ASSIGNMENT ON CORPORATE

GOVERNANCE AND BUSINESS ETHICS

(IC504)
TOPIC: - NARESH CHANDRA COMMITTEE

SUBMITTED TO: - SUBMITTED BY: -

PROFESSOR MANISH KUMAR PALAVI KUMARI (MCI15028)
DEPARTMENT OF COMMERCE INTEGRATED M.COM (7TH SEMESTER)
TEZPUR UNIVERSITY DEPARTMENT OF COMMERCE

TEZPUR UNIVERSITY
 ACKNOWLEDGMENT
I would like to express our deepest gratitude to Prof. Manish kumar, Course Instructor, for
giving me the opportunity to carry out this assignment on NARESH CHANDRA
COMMITTEE and also for giving me a good guideline for the assignment throughout
numerous consultations.
I would also like to expand my deepest gratitude to all those who have directly
and indirectly guided me in writing this assignment.
INTRODUCTION:
 Naresh Chandra Committee report on ‘Corporate Audit & Governance’ derives its
inspiration from the recommendations of the Kumar Mangalam Birla Committee on
corporate governance being set up by SEBI (Securities and Exchange Board of India)
with two major concerns:
 Representation of independent directors on a company’s board.
 The constitution of the audit committee.

WHY NARESH CHANDRA COMMITTEE (2002) was set up?

 Prominent reasons to constitute this committee in 2002 was ENRON SCANDAL,
WORLDCOM SCANDAL, TYCO SCANDAL, COLLAPSE OF ANDERSEN,
GLOBAL CROSSING etc. These scandals were so portentous that it triggered another
more vigorous phase of reforms in corporate governance. I have taken the example of
three scandals which was taken place at that time-
 ENRON SCANDAL (2001): In this scandal, CEO and former CEO were
involved and they did it by keeping huge debt off balance because of this
stakeholders lost $74 billion, thousands of employees and investors lost their
retirement account. In this scandal, Arthur Andersen audit firm were also
involved which was one of the top five audit firm company like PWC which
leads to collapse of Andersen’s firm. After this United States of Congress
enacted the Sarbanes Oxley Act.
 TYCO SCANDAL (2002): In this scandal, CEO and CFO were involved and
they did it by inflating company’s income by $500 billion and they stole $150
billion then siphoned out the money through unsanctioned loans and fraudulent
stock sales.
 WORLDCOM SCANDAL (2002): CEO was involved in this scandal too. They
augmented assets by as much as $11 billion and they did it by decreasing the
cost and inflating the revenues with fake accounting.

So here we have seen that at that time in the corporate world, mostly the CEO,
CFO, AUDIT FIRM were involved in scandals. So in India for good corporate governance the
Naresh Chandra committee was set up by Securities and Exchange Board of India (SEBI).
Naresh Chandra committee has given recommendations related to auditor- company
relationship, independent director, CEO – CFO certification etc.
RECOMMENDATIONS IN RELATION TO AUDITOR-COMPANY
RELATIONSHIP:
1. DISQUALIFICATIONS FOR AUDIT ASSIGNMENTS:
 Prohibition of any direct financial interest in audit client by audit firm or audit
firm’s partner or its engagement team or prohibition of interest of more than 2%
of share of profit or equity capital of audit client by audit firm or audit firm’s
partner or its engagement team or their any relative.
 Taking any loans and/or guarantees from or on behalf of the audit client by audit
firm or audit firm’s partner or its engagement team or their any relative are
forbidden.
 If audit firm or audit firm’s partner or its engagement team or their any relative
wants to join client’s firm or the key officer of the client’s firm wants to join the
audit firm, they can only do so after 2 years of preparation of accounts and audit
of that client.
 Too much reliance on one audit client is forbidden. The fees given by the audit
client should not exceed 25% of the total revenue of the audit firm. But this
criterion cannot be applied to newly established audit firms until they complete
their 5 years since commencement or those with not more than Rs.15 lacs per
year.

2. Prohibited non- audit services:

As the work of the auditor is to check the accounts whether it is truly and
fairly represented or not so they are not allowed to do other services if they do so then
it should be with proper approval. Following the list of prohibited non-audit services
 Services related to book keeping and accounting.
 Internal audit services
 Planning and execution of financial information system with the help of
information technology.
 Actuarial services.
 Broker, dealer, investment adviser or investment banking services.
 Outsourced financial services.
 Management functions, including the provision of temporary staff to audit
clients.
 Any form of staff recruitment, and particularly hiring of senior management
staff for the audit client.
 Valuation services and fairness opinion.

