4

Rights and Privileges of Shareholders

• Introduction
• Rights of Shareholders
• Views of Various Committees on the Issue
• Poor Track-record of Shareholder Protection
• Grievance Redressal Process

Introduction

Corporate governance is needed to create a corporate culture of consciousness, transparency and openness. It refers to a combination of laws, rules, regulations, procedures and voluntary practices to enable companies to maximise shareholders’ long-term value. It should lead to increasing customer satisfaction, shareholder value and wealth. Corporate governance deals with a company’s ability to take managerial decisions vis-á-vis its claimants, in particular its shareholders apart from other stakeholders.

 

Theoretical Basis—Agency Costs

The most fundamental theoretical basis of corporate governance is agency costs. Shareholders are the owners of joint-stock, limited liability company, and are its principals. By virtue of their ownership, the principals define the objectives of the company. The management, directly or indirectly selected by shareholders to pursue such objectives, are the agents. While the principals might assume that the agents will invariably do their bidding, it is often not so. In many instances, the objectives of managers are quite at variance from those of the shareholders. This divergence in objectives between ownership and management leads to agency costs, which in turn leads to the need for corporate governance.

Two broad instruments that reduce agency costs and hence improve corporate governance are as follows:

• Financial and non-financial disclosures.
• Independent oversight of management, which consists of two aspects the first relates to the role of the independent, statutory auditors and the second aspect of independent oversight is the board of directors of a company.

Long-term Shareholder Value

There is a global consensus about the objective of ‘good’ corporate governance: maximising long-term shareholder value. It is useful to limit the claimants to shareholders for three reasons:

1. In most of the countries, generally labour laws are strong enough to protect the interests of workers in the organised sector, and employees as well as trade unions are well aware of their legal rights. In contrast, there is very little in terms of the implementation of the law and of corporate practices that protects the rights of creditors and shareholders.
2. There is much to recommend in law, procedures and practices to make companies more attuned to the need for servicing debt and equity properly.
3. Managers have to look after the rights of shareholders to dividends and capital gains, because if they do not do so over a period of time, they face the real risk of take-over.

For a corporate governance code to have real meaning, it must first focus on listed companies. These are financed largely by public money (be it equity or debt) and, hence, need to follow codes and policies that make them more accountable and value oriented to the investing public.

There have been various committees and boards that have been set up both internationally and in India to improve the situation of shareholders with regard to corporate governance. Before we see how a shareholder could help bring about good corporate governance we need to see what are the rights of the shareholders as laid down by the Indian Companies Act of 1956.

Rights of Shareholders

The members of a company enjoy various rights in relation to the company. These rights are conferred on the members of the company either by the Indian Companies Act of 1956 or by the Memorandum and Articles of Association of the company or by the general law, especially those relating to contracts under the Indian Contract Act, 1872.

 

Some of the more important rights of shareholders as stressed by the above Acts are the following:

• He has a right to obtain copies of the Memorandum of Association, Articles of Association and certain resolutions and agreements on request, on payment of prescribed fees (Section 39).
• He has a right to have the certificate of shares held by him within 3 months of the allotment.
• He has a right to transfer his shares or other interests in the company subject to the manner provided by the articles of the company.
• He has a right to appeal to the Company Law Board if the company refuses or fails to register the transfer of shares.
• He has the preferential right to purchase shares on a pro-rata basis in case of a further issue of shares by the company. Moreover, he/she also has the right of renouncing all or any of the shares in favour of any other person.
• He has a right to apply to the Company Law Board for the rectification of the register of members.
• He has the right to appeal to the competent Court to have any variation or abrogation to his/her rights set aside by the Court.
• He has the right to inspect the register and the index of members, annual returns, register of charges and register of investments not held by the company in its own name without any charge. He/she can also take extracts from any of them.
• He is entitled to receive notices of general meetings and to attend such meetings and vote either in person or by proxy.
• He is entitled to receive a copy of the statutory report.
• He is entitled to receive copies of the annual report of directors, annual accounts and auditors’ report.
• He has the right to participate in the appointment of auditors and the election of Directors at the annual general meeting of the company.
• He has a right to make an application to the Company Law Board for calling annual general meeting, if the company fails to call such a meeting within the prescribed time limits.
• He can require the Directors to convene an extraordinary general meeting by presenting a proper requisition as per the provisions of the act and hold such a meeting on refusal.
• He can make an application to the Company Law Board for convening an extraordinary general meeting of the company where it is impracticable to call such a meeting either by the directors or by the members themselves.
• He is entitled to inspect and obtain copies of minutes of proceedings of general meetings.
• He has a right to participate in declaration of dividends and receive his/her dividends duly.
• He has a right to demand a poll.
• He has a right to apply to the Company Law Board for investigation of the affairs of the company.
• He has the right to remove a director before the expiry of the term of his office.
• He has a right to make an application to the Company Law Board for relief in case of oppression and mismanagement.
• He can make a petition to the High Court for the winding up of the company under certain circumstances.
• He has a right to participate in passing of a special resolution that the company be wound up by the court or voluntarily.
• He has a right to participate in the surplus assets of the company, if any, on its winding up.

