Corporate Compliance Management – Secretarial Audit : Compliance Audit, Reporting & Disclosures Dr. K. R. Chandratre*, FCS, Company Secretary, Pune. Secretarial audit is the most effective mechanism to ensure the compliance of the multifarious requirements by the corporate enterprises under a host of legislations. The benefits of such audit, its process and other related aspects have succinctly been brought out in this article including a check list of activities, format of audit report etc.

Need for Legal Compliance Reporting System The multiplicity of laws, rules, regulations, etc. has necessitated introduction of a system to ensure compliances under the laws. This has a two-fold objective:— a. Firstly, to protect the interests of the customers, employees, revenue, environment and the directors and officers of the company. b. Secondly, to avoid any unwarranted legal actions by the law-enforcing agencies and other persons as well. Under most laws, the persons responsible for compliance and liable for punishment are directors, company secretary and some of the senior officers who have been designated for specific compliances. Amongst the directors, the responsibility of managing and executive directors is greater. As a result of stricter enforcement of laws and implications of recent decisions of the courts in some cases, it has become imperative have (or if it already exists, to strengthen) the Legal Compliance Reporting System (LCRS) with a view to making it more effective. It has, therefore, been decided to revamp and refine the existing LCRS. Sub-clause I(c)(iii) of Clause 49 of the Listing Agreement provides “The Board shall periodically review compliance reports of all laws applicable to the company, prepared by the company as well as steps taken by the company to rectify instances of non-compliances.” Accordingly, all listed companies will have to have a system for reporting compliances with laws applicable to them to the Board. Hence, a LCRS is necessary to comply with sub-clause I(c)(iii) of Clause 49 of the Listing Agreement. The objectives of an LCRS should be :    

to check and report on compliances; to point out non-compliances and inadequate compliances; to protect the interests of directors and officers. to avoid legal actions by the law-enforcing agencies and others.

Compliance Certification versus Secretarial Audit The Secretarial Audit (SA) is a part of LCRS but is wider in scope than Compliance Certification (CC). The CC was made statutorily applicable in 2000 Inserted by the Companies (Amendment) Act, 2000, w.e.f. 1312-2000, which inserted a provision in section 383A(1) of the Companies Act making it mandatory every

company not required to employ a whole-time secretary under sub-section (1) and having a paid-up share capital of Rs. 10 lakhs or more shall file with the Registrar a certificate from a secretary in whole-time practice in such form and within such time and subject to such conditions as may be prescribed, as to whether the company has complied with all provisions of this Act and a copy of such certificate shall be attached with Board’s report referred to in section 217. The Companies (Compliance Certificate) Rules, 2001 prescribe a 33-item formula for CC. The CC came to be introduced on the recommendation of the Working Group on redrafting of the Companies Act (in 1997). The Working Group had recommended: “Submitting the Secretarial Compliance Certificate to the Registrar would be mandatory for companies having a paid up capital in excess of Rs. 10 lakhs but below Rs. 2 crores”, it did ask a question “how could one ensure more effective secretarial compliance under the Act?” The Group’s hypothesis was that “Since a whole-time company secretary falls under the category of ‘officer who is in default’, it is presumed that he has every reason to discharge his obligations as per the Act. Therefore, companies with a whole-time secretary would not require to submit a separate compliance certificate to the Registrar”, may be logical with reference to the context in which it made this observation, but it certainly cannot form the basis to countenance the argument that a company having whole-time secretary (as its employee indisputably owning allegiance to his/her employer and has to obey the orders of his master) does not need to have CC or secretarial audit. The CC is an abridged version of or a prelude to a full-fledged secretarial audit; it can be likened to an abridged prospectus, but not a full-fledged prospectus. The CC should be viewed in a broader perspective as a measure or means of furthering the function of auditing, such as the audit of accounts namely, The inspection of an organization’s accounts by an external professional, in order to obtain an opinion as to the veracity of the accounts. The object of Auditor’s Report is to form an opinion, based on the inspection of an organization’s accounts, and to report to the organization’s owners as to whether the company’s accounts give a true and fair view of its profit or loss for the period of the report and of its state of affairs at the end of that period; and to certify that the accounts are prepared in accordance with the requirements of law. Likewise, the object of the Secretarial Auditor’s Report is to form an opinion, based on the inspection of an organization’s secretarial and legal record, and to report to the organization’s owners as to whether, and if so, to what extent, the company has complied with the laws comprising various statutes, rules, regulations, etc. The SA requires expert knowledge of all corporate laws; whereas CC requires knowledge of the Companies Act. The SA may have a need of a large number of compliances to be covered; whereas under CC compliances under the Companies Act, need to be undertaken. The SA may be undertaken voluntarily by any company; whereas CC has to be undertaken every year statutorily by such companies paid up capital is more than Rs.10 lacs but less than Rs. 2 crores.