3. Mandating audit partner rotation:

If the partner and atleast 50% of its engagement team (excluding article clerks
and trainees) should be rotated every 5 years if they are responsible for the
audit of either:
 A listed company, or
 Companies with paid up capital and free reserve are not less than 10
crores, or
 Companies whose turnover is not less than 50 crores
4. Auditor’s disclosure of contingent liabilities:
Auditor should disclose the contingent liabilities to shareholders and investors
because they have the right to know about the risk involved in company’s growth.

5. Independence standard for consulting and other entities that are affiliated to audit
firm: this is the extended recommendation of first one’s fourth point.
 Too much reliance on one audit client is forbidden. The fees given by the audit
client should not exceed 25% of the total revenue of the audit firm. But this
criterion cannot be applied to newly established audit firms until they complete
their 5 years since commencement or those with not more than Rs.15 lacs per
year. Here the total revenue means that their revenue including all affiliated and
subsidiary company.

6. Auditor’s annual certification of independence:

In Auditor’s annual certificate of independence stated that
 they are independent and don’t have any relationship with client’s company.
 They have not engaged in any non-audit services which is forbidden in the
recommendation.
 They are not disqualified from audit assignments.

7. Appointment of auditors:
To release this trustworthy responsibility, the audit committee will –
 Converse about the annual work programme with auditor.
 Assess the audit firm’s independence that they are not disqualified with the
above recommendation.
 Recommend to the board with reasons whether they are appointing or re-
appointing or removing the external auditor along with the annual audit
remuneration.

8. CEO and CFO certification:

There should be a certification by the CEO which should state that the signing
officers-
 They have assessed the balance sheet and profit and loss account and all its
schedules, notes on accounts, the cash flow statements and the Directors’
Report.
 They are accountable for building and maintaining internal controls.
 They have also revealed to the auditors as well as the Audit Committee
occurrence of significant fraud.
 They shall return to the company that part of any bonus or incentive- or equity-
based compensation which was increased on account of such errors, as decided
by the Audit Committee.
RECOMMENDATION IN RELATION TO AUDITING THE AUDITORS:
1. Setting up of independent Quality Review Board
three independent Quality Review Boards (QRB), one each for the ICAI, the
ICSI and ICWAI
 Composition of Quality Review Board of ICAI: there will be 11 members
including the chairman. six members of the board including chairman shall
be nominated by department of company affairs and the remaining five will
be nominated by the council of the ICAI.
 Composition of Quality Review Board of ICSI: there will be 5 members
including the chairman. Three members of the board including chairman
shall be nominated by department of company affairs and the remaining two
will be nominated by the council of the ICSI.
 Composition of Quality Review Board of ICWAI: there will be 5 members
including the chairman. Three members of the board including chairman
shall be nominated by department of company affairs and the remaining two
will be nominated by the council of the ICWAI.
These three Quality Review Board will be funded by their respective
institutes. In the occurrences of any conflict between the findings of Quality
Review Board and reviews, the matter should be referred to an appropriate
appellate forum which is given in the next recommendation.

2. Suggested disciplinary mechanism:

 The offences required to be categorized according to the severity of the

wrongdoing. Within the structure of the ICAI the prosecution directorate
will be created. Director level person will head the office and that person
should be with legal background.

 Prosecution directorate will have the same power as are given in a civil court
under the court of civil procedure regarding
(a) in finding and making of any document, and
(b) taking proof on affidavit.

 Process for dealing complaint cases:

(a) the prosecution director will register the complaint and sent it to the
member or firm under 15 days of registration of such complaints,
(b) prosecution director will obtain the required document from both the
sides within 60 days,
(c) prosecution directorate shall be placed before the Disciplinary
Committee under 20 days along with the reviews.
RECOMMENDATION IN RELATION TO INDEPENDENT DIRECTOR:
1. Definition of an independent director: an independent director of a company
is a non-executive director of a company who-
 Apart from receiving director’s remuneration, should not have any
material monetary relationships or transactions with the company
 Is not associated to promoters or management at the board level, or one
level below the board.
 Has not been an executive of the company in the preceding 5 years.
 Is not a substantial shareholder of the company, i.e. owning 2 per cent
or more of the block of voting shares.
 Has not been a director, independent or otherwise, of the company for
more than three terms of three years each (not exceeding 9 years in any
case).
 If an executive of company X has become the non-executive director of
company Y and if an executive of company Y becomes a non-executive
director of company X, then neither will not be treated as independent
director.
This is applied to listed companies and unlisted companies
with paid up capital and free reserve not have less than 10 crores and
turnover should not have less than 50 crores.

2. Percentage of independent director:

At least 50% of the board should comprise of independent director. But this
will not be applied for unlisted public companies who have less than 50
shareholders and unlisted subsidiaries of listed companies.