However, whether the shareholder has these rights in reality or he is even aware of his rights is a moot question that leads invariably to unscrupulous managements taking the unwary investors for a ride.

Views of Various Committees on the Issue

Working Group on the Companies Act, 1996

Various committees have been set up to guide shareholders with regard to good corporate governance practices especially with reference to protection of their long-term interests. One among them was the Working Group on the Companies Act set up in 1996 by the Government of India which has recommended many financial as well as non-financial disclosures. These disclosures call for greater transparency in the accounting of the organisation. It calls for a tabular form containing details of each director’s remuneration and commission which should form a part of the directors’ report, in addition to the usual practice of having it as a note to the profit and loss account. Also, any cost incurred in using the services of a Group Resource Company must be clearly and separately disclosed in the financial statement of the user company. Again, where the company has raised funds from the general public, it would have to give a separate statement showing the end-use of such funds, namely, how much was raised versus the stated and actual project cost; how much has been utilised in the project up to the end of the financial year; and where are the residual funds, if any, invested and in what form. There should also be a disclosure on the debt exposure of the company. With regard to the non-financial disclosure, the Working Group called for a comprehensive report on the relatives of directors either as employees or board members to be an integral part of the directors’ report of all listed companies. The company should also maintain a register which discloses interests of directors in any contract or arrangement of the company, and the fact that such a register is made and is open for inspection needs to be made known to the shareholders in the Annual General Meeting. Details of loans to directors should be disclosed as an annex to the directors’ report in addition to being a part of the schedules of the financial statements. Such loans should be limited to only three categories—housing, medical assistance, and education for family members, and be available only to fulltime directors. The detailed terms of the loan would need shareholders’ approval in a General Body Meeting. These are some of the disclosures that need to be made. The company should understand that though all other things being equal, greater the quality of disclosure, the more loyal are the company’s shareholders. Based on these recommendations, a number of changes were introduced in the Companies Bill, 1997. However, since many of these recommendations were not mandatory, it did not have much impact on the corporate governance scenario in India.

 

CII’s Committee on Corporate Governance, 1996

The next committee that had considerable impact on the corporate world with regard to the rights of shareholders to ensure corporate governance in the organisation was the report submitted by the Confederation of Indian Industry (CII). The CII has pioneered the concept of corporate governance in India and is an internationally recognised name in this field. Its code, the Desirable Code of Corporate Governance, was the first of its kind in India and is recognised as one of the best in the world. Corporate India has started recognising the pivotal role that disclosures play in creating corporate value in the increasingly market oriented environment, since the time the code was widely publicised.

 

The objective of the CII was to develop and promote a code of corporate governance to be adopted and followed by Indian companies, be these in the private sector, banks or financial institutions, all of which are corporate entities. This initiative by the CII flowed from public concern regarding the protection of investor’s interest, especially the small investor, the promotion of transparency within business and industry; the need to move towards international standards in terms of disclosure of information by the corporate sector and, through all of these, to develop a high level of public confidence in business and industry.

