Director. The requirement of appointing an independent director   is therefore thrust upon  a private company which falls under the ambit of Section 135(1).

Rule 5 (1) as above negates the need for appointing an independent director in a private company. Thus private companies get a huge reprieve from the onerous responsibility of having an independent director on board due to the insert of the above Rule.

In as much as the requirement  appointing an independent director as part of the CSR Committee is enshrined in the Statute itself u/s 135(1),the question that emanates is whether Rule 5(1) above would have the legal force to displace a statutory provision.

The Supreme Court has held in Hukamchand Vs Union of India (AIR 1972, SC2427) that the power to make subordinate legislation is derived from the enabling Act and it is fundamental that the delegate on whom such a power is conferred has to act within the limits of authority conferred by the Act.

The Apex Court has  also observed in St.Johns Teachers Training Institute Vs Regional Director(2003)3SCC 321 at page 331) that  Rules cannot be made to supplant the provisions of the enabling Act but to supplement it.

The above observations of the Apex Court are relevant in the   context of this discussion   and certainly cast a shadow of doubt as to the validity of Rule 5(1) as it has the effect  ,in a sense, of diluting or overriding the statutory provision contained in section 135(1) of the Act.

We would also point out that the CSR Rules have been notified in exercise of the powers conferred under sections 135 and 469 of the  Act . It is pertinent to note that Section 135 does not empower the  Central Govt. to notify any sub-ordinate legislation. We have discussed above the provisions contained in Section 469 which empower the Central Govt. to make rules for carrying out the provisions in the Act.

We may now turn our attention to Section 462 of the Act which empowers the central Govt. to ,inter alia, direct ,in the public interest, by notification that any of the provisions of the Act shall not be applicable to such class or classes of companies as considered appropriate. We have explained above that Rule 5(1) has the effect of supplanting the provisions of Section 135 (1) in terms of which the requirement of appointing at least one independent director in the CSR Committee applies to every company which satisfies the criteria laid down in the said section. If companies belonging to a particular genre are to be exonerated from the rigours of a particular provision, the right course would have been to invoke the powers provided by Section 462. It is pertinent to note that as specified in Section462(2) the copy of every notification proposed to be issued under this Section has to be placed in draft form in  both houses of parliament when it is in session and the notification can be issued only after the same is approved by both houses.. Having regard to the fact that parliament is not in session ,  for facility of disposal, the CSR Rules have been notified u/s 469.  Rule 5(1) ought to have been issued in our view  ,  only through authority conferred u/s 462 for it to be legally sustainable.

Tax admissibility of CSR Spends

The amendments made to Schedule VII of the Act have widened the canvas of CSR activities. One conspicuous omission from the original list of activities is that contributions made to funds set up by the state Governments for socio-economic development and  relief and funds for the development of scheduled castes etc will not be considered as CSR spends.

The draft CSR Rules issued earlier provided that tax treatment of CSR spends shall be in accordance with the Income Tax Act as may be notified by the CBDT. The final rules     now notified do not throw any light on the tax treatment to be accorded to CSR spends. Given the fact that the CSR requirements will kick in come April 1, 2014  ,corresponding to Assessment year 2014-15, the Income tax law should be suitably tweaked to accommodate CSR spends. As per the existing provisions in the Income Tax Act,1961, CSR expenditure can be conceivably  admitted only under the residual provisions of section 37.  There are three conditions as given below   which have   to be satisfied in Section 37 for any expenditure to be allowed as a business deduction .

1)      The Expenditure should be incurred wholly and exclusively for the purposes of business.

2)      It should not be in the nature of capital expenditure.

3)      It should not represent personal expenses of the Assessee.

CSR spends can be capital in nature such as the construction of a school building, old Age home etc which cannot pass muster u/s 37.Further in the case of several spends for CSR, the nexus between the expenditure and the business cannot be strongly established. Hence unless the provisions of the Income Tax Act are appropriately enabled to admit CSR spends incurred both on revenue and capital account, India Inc will certainly not be over-enthused   in embracing the  CSR obligations.

Conclusion

The CSR Rules notified do clear to some extent the cobwebs of doubt that existed before. However, a lot is yet to be said and done in particular the tax status of CSR spends. Time is running out in so far as putting in place the amendments in   the Taxation law is concerned. Also, as pointed out in our discussion, the legal sustainability of the amendments are   not beyond a shadow of doubt.