3. Minimum board size of listed companies: the board should comprise of 7

members of which at least 4 members should be independent director. But this
will not be applied for unlisted public companies who have less than 50
shareholders and unlisted subsidiaries of listed companies.

4. Board meeting/ committee meeting: Timing and the duration of the meeting
with its date and member’s attendance must be disclosed by the minute of the
board meetings and audit committee meetings.

5. Tele-conferencing and video-conferencing: This recommendation is given to

reduce the cost of board meetings. If a director cannot be physically present but
wants to participate in the proceedings of the board and its committees, then a
minuted and signed proceedings of a tele-conference or video conference should
constitute proof of his or her participation.

6. Independent director on audit committee of listed companies: Audit

committee of listed company should exclusively comprise of independent
director. But this will not be applied for unlisted public companies who have
less than 50 shareholders and unlisted subsidiaries of listed companies.
OTHER RECOMMENDATIONS
1. SEBI and subordinate legislation: SEBI regulates activities in dynamic
market conditions, the DCA have to respond to SEBI’s demand fast.
Sometimes there is over lap of rules so to avoid this they should work together
and ensure harmony and co-ordination.

2. Improving services in the DCA offices: to strengthen the DCA offices, they
recommend to improve the services by increasing the outsourcing of the work,
contractual appointment of specialist and computerization and also by
providing regular training services.

3. Corporate Serious Fraud Office (CSFO): This office should be set up in the
Department of Company Affairs with specialists admitted on the basis of
transfer/deputation and on special term contracts. It should be in the form of
multi-disciplinary teams who not only detect the fraud but also supervise the
prosecution directorate. It should be a task force which is head by one person.

NARESH CHANDRA COMMITTEE, 2003

This committee again in 2003, given recommendation related to small private
companies as the scams normally done by big firms but the rules and standard are made
according to the level of that firms then this committee thought that because of this majority of
the small private companies have to face extensive strictly compliance with the law. So they
want to simplify and rationalize the entry and exit procedure and providing a sustainable
environment for their incessant growth and prosperity.
1. Criteria for small private companies:
In the first recommendation they have set up the criteria for small private
companies are as-
 Paid up capital and free reserve should be less than Rs.50 lacs
 Aggregate receipt from sales or any other receipts should not exceed Rs.5 crores
 SMPs should be registered as Small Scale Industry in spite of its paid up capital
and reserve.

2. Standard form for incidental object clause:

There is the standard form which is given and there should not be any other
objective, there should be only one main objective in the memorandum of association.
The standard format is as- "In connection with the main objects, the Company shall
have the power to invest its funds in real property and securities, to borrow and make
advances, to acquire, own, and dispose of real and personal property, and to do all other
acts incidental and necessary, as may be prescribed, for the accomplishment of the
purposes stated in the main objects clause.”
 3. Validity of share transfer:
There is difficulty facing by them for getting extension under sec 108(ID) of the
Act. So the validity of the instrument of transfer of its shares is one year from the date of
presentation before the prescribed authority.

4. Shifting of the registered office:

If SMPs want to shift their registered office, then they only have to take the
approval of board of directors but before implementation they need to inform to their
employees.
5. Not required advertisement:
SMPs don’t have to give the advertisement in the newspaper for closing register
of members, foreign members and debenture holders.

6. No need to main separate dividend account.

7. Payment of interest of capital is exempted from all the restrictions and requirement of
the approval of government.

OTHER RECOMMENDATIONS
These recommendation is given to limit the exemption they are getting; this recommends where
they need to approach government for approvals.

1. Definition of a public company: committee recommends to have a proper definition of

public and private companies so it should not create any confusion as the existing one.

2. Independent director: the statutory limit on sitting fess should be reviewed and non-
executive director should be exempted from the civil liabilities.
3. Principle of recording shareholders' agreements etc.:
 the company, when notified of any breach or demand for specific
performance, shall not abet and shall be bound not to abet in the breach of the
agreement
 the shareholders severally shall not have the right to use the company's funds
to litigate the enforcement of the shareholder agreement or to defend the
contractual right of any shareholder under the shareholder agreement.

4. Flexibility for further simplification: A proper provision should be provided to get

more exemptions to SPCs. But also allow government to impose fine of any misuse of
liberation and government may remove any or all of the exemptions if the
circumstances say so.
 BIBLIOGRAPHY

file:///D:/FILES/7th%20sem/corporate%20governance/ncc-executive%20summary.pdf
file:///D:/FILES/7th%20sem/corporate%20governance/3-
Naresh%20Chandra%20committee%20report%20on%20regulation%20of%20private%20co
mpanies%20and%20partnerships,%202003.pdf
file:///D:/FILES/7th%20sem/corporate%20governance/Draft_Report_NareshChandra_CII.pd
f