This code required listed companies to give the following information under “Additional Shareholder’s Information”:

• High and low monthly averages of share prices in a major stock exchange where the company is listed for the reporting year.
• Greater details on business segments upto 10 per cent of turnover, giving share in sales revenue, review of operations, analysis of markets and future prospects.

But the recommendations made by CII were not mandatory just like those of the Working Group and therefore most of the companies did not take them seriously.

Kumar Mangalam Birla Committee, 1999

The CII was the first to come out with its version of an audit committee. The SEBI, as the custodian of investor interests, did not lag behind. On 7 May 1999, it constituted an 18-member committee, chaired by the young and forward-looking industrialist, Kumar Mangalam Birla (a chartered accountant himself), on corporate governance, mainly with a view to protecting the investors’ interests. The committee made 25 recommendations, 19 of them “mandatory”, that is, these were enforceable. The listed companies were obliged to comply with these on account of the contractual obligation arising out of the listing agreement with stock exchanges.

 

It is interesting to note that the Kumar Mangalam Birla Committee while drafting its recommendations was faced with the dilemma of statutory versus voluntary compliance. As mentioned earlier, the Desirable Code of Corporate Governance, which was drafted by the CII and was voluntary in nature, did not produce the expected improvement in corporate governance. It was thus felt that under Indian conditions, a statutory rather than voluntary code would be far more effective and meaningful. This led the committee to decide between mandatory and non-mandatory provisions. The committee felt that some of the recommendations were absolutely essential for the framework of corporate governance and virtually would form its code, while others could be considered as desirable. Besides, some of the recommendations needed a change of statute, such as the Companies Act for their enforcement. Faced with this difficulty, the committee settled for two categories of recommendations—namely, mandatory and non-mandatory. This committee made some recommendations especially with regard to shareholders.

Recommendations Relating to Shareholders

The shareholders are the owners of the company and as such they have certain rights and responsibilities. But in reality companies cannot be managed by shareholder referendum. They are not expected to assume responsibility for the management of corporate affairs. A company’s management must be able to take business decisions quickly, which cannot be done if they were to consult shareholders, who are too numerous and scattered for any meaningful consultation. Shareholders, therefore, delegate many of their responsibilities as owners of the company to the directors who then become responsible for corporate strategy and operations. The implementation of this strategy is done by a management team. This relationship, therefore, brings in the accountability of the boards and management to shareholders of the company. A good corporate framework is one that provides adequate avenues to shareholders for effective contribution in the governance of the company while insisting on a high standard of corporate behaviour without getting involved in the day-to-day functioning of the company.

 

Responsibilities of Shareholders

The committee believed that the general body meetings provide an opportunity to shareholders to address their concerns to the board of directors and comment on and demand any explanation on the annual report or on the overall functioning of the company. It is important that shareholders use the forum of general body meetings for ensuring that the company is being stewarded for maximising the interests of shareholders. This is important especially in the Indian context. It follows from the above that for effective participation, shareholders must maintain alertness and decorum during the general body meeting, so that it constitutes the forum in which they can get their doubts clarified, apart from airing their grievances, if any.

The effectiveness of the board is determined by the quality of the directors whereas the quality of the financial information is dependent to an extent on the efficiency with which the auditors carry on their duties. Shareholders must, therefore, show a greater degree of interest and involvement in the appointment of directors and auditors. They should indeed demand complete information about directors before approving their directorship.

The committee recommended that in case of the appointment of a new director or re-appointment of a director, shareholders must be provided with the following information:

• A brief resume of the director.
• Expertise in specific functional areas.
• Names of companies in which the person also holds directorship and membership of committees of the board. This is a mandatory recommendation.

Rights of Shareholders

As we have seen earlier, the Companies Act of 1956 confer certain rights on shareholders to enable them enjoy their rights as rightful owners of companies. The basic rights of shareholders include the right to transfer and obtain registration of shares, obtaining relevant information on the company on a timely and regular basis, participating and voting in shareholder meetings, electing members of the board and sharing in the residual profits of the corporation.

