Is the Companies Bill 2011 final proof that India has given up relying on promoters to run compliant ethically governed companies?

Since 1956, we have had a stable corporate legal regime based on credible deniability where no individual director had responsibility. While SEBI’s party spoiling Investor Protection Guidelines required Independent Directors to actively drive governance, it let them off the hook unless the “offence has been committed by the connivance or is attributable to any gross negligence of the officer” (Sec 21 SCR Act). In the result, this bit of “tokenism” kept the crony democracy status quo in place while feeding our appetite for moral posturing.

The Companies Bill 2011 tries to alter the status quo by compelling Independent Directors to spearhead radical change even as the other directors carry a limited generic burden of working in everyone’s interest with minimal penalties for failures. The Independent Directors’ burden may be summarized in four parts: (1) to drive Governance and Compliance in a manner that may provoke Board hostility, (2) to protect unnamed minority shareholders while battling the controlling shareholders, (3) to “scrutinise the performance of management in meeting agreed goals and…monitor the reporting of performance”, and (4) to hold separate meetings without management or the other directors and review the performance of the rest of the Board!

The price of failure is high. Independent Directors are liable for all company actions “which had occurred with his knowledge, attributable through board processes, and with his consent or connivance or where he has not acted diligently”. Under Schedule IV, acting diligently includes the obligation to “uphold ethical standards of integrity and probity” (Part I clause 1), “assist the company in implementing the best corporate governance practices” (Part I clause 9), “satisfy themselves on the integrity of financial information” (Part II, Clause 4) amongst others. Failure to do so leads to ten years in jail and Rs. 25 Crores in penalties (Sec 23M, SCR Act).

What the Independent Directors don’t do, Auditors are now expected to do. Instead of merely qualifying balance sheets, Auditors are now expected to investigate their own clients till they have “sought and obtained all the information and explanations which to the best of his knowledge and belief were necessary for the purpose of his audit” [Section 143(3)(a)]. Next, the auditor is expected to whistle blow his own client and inform the Central Government if he “has reason to believe that an offense involving fraud is being or has been committed against the company” [Sec 143(12)]. Finally, the Auditor now risks a Rs 25 lakh fine for failure to whistle blow [Section 145(15)] and a year in jail with another Rs. 25 lakh fine if he fails to do his job [Sec 147(2]. Worse, if a partner “has or have acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to or by, the company or its directors or officers”, all his partners become jointly and severally liable with him, not just to the money but to going to jail as well [Section 145(5)]. The substance of the difference comes down to this: In the old days, an Auditor had to be suspicious before he asked inconvenient questions: the Auditor now has to ask questions till he precludes suspicion! This new role collides horrifically with the reality of India’s corporate landscape because accounting frauds and corporate sponsorships fund the entire democracy machine in India. It was the auditor’s job to ‘dent and paint’ a balance sheet to refurbish its beauty, not paralyse the company’s ability to make political payments and run its business.

Similarly, to ask Independent Directors to “uphold ethical standards of integrity and probity” and to “satisfy themselves on the integrity of financial information” is to ask them for something that we know they cannot achieve. This is because India’s democracy is a formalized contest between competing elitist groups – some rich and urban and others poor, OBC, dalits or whatever – to come together in political combinations and seize power through the ballot box. To garner support sufficient to be able to win, leaders of these groups have to promise post electoral benefits to their constituents. If they win, they usurp the country’s enormous wealth and revenue stream and redistribute it to these groups by fair means and foul. Inevitably, large scale financial skulduggery informs the corporate world. Unless financed by alternative legitimate means, Indian’s democracy will shudder to a halt if you now require that every account of every company in the country be snot-free and spotless. Clearly, we have to change the operating paradigm before we can enforce corporate compliance. This piecemeal change by the Companies Bill 2011 merely means that Independent Directors and Auditors now have exposure they cannot risk-manage.