It should not therefore end up as a story of  the cart being put before the horse.

Ramaswami Kalidas

Two-Tier Boards in Indian Corporations? An analysis

Corporate governance practices are in a continuous state of evolution, particularly in a developing economy such as India. It is argued that corporate governance practices in India are an imperfect emulation of western practices, particularly of the Cadbury Committee Report, and subsequently, the UK Corporate Governance Code and the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). While arguably, Sarbanes-Oxley was a knee jerk reaction to corporate accounting frauds by corporate managers of Enron, WorldCom and Adelphia Communications,[1] the Cadbury Committee was occasioned in particular by the sudden financial collapse of two companies, Wallpaper Group’s Coloroll and Asil Nadir’s Polly Peck consortium.[2]

While the United Kingdom and the United States of America seemed to take corrective action in the wake of the economy-damaging corporate frauds, India has adopted a more pre-emptive stance to combat corporate misdemeanors. Though no law can preemptively eradicate every form of illegality it seeks to address, as is evident from scams such as Satyam, imposition of appropriate supervisory models may largely decrease such instances.

This article examines whether a supervisory corporate management system in the form of a “supervisory board” may be necessary to preempt the effects of corporate greed and neutralize impact of “moral hazard”.

Current legal framework in India

The Indian Companies Act, 1956 and the listing rules of the stock exchanges currently guide the composition of the board of directors on Indian corporations. Indian law mandates a one tier board system. The board of companies whose securities are listed on the stock exchanges must be comprised of atleast 50% independent directors, if the chairman of the board is an executive director. In cases where the chairman is a non – executive director, the minimum number of independent directors on the board goes down to 1/3rd of the total number of directors on a board. For unlisted companies (whether public or private), there is no requirement to appoint any independent directors on the board[3].

Framework for the supervision of corporate management

Corporate boards are predominantly divided into one-tier boards and two-tier boards. Within Europe, the United Kingdom adopts the single board system consisting of executive and non-executive directors. The United States of America follow the monistic board structure as well. On the other hand, Germany traditionally employs the dualism of a management board and a separate supervisory board. This dual system is also found in the Netherlands, Austria, Finland and Denmark.[4]    

The structures and legal frame work governing one-tier boards need little elaboration. Most jurisdictions adopting this framework insist on an optimum combination of executive and “outside” or “independent” directors on the board of a company. These “outside” or “independent” directors are expected to be unconnected to the company, its promoters and its majority shareholders.

What is a two tier board system?

The German Stock Corporation Act, 1965 envisages a two–tier board structure comprised of the management board and supervisory board. Comprised entirely of executive directors, the management board is responsible for managing the enterprise and its day to day operations. The supervisory board appoints, supervises and advises the members of the management board and is directly involved in decisions of fundamental importance to the enterprise.[5] The supervisory board’s more important functions include approval of the annual accounts of a company and initiating court actions against the board members. A maximum of half the members of the supervisory board are elected by the shareholders at the general meeting of the company.[6] The supervisory board is entirely comprised of non – executive directors.

The supervisory board, in many ways, is superior to the management board as it has the power to appoint and supervise the management broad. The company is truly controlled by its stakeholders with executive directors taking up the role of traditional senior managers rather than directors.

Strengths and weaknesses of the dualistic system

Reduction of information asymmetry between the board and the shareholders

There exists an information asymmetry between shareholders and the board of directors.  The directors take “inside decisions”, the genesis of which is unknown to the shareholders. These “inside decisions” affect the value of the shareholders’ investments in the company. When a model enumerated by the German Stock Corporation Act, 1965 is followed, where the representatives of the shareholders are appointed to the supervisory board, the presumption leans towards the reduction of information asymmetry.

The fallibility of this two-tier system in a country like India could be due to the nature of Indian corporations. Ordinarily, Indian companies are closely held family concerns. A large majority of the shares of a company are held by a single or a connected group of shareholders. Under such circumstances, the shareholder’s representatives on the supervisory board may not be truly independent. Also, some of the members of the supervisory board are nominated by the creditors of the company and clearly, they would not be categorised as independent directors.

However, with India opening up its borders to most multinational conglomerates, there could be a presumption that, over time, the Indian corporate scenario may witness a higher number of widely held corporations. Introduction of two-tier boards as an option for widely held companies could align regulatory foresight to this flux.