 

The committee, therefore, recommended that as shareholders have a right to participate in, and be sufficiently informed on decisions concerning fundamental corporate changes, they should not only be provided information as under the Companies Act, but also in respect of other decisions relating to material changes such as takeovers, sale of assets or divisions of the company, changes in capital structure which will lead to change in control or may result in certain shareholders obtaining control disproportionate to their equity ownership.

The committee recommended further that information such as quarterly results, presentation made by companies to analysts may be put on their websites or may be sent in such a form so as to enable the stock exchange on which the company is listed to put it on its own website.

The committee also recommended that the company’s half-yearly declaration of financial performance including summary of significant events in the last six months, should be sent to each household of shareholders. This recommendation is mandatory.

The Kumar Mangalam Birla Committee prescribed too that a company must have appropriate systems in place, which will enable shareholders to participate effectively and vote in shareholders’ meetings. The company should also keep shareholders informed of the rules and voting procedures, which govern the general shareholder meetings. This recommendation is mandatory.

The annual general meetings of the company should not be deliberately held at inconvenient venues or the timing should not be such which makes it difficult for most of the shareholders to attend. The company must also ensure that it is not inconvenient or expensive for shareholders to cast their votes. This recommendation is mandatory.

Currently, although the formality of holding the general meeting is gone through, in actual practice, only a small fraction of the shareholders of the company do or can really participate therein. This virtually makes the concept of corporate democracy illusory. It is imperative that this situation which has lasted too long needs an early correction. In this context, for shareholders who are unable to attend meetings, there should be a requirement which will enable them to vote by postal ballot for key decisions such as investment proposals, appointment of directors, auditors, committee members, loans and advances above a certain percentage of net worth, changes in capital structure which will lead to change in control or may result in certain shareholders obtaining control disproportionate to equity shareholding, sale of assets or divisions and takeovers etc. This would require changes in the Companies Act. The committee was informed that SEBI has already made recommendations in this regard to the Department of Corporate Affairs. The committee recommended that the Department of Corporate Affairs should again be requested to implement this recommendation at the earliest, if possible by issue of an ordinance, so that corporate democracy becomes a reality in the true sense.

The committee recommended that a board committee under the chairmanship of a non-executive director should be formed to specifically look into the redressing of shareholder complaints such as transfer of shares, non-receipt of balance sheet, non-receipt of declared dividends, etc. The committee believed that the formation of such a committee would help focus the attention of the company on shareholders’ grievances and sensitise the management to the redressal of their grievances. This is a mandatory recommendation.

The committee further recommended that to expedite the process of share transfers, the board of the company should delegate the power of share transfer to the registrars and share transfer agents. This is a mandatory recommendation.

Naresh Chandra Committee, 2002

Another committee that was set up with a view to promoting corporate governance and, through it, long term shareholder value was the Naresh Chandra Committee. The Naresh Chandra Committee’s report on “Audit and Corporate Governance” has taken forward the recommendations of the Kumar Mangalam Birla Committee on corporate governance. Two major issues the committee addressed and made appropriate recommendations were:

• Representation of independent directors on a company’s board.
• The composition of the audit committee.

The Naresh Chandra Committee has made no distinction between a board with an executive chairman and a non-executive chairman. It recommended that all boards need to have at least half of its members as independent directors. As regards the audit committee, the Kumar Mangalam Birla Committee had stated that it should have three non-executive directors as its members with at least two independent directors and that the chairman of the committee should be an independent director. But the Naresh Chandra Committee recommended that all audit committee members should be independent directors.

The Naresh Chandra Committee has laid down stringent guidelines defining the relationship between auditors and their clients. In a move that could impact small audit firms, the committee recommended that along with its subsidiaries, associates or affiliated entities, an audit firm should not derive more than 25 per cent of its business from a single corporate client. This, the committee said, would improve the independence of audit firms. While turning down the proposal for a compulsory rotation of audit firms, the committee stressed that the partners and at least 50 per cent of the audit team working on the accounts of a company need to be rotated by a firm once every 5 years.