Benefits and Beneficiaries of SA a. Owners Assures the owners that those in charge of the management of the company are conducting its affairs in accordance with requirements of laws, and that the owners’ stake is not being exposed to undue risk.

a. Management Ensures the Management of a company that those who are charged with the duty and responsibility of compliance with the requirements of law are performing their duties competently, effectively and efficiently, so that the people in-charge of the day-to-day management of the company are not likely to be exposed to penal or other liability (and consequential risk and embarrassment) on account of non-compliance with law.

a. Legal compliance officers Ensures them that they have done everything required under law.

a. Independent directors Ensures them that the company has complied with the laws and, therefore, they are not likely to be exposed to action by law enforcement agencies for non-compliance by the company.

a. Government authorities The SA being pro-active measure for compliance with a plethora of laws, SA will have a salutary effect of substantially lessening the burden of the law-enforcement authorities.

a. Other parties The SA can assist bodies like SEBI, Stock Exchanges, Financial Institutions, Banks, etc. to gauge or measure the levels of compliance and non-compliance by the companies with whom they are concerned.

a. Investors To provide comfort to investors that the company has been conducting its affairs in accordance with laws and, therefore, their investment is safe and being taken due care of. SA will help unearth and check these practices and also enable law-enforcing agencies take timely corrective action by brining to book the guilty. In the era of Corporate Governance, SA will provide comfort to shareholders about the compliance as also to feel secure about their investments.

a. Prospective acquirer The SA can be an effective due diligence exercise for the prospective acquirer of a company or controlling interest or a joint venture partner.

Secretarial Audit : What and how I do  Check and report on compliances.

 SA wider in scope than Compliance Certificate under section 383A.  SA covers –  Listed Co: Company Law, Articles of Association, Listing Agreement, Insider Trading Code, Takeover Code, Depositories Act, Securities Contracts (Regulation) Act and Rules, etc.  Unlisted Co: Company Law, Articles of association.  SA is a continuous process- SA Reports are generated quarterly and are placed before Board.  SA is a voluntary compliance audit.  The objective is to check compliances and guide the company for compliance and better compliance.  SA of a listed company involves intense exercise and will call for a higher degree of skill and greater manpower.

The SA Process The SA process comprises the following steps : Prepare checklists for verification of records (for sample checklists, see Annex 1 below). Prepare a list of documents to be checked. Draw up a timetable. Know the people to interact with. Depute the persons to do checking. Commence the SA process. Review progress at suitable intervals depending upon coverage. Complete the SA. Make a draft SA Report. Discuss non-compliances or inadequate compliances for corrective action, eg non-filing and late filing of forms.  Discuss substantive issues, eg whether Board composition is as per cl 49 of LA; whether Takeover Code applies to the acquisition of shares.  Make final SA Report. The reporting is done on quarterly basis (for a sample quarterly report, see Annex 2 below)          

The Secretary of the company places quarterly SA Report before the Board and arranges for Annual SA Report to be approved by Board and published in Company’s Annual Report (see Annex 3 and Annex 4).

Why PCS is fit to do SA?  Practising Company Secretary (PCS) is most competent, fit and proper professional to do SA.  Corporate law is the core competence of SA.  PCS is a highly specialized professional in matters of statute law, and procedural and practical aspects involved in legal compliances under various corporate laws.

Annex 1 : Sample checklists and list of documents to be verified 1. Status of a company as a private company Check whether  the company’s name in the memorandum is in accordance with the Name as stated on the Certificate of Incorporation.  the Certificate of Incorporation confirms that the company is a private company.  the company has paid up share capital of at least Rs.1 lakh.  the company’s articles of association contain the requirements stipulated in s. 3(1)(iii) to constitute the company as a private company.  the company has complied with the four conditions specified in s. 3(1)(iii) of the Act as contained in its articles and there has been no contravention of any of these conditions.  if any of the conditions specified in s. 3(1)(iii) was complied, an order of the CLB had been obtained in terms of s. 43.  the company is a subsidiary of a public company (In this case, though the basic structure of the company has been kept that of a private company, all the provisions of the Act which are applicable to a public company have been complied with). Documents to be verified a. b. c. d. e. f. g. h.

Memorandum of association Articles of association Certificate of Incorporation Latest audited balance sheet Ledger (Share Capital Account) Register of Members. Return/s of Allotment. Names depositors, if any.

