‘Class-action suits can pose problems’

It may improve shareholder participation, make auditors more accountable and crack down on fly-by-night operators taking public deposits. But the New Companies Bill also has some provisions that may prove to be a challenge for companies, says S. Santhanakrishnan, Chairman of the Institute of Chartered Accountants of India’s Corporate Laws Committee . Santhanakrishnan is also Managing Partner at PKF Sridhar & Santhanam , a Chennai-based auditing firm. Excerpts from an interview:

What impact will the New Companies Bill have on companies?

Corporate governance is one area which has been given impetus. Some aspects of the Bill, such as tightening rules on related party transactions and independent directors may not find favour with Indian companies.

But the provision for a one-man company and initiatives such as mandatory CSR spend, empowering of the Company Law Tribunal for M&A approvals, and increasing the maximum limit on membership for private companies to 200 people are very positive. But the bigger challenge is to ensure effective administration of the new provisions.

The rules defining the actual implementation of these new measures will provide better clarity on the effectiveness of the new Bill.

What aspects of the Bill favour investors?

The new Bill has enabled postal ballot and electronic voting. This will improve the participation of minority shareholders in making critical decisions.

It also aims to restrict public deposit mobilisation by companies. Public deposits have been the biggest headache. The new Bill resolves to check indiscriminate deposit-taking by fly-by-night operators. This will definitely protect investors from fraudulent companies.

What are the shortcomings of the Bill?

Even as many of the new provisions are very positive, some may pose hurdles.

For instance, though the introduction of class action suits against management in the event of fraudulent acts and mismanagement appears to empower investors, it may actually hamper the functioning of the business.

As administration of justice in India takes a very long time, this will certainly increase the legal costs for the companies, investors and auditors.

Instead, a provision by which the minority investor can settle the issue through arbitration would have been more effective in resolving the problems of minority shareholders.

For instance, giving an aggrieved minority shareholder an option to sell his stake back to the promoters at a price considered fair by him may have been a more effective tool.

The implementation of the new policy remains a challenge too. It needs to be seen how the Government is going to address the minor pitfalls through safeguards. For instance, take the case of a one-man company; the advantage in this set-up over sole-proprietorship is its limited liability. But, it is important to ensure that individuals do not misuse this for their own ulterior motive.

Under the new policy, an Independent Director cannot hold office for more than three terms, which is nine years.

This is going to be demanding for companies as it may be difficult to appoint suitable independent directors. With the responsibility of independent directors mounting, post the Satyam fiasco, they need to be adequately compensated too.

How will the new Bill benefit India Inc?

New structures of businesses such as one-man company, small company, dormant company, etc., have been introduced. Also, cross-border mergers are being made feasible. Further, even domestic M&A and arrangements can now get executed through a speedier mechanism.

Companies will be allowed to revise their past financials, with the approval of the tribunal. This is certainly positive as it will help companies provide an accurate picture of their operations.

But, as auditors will have to be rotated every 10 years, companies may encounter issues if they have to restate financials verified by the previous auditor.

How will life change for the audit professional?

The new Bill is certainly more challenging for audit professionals. The restriction on auditors has increased manifold after the Satyam episode. While there have been some lapses, all of them cannot be attributed to auditors.

A new concept, namely NFRA (National Financial Reporting Authority) has been introduced, similar to the PCAOB (Public Company Accounting Oversight Board) in the US which oversees the large companies.

NFRA is supposed to supervise large companies to avert Satyam-like frauds. It will also be responsible for setting up accounting and auditing standards and also disciplining the profession. Top listed companies will be covered by this. The impact remains to be seen.

Secondly, the provision that if one partner of a large accounting firm commits a fraud, the entire firm will be held responsible, is a concern.

We hope for some safeguards in the rules, which may exempt other partners with no direct knowledge of the fraud. In the event of a class action suit filed by an investor, the auditor can be summoned and questioned.

This, coupled with class action suits, will increase the cost of audit as they need to insure themselves against any such eventualities.

But on the positive side, today criminal and civil liabilities have increased and hopefully this will lead to an improvement in the quality of audit service.

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