While the committee said that it had no objection to an audit firm having subsidiaries or associate companies engaged in consulting or other specialised businesses, it has drawn up a list of prohibited non-audit services more or less on lines of the American Sarbanes-Oxley Act with certain modifications to suit the Indian corporate sector. The Naresh Chandra Committee on “Corporate Audit and Governance” has recommended an increased role for independent directors by assigning them at least 50 per cent seats on the board of a public limited company with a paid up capital of Rs. 100 million and above, and a turnover of Rs. 500 million and above. It has significantly asserted that nominees of financial institutions (FIs) could not be counted as independent directors.

The committee has further recommended the following:

1. Asking the auditors to make an array of disclosures.
2. Calling upon chief executive officers and chief financial officers of all listed companies to certify their companies’ annual accounts, besides suggesting.
3. Setting up of quality review boards for the Institute of Chartered Accountants of India (ICAI), the Institute of Company Secretaries of India (ICSI) and the Institute of Cost and Works Accountants of India, (ICWA) and a Public Oversight Board similar to the one in the United States.

At a time when people are shying away from accepting the post of an independent director in a company because of the liabilities that might follow, the Naresh Chandra Committee has come up with recommendations that will help remove the fears. To attract quality independent directors on the board of directors of a company, the committee has recommended that these directors should be exempted from criminal and civil liabilities under the Companies Act, the Negotiable Instrument Act, the Provident Fund Act, the Factories Act, the Industrial Disputes Act and the Electricity Supply Act.

However, unlisted public companies that do not have more than 50 shareholders and carry no debt from the public, banks or financial institutions, and unlisted subsidiaries of listed companies have been exempted from these recommendations.

Thus it can be seen that though the law has provided for the rights of the shareholder to have access to information as it may seem fit that the shareholder requires, very rarely organisations make this information easily accessible to them. It is because of such prevalent situation that various committees have to intervene and see to it that they are being taken care of. However, notwithstanding all these efforts, nothing concrete has been done by public authorities to prevent corporate misgovernance.

Narayana Murthy Committee, 2003

This SEBI-appointed Narayana Murthy Committee on Corporate Governance, which submitted its Report on 8 February 2003, has in its own words, “primarily focussed on investors and shareholders, as they are the prime constituencies of SEBI”.

 

The committee recommended that in order to achieve the objectives of corporate governance and to realise long term shareholder value, companies should agree to the following terms and conditions.

1. In case of the appointment of a new director or reappointment of a director, the shareholders must be provided with the following information:
   1. A brief resume of the director.
   2. Nature of his expertise in specific functional areas.
   3. Names of companies in which the person also holds the directorship and the membership of committees of the board.
2. Information such as quarterly result and presentation made by companies to analysts shall be put on company’s website or shall be sent in such a form so as to enable the stock exchange on which the company is listed to put it on its own web site.
3. A board committee under the chairmanship of a non-executive director shall be formed to specifically look into the redressing of shareholder and investors complaints such as transfer of shares, non-receipt of balance sheet, declared dividends, etc. This committee shall be designated as “Shareholders/Investors Grievance Committee”.
4. To expedite the process of share transfers the board of directors shall delegate the power of share transfer to an officer or a committee or to the registrar and share transfer agents. The delegated authority shall attend to share transfer formalities at least once in a fortnight.

Shareholders’ Rights and Postal Ballots

The Narayana Murthy Committee asserted shareholders’ rights to receive from the company half-yearly declaration of financial performance including summary of the significant events during the past 6 months.

The committee recommended the facility of postal ballot to such of those shareholders who cannot participate in the AGM of the company they have invested in, so as to participate effectively in corporate democracy and in the decision-making process. Key issues that may be decided by postal ballots could include the following:

1. Alteration in the Memorandum of Association.
2. Sale of whole or substantially the whole of the undertaking.
3. Sale of substantial investments in the company.
4. Making a further issue of shares through preferential allotment or private placement basis.
5. Corporate restructuring.
6. Entering into a new business not germane to the existing business of the company.
7. Variations in rights attached to class of securities.
8. Matters relating to change in management.