1. Loans to directors Check whether  During the relevant financial year, the company gave a loan to any of the following parties : a. b. c. d. e. f. g. h.

any director of the lending company; any director of the lending company’s holding company; any partner of a director of the lending company; any partner of a director of the lending company’s holding company; any relative of a director of the lending company; any relative of a director of the lending company’s holding company; any firm in which a director of the lending company is a partner; any firm in which any relative of a director of the lending company is a partner; i. any private company of which a director of the lending company is a member; j. any private company of which a director of the lending company is a director;

k. any body corporate at a general meeting of which not less than 25% or more of the total voting power is exercised or controlled by any one or more directors of the lending company; l. any body corporate, the Board of Directors, managing director or manager whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.  No compliance with section 295 was necessary because such loan was eligible for exemption under section 295(2) becausea. The company which gave the loan was a private company not being a subsidiary of a public company; or b. The loan was given by a holding company to its subsidiary. c. The loan was given to a managing director or whole-time director of the company for housing purpose and it was in conformity with the guidelines issued by the DCA.  If the loan was not eligible for exemption, the Board had approved the giving of the loan and previous approval of the Central Government was obtained.  The loan is being recovered in accordance with the terms and conditions stipulated and if there is default, the company took effective steps to recover the loan.  If the loan is secured one, security was created immediately after the loan was disbursed and proper documentation in connection therewith was done create effective and foolproof security. Documents to be verified : a. Minutes of the Board meeting at which the loan was approved by the Board. b. Copy of the application which was made to the Department of Company Affairs for its approval for giving the loan. c. Copy of the DCA’s letter giving approval for giving the loan. d. Loan agreement or sanction letter. e. If the loan is secured one, the documents creating the security. f. Ledger (to verify recovery of the loan).

1. Contracts with directors and others attracting section 297 Check whether –  During the relevant financial year, the company entered into any contract, whether a formal or informal, written or orala. for the sale, purchase or supply of any goods or materials; b. for the sale, purchase or supply of any services; c. for underwriting the subscription of any shares in, or debentures of, the company, with any of the following –  any director of the company;  any relative of any director of the company;  any partnership firm in which any director of the company is a partner;

 any partnership firm in which any relative of any director of the company is a partner;  any partner of the partnership firm in which any director of the company is a partner;  any partner of the partnership firm in which any relative of any director of the company is a partner;  any private company in which any director of the company is a member;  any private company in which any director of the company is a director.  The contract did not require compliance with section 297, either because the contract did not attract the provisions of section 297 or it was eligible for exemption under any of the clauses (a), (b) and (c) of sub-section (2) of section 297.  If the contract fell within the purview of section 297 and it was not one of the three exempted classes, a consent to the contract was given by the Board of Directors –  Either before entering into a contract; or  after entering into of a contract in circumstances of urgent necessity, and in the latter case, the consent was given within three months of the date on which the contract was entered into.  The consent was given by the Board by a resolution passed at its meeting and not otherwise (eg by a circular resolution or in any other manner).  There was requisite disinterested quorum at the Board meeting whereat the Board gave its consent to the contract and the director who was interested in the contract had not been counted in quorum and had not participated in the discussion and voted on the matter at the Board meeting in view of section 300. Documents to be checked : a. Register of Contracts, Companies and Firms in which Directors are interested [see next item]. b. Notices of disclosure of directors’ interests in Form No. 24AA as well as specific notices received from time to time from the directors and recorded in the minutes of Board meetings. c. Minutes of Board meetings. d. Copies of contracts made between the company and any of the parties mentioned above.

Annex 2 : Sample Quarterly SA Report The Board of Directors … Limited SECRETARIAL AUDIT REPORT FOR THE QUARTER ENDED ON … In this Report  “the Act” means the Companies Act 1956.  “the Audit Period” means the period mentioned in the title of this report.

   

“the Board” means the Board of Directors of … Limited. “BSE” means Bombay Stock Exchange Limited. “the Company” means ....Limited. “NSE” means The National Stock Exchange of India Limited.

Foreword In terms of my appointment for conducting Secretarial Audit and the instructions I received, I conducted the audit of the records and documents maintained by the Company under the –  The Act;  The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations 1997  The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 1992; and  The Listing Agreement with the Stock Exchanges. I submit my report on the Secretarial Audit relating to the three months from … … to … ….