Reduction of the negative impact of moral hazard

As a concept, “moral hazard” is the situation where a person takes risks because the negative impact of those risks would not be felt by him personally. The decisions of corporate managers are immune to scrutiny in the absence of fraud and gross negligence. Hence, there may be occasions where managers tend to be less careful about their decision making processes if they themselves are not affected in any way by the result of their decisions. A supervisory board would supervise all important decisions proposed to be taken by the management board. Also, as shareholders’ representatives, the supervisory board would ensure that such decisions are consistent with the interest of the shareholders.  Moreover, the ability of the members of the supervisory board to institute court actions against the executive directors would drastically reduce moral hazard.

Most businesses require the directors to utilise foresight in taking certain business decisions which at that point may seem aggressive. In the event that the supervisory board does not share the vision of the executives, then in their conservative attempt to maintain shareholder value, there may prove to be a stalemate leading to an unworkable situation.

Attractive proposition for reputed investors

Appointment on marquee names on the supervisory board of a company lends immense confidence to shareholders. This allows a company to attract investment as well as boost such investor confidence.

As a minor persuasion, reputed personnel on the supervisory board may also significantly reduce transaction costs. Most foreign private equity or other investors insist on inclusion of stringent risk allocation tools within their investment agreement, once they decide to invest in Indian companies. There would be a greater presumption towards a company’s ability to general positive cash-flows with established managers on the supervisory board advising and supervising the activities of the management board. Consequently, transaction costs would reduce as a result of shorter and more passive negotiations.

Structural weaknesses of the two–tier board system

The independence of the members of the supervisory board due to the separation of the control is the reason for a number of structural weaknesses.

The exercise of power of the supervisory board is mostly reactive, which decreases the “quality” of its control. Consequently, the system reduces the possibility of the occurrence of the same mistake, rather than preempt an error.

Information asymmetry between the two boards: There is a strong presumption that complete information about a company’s day to day business activities and future plans would only be available with the management board. There exists, in most cases, an information asymmetry between the management and the supervisory boards. As filtered information is received by the supervisory board, there is a possibility that deficiencies may remain undiscovered.

Customising the two–tier system for India

Possibly, the largest deterrent to introduction of the two-tier board system in India is possibly due to Indian companies being predominantly closely held. Closely held companies with a single or single group of shareholders holding a significant majority of the shares would ensure that such majority’s representatives would hold majority of the board positions on the supervisory board as well.

The German model could be suitably modified for India. One of the possible changes that could be adopted is that the financial statements would have to be confirmed and finalised only on the review and approval by the minority shareholder’s representatives. Also, the minority shareholder’s representatives could institute legal proceedings against the directors in the face of gross negligence and fraud. However, the admission of such proceedings before the Company Law Board[7] or any other forum should not be used as an arm twisting tool and should be subject to stringent controls.

[1] See “Much Ado About Nothing: Looking Past the Drama of the Sarbanes-Oxley Act and Reevaluating the U S Delisting Trend among Non-U.S. firms” – Kalani A Morse

[2]  http://www.jbs.cam.ac.uk/cadbury/report/index.html

[3]The Indian Companies Act 1956 is under the process of being replaced by the Indian Companies Act, 2013 (2013 Act). Certain sections of the 2013 Act have been notified and are currently effective. However, the provisions pertaining to the board of directors are yet to be notified. The provisions on the composition of the board of directors under the 2013 Act mandate the appointment of independent directors on the board of unlisted companies as well.

[4] See “The German Two-Tier Board: Experience, Theories, Reforms” in Klaus J Hopt and others (eds), Comparative Corporate Governance: The State of the Art and Emerging Research

[5] Section 5.1.1 of the German Corporate Governance Code

[6] See the German Corporate Governance Code: “In enterprises having more than 500 or 2,000 employees in Germany, employees are also represented in the Supervisory Board, which then is composed of employee representatives to one third or to one half respectively. For enterprises with more than 2000 employees, the Chairman of the Supervisory Board, who, for all practical purposes, is a representative of the shareholders, has the casting vote in the case of split resolutions.”

[7] The Company Law Board is a quasi-judicial authority that decides on matters arising out of disputes or breaches of company law in India. It is established by statute and largely excludes the jurisdiction of regular civil courts in India.