Poor Track Record of Shareholder Protection

Though the above detailed analysis of shareholders’ rights as stressed by the Companies Act, other statues and various committees give an investor or the general readers the impression that there are enough previsions in the laws of the land, there has hardly been any conviction under them all these years. Since 1991 when the Indian economy was liberalised seemed to have opened the floodgates of scams and provided vast opportunities to fly-by-night operators to destroy shareholder values. As the result of some scams such as the Unit Trust of India (UTI) non-banking finance companies’, plantations’ and vanishing companies’, millions of small investors lost their savings and investments. The plight of millions of such small shareholders was indeed pitiable and heart-rending. Most of them, especially those who invested in NBFCs, lost their life-earnings and were driven to the street penniless. In spite of such misery caused to the poor investors and the high dent in their confidence, the government and regulatory authorities were grinding too slowly and did nothing to trace and penalise the scamsters or retrieve and return the poor investors’ money.

Between 1991 and 2006, more than Rs. 600,000 million were collected from prospective shareholders by several companies that did the vanishing trick. Though their names are posted in the web, none of the directors or promoters had been prosecuted either by the Registrar of Companies or the Securities and Exchange Board of India who can file criminal complaints against them under Section 621 of the Companies Act. Directors and promoters can be made personally liable for damages for false statements found in the prospectus. Apart from civil liability, Section 63 of the Companies Act stipulates that persons issuing false or untrue statements will be punishable with imprisonment for 2 years. Section 68 stipulates that any person who dishonestly induces other persons to subscribe to shares or debentures can be imprisoned for 5 years. But neither the government nor SEBI has thought it fit to prosecute these scamsters for more than a decade.¹

Better late than never. However, it is heartening to note that recently, after a decade of inactivity the ministry has cracked the whip on vanishing companies. Prioritising investor protection, particularly small investors, the Ministry of Corporate Affairs (MCA) has initiated prosecutions against vanishing companies under the Companies Act as well as other legislations.² According to a spokesman of the Ministry of Corporate Affairs: “On review of the ongoing actions against the vanishing companies, those companies who came up with public issues during 1993–94 and 1994–95 and vanished with public money, focus has been laid on taking timely and effective action against such companies, their promoters and directors.” Besides, launching prosecutions under the Companies Act, action has been taken against such entities by way of registering first information report (FIRs) under Indian Penal Code, and vigorously pursuing the prosecutions already launched.

In its report, the “Special Cell on Vanishing Companies” in the ministry has stated that out of the 52 vanishing companies’ cases in the western region, prosecutions have been filed against 48 companies, while the remaining four are under liquidation. “In fact, in the case of Maa Leafin & Capital Ltd, the accused has been convicted for, non-filing of statutory return,” a ministry official said. Further, FIRs have been launched against 40 companies, of which 28 have been registered. In the case of Trith Plastic Ltd. of Gujarat, charge-sheet has been filed in the Court and Directors of the company have been arrested.

Of the 36 cases in the southern region, prosecutions have been filed against 32. For non-filing statutory returns, 21 prosecutions have been filed while FIRs have been filed against 19 companies. Of the 19 FIRs launched, nine have been registered. In the case of one company, Global Property Ltd., public issue money has been refunded.

In the northern region, prosecutions have been filed against all 20 vanishing companies. In the case of Simplex Holdings, the accused has been convicted. For non-filing of statutory returns, 19 prosecutions have been filed. In the case of Dee Kartvya Finance Ltd., the accused has been convicted and fined. FIRs have been filed against 15 companies of which four have been registered.

In the eastern region, of the 14 vanishing companies cases, prosecutions have been filed against 11 companies. The remaining three are under liquidation. FIRs have been filed in all 14 cases of which 13 have been registered. Further, 11 prosecutions have been filed for non-filing of statutory returns. In the case of Cilson Organics Ltd. the Managing Director of the company has been convicted and a fine of Rs. 14,000 has been imposed.

However, it should be remembered that it has taken more than a decade for the government to initiate legal action against the scamsters. Besides, it should be kept in mind that the slow