SECTION A : THE COMPANIES ACT AND RULES MADE THEREUNDER 1. Status of the company as a public company [section 3(1)(iv)]  The Company has complied with the requirements of section 3(1)(iv) concerning the definition of a ‘public company’ and the minimum paid-up share capital. 2. Common seal [sections 50, 147]  The Company has a Common Seal with its name engraved on it in legible characters, which is not affixed to any document except in accordance with Article 173 of the articles of association of the Company.  M/s. … (the “R&T Auditors”) have confirmed that the Common Seal is affixed on every new share certificate issued in lieu of the defaced, mutilated or torn ones and issue of duplicate share certificates in lieu of the certificates lost or destroyed. 3. Service of documents by the company on the members [section 53]  The R&T Auditors have confirmed that every document sent to any member of the Company is served on him by the Company or by its Share Transfer Agent in accordance with the provisions of section 53 of the Act. 4. Renewal / exchange of a share certificate and issue of duplicate share certificates [section 84]  The R & T Auditors have confirmed that, the provisions of section 84 of the Act, the Companies (Issue of Share Certificates) Rules 1960, the articles of association of the Company, the guidelines/instructions issued by the SEBI and the Listing Agreement have been complied with in respect of the renewal/exchange of the share certificates in lieu of the defaced, mutilated or torn ones and issue of duplicate share certificates in lieu of the certificates lost or destroyed.  During the Audit Period, the Shareholders’/Investors’ Grievance Committee has duly authorized issue of duplicate share certificates.

5. Transfer of shares and debentures [section 108]  The R & T Auditors have confirmed that –  The requirements of section 108 of the Act, the articles of association of the Company, the guidelines/instructions issued by the SEBI and the Listing Agreement have been complied with in respect of transfer of shares of the Company received by the Share Transfer Agent/the Company during the Audit Period;  All transfer applications received, except those which have been returned for rectification or they being otherwise invalid, have been approved by the person duly authorised by the Board of the Company;  All the approved transfers have been entered in the Register of Transfers & Transmissions and the Register of Members; and  The transferees concerned have been sent the share certificates within the stipulated time.  The R&T Auditor has confirmed that the necessary Statutory Registers and Records concerning the share transfer and incidental activities, as required by the Act are being maintained. 6. Transmission of shares  v The R & T Auditors have confirmed that The requirements of the articles of association of the Company, the guidelines/instructions issued by the SEBI and the Listing Agreement have been complied with in respect of transmission of shares of the Company received by them/the Company during the Audit Period ;  All the applications for transmission of shares received, except those which have been returned for rectification or they being otherwise invalid, have been approved by the person duly authorised by the Board of the Company ;  All the approved transmissions have been entered in the Register of Transmissions and the Register of Members ; and  The persons concerned with them have been intimated about it and sent the share certificates within the stipulated time. 7. Issue and Delivery of share certificates [sections 83, 84, 113, 53  The R & T Auditors have confirmed that  The requirements of sections 83, 84 and the Companies (Issue of Share Certificates) Rules 1960, the articles of association of the company, the guidelines/instructions issued by the SEBI and the Listing Agreement have been complied with in respect of the share certificates issued and/or delivered during the Audit Period ;  The share certificates have been delivered within the time stipulated in section 113 of the Act and the Listing Agreement; and  The share certificates have been delivered by registered post and in the manner stated in section 53 of the Act. 8. Register and Index of Members [sections 150, 151, 153, 163]  A copy of the Register of Members in electronic form made available to the company by the Share Transfer Agent is kept at its registered office at Mumbai. It has been informed that, a hard (print)

copy of the Register of Members is not maintained in view of the large number of members of the company holding equity shares in the Company. However, the company maintains the Register of Members holding equity shares in soft copy at its registered office.  The R & T Auditors have confirmed that the Company has complied with the provisions of sections 150 and 151 of the Act regarding Register of Members and the Index of Members respectively; and  The Register of Members, statutory registers and records concerning the transfer and incidental activities are being maintained as required by the Act and Regulation 15 of the Securities and Exchange Board of India (Registrar to an issue and Share Transfer Agent) Regulations, 1993. 9. Register and Index of Debenture Holders [section 152, 163]  The company has maintained a register of debenture holders.  A copy of the Register of Debenture Holders in a print form is kept by the company at its registered office at Mumbai.

Annex 3: Extract from Board’s Annual Report Secretarial Audit Report Dr. K.R. Chandratre, Practicing Company Secretary conducted Secretarial Audit of the Company for the financial year …. The Secretarial Audit report confirms that the Company has complied with all the applicable provisions of –    

the Companies Act, 1956; Listing Agreement with the Stock Exchanges; Securities Contracts (Regulation) Act, Depositories Act; and the Regulations of SEBI as applicable to the Company, including the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 and the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992.

Annex 4 : The Annual SA Report as publishedin the Annual Report Secretarial Audit Report The Board of Directors ....Limited I have examined the registers, records and documents of … Limited (“the Company”) for the financial year ended on … maintained under the provisions of –  The Companies Act, 1956 and the Rules made under that Act ;  The Depositories Act, 1996 and the Regulations and the Bye-laws framed under the Act ;  The following Regulations and Guidelines prescribed under the Securities and Exchange Board of India Act, 1992 (‘SEBI Act’) – a. The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992; and b. The Securities and Exchnage Board of India (Disclosure and Investor Protection) Guidelines, 2000

c. The Securities and Exchnage Board of India (Employee Stock Options Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 d. The Securities Contracts (Regulation) Act, 1956 (‘SCRA’) and the Rules made under that Act; e. The Listing Agreement with Bombay Stock Exchange Limited and National Stock Exchange of India Limited and Luxembourg Stock Exchange. 1. I report, based on my examination and verification of the records produced to me and according to the information and explanations given to me by the Company, that the Company has, in my opinion, complied with the provisions of the Companies Act, 1956 (“the Act”) and the Rules made under the Act and Memorandum and Articles of Association of the Company, inter alia with regard to : a. maintenance of various statutory registers and documents and making necessary entries therein; b. closure of Register of Members/Debenture Holders; c. forms, returns, documents and resolutions required to be filed with the Registrar of Companies; d. service of documents by the company on its members, and Registrar of Companies. e. notice of meetings of the board and meetings of committees of directors; f. the meetings of the board and of committees of the board including passing of resolutions by circulation; g. the … annual general meeting held on …; h. the consent of the members obtained by way of special resolutions passed through postal ballot in terms of Section 192A of the Companies Act, 1956 read with the provisions of the Companies (Passing of the Resolution by Postal Ballot) Rules, 2001; i. approval of the shareholders, secured creditors (including debenture holders) and unsecured creditors in their respective court convened meetings held on … in terms of the Hon’ble Bombay High Court Order under Sections 391-394 of the Companies Act, 1956 read with the Companies (Court) Rules, in relation to amalgamation of Indian Petrochemicals Corporation Limited with the Company; j. minutes of proceedings of General Meetings and of Board and other meetings; k. approvals of shareholders, the Board of Directors, the Committee of Directors and government authorities, wherever required; l. constitution of the Board of Directors and appointment, retirement and re-appointment of directors; m. appointment and remuneration of Directors including the Managing Director and Wholetime Directors; n. appointment and remuneration of Auditors and Cost Auditors; o. transfers and transmissions of the Company’s shares and debentures and issue and delivery of original and duplicate certificates of shares and debentures; p. declaration and payment of dividends including interim dividend and redemption of debentures ; q. form of balance sheet as prescribed under Part I of Schedule VI to the Act and requirements as to Profit & Loss Account as per Part II of the said Schedule; r. transfer of certain amounts as required under the Act to the Investor Education and Protection Fund; s. borrowings and registration, modification and satisfaction of charges; t. Investment of Company’s funds including inter corporate loans and investments; u. contracts, common seal, registered office and publication of name of the Company; and v. generally, all other applicable provisions of the Act and the Rules made under that Act; 2. I further report that :

a. the Company’s Directors have complied with the requirements as to disclosure of interests and concerns in contracts and arrangements, shareholdings/debenture holdings and directorships in other companies and interests in other entities. b. Company has obtained all necessary approvals of the Central Government or such other authorities, as the case may be, under the various provisions of the Act. c. there was no prosecution initiated against or show cause notice received by the Company and no fines or penalties were imposed on the Company under the Companies Act, SEBI Act, SCRA, Depositories Act, Listing Agreement and Rules, Regulations and Guidelines framed under the said Acts against the Company, its Directors and Officers. 3. I further report that the Company has complied with the provisions of the Depositories Act, 1996 and the Bye-laws framed thereunder by the Depositories with regard to dematerialisation /rematerialisation of securities and reconciliation of records of dematerialized securities with all securities issued by the Company. 4. I further report that : a. the Company has complied with the requirements under the Listing Agreements entered into with Bombay Stock Exchange Limited, National Stock Exchange of India Limited and Luxembourg Stock Exchange. b. the Company has complied with the provisions of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 with regard to the disclosures and maintenance of records required under the Regulations. c. the Company has complied with the provisions of the Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 with regard to disclosures and maintenance of records required under the Regulations. d. the Company has complied with the provisions of the Securities and Exchange Board of India (Employee Stock Options Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 with regard to implementation of Employees Stock Option Scheme, Grant of Options and related disclosures and other aspects. e. the Company has complied with the provisions of the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000 with regard to issue and allotment of convertible warrants on preferential basis to entities in the Promoter Group.

FOOTNOTES * Past President, The ICSI, email: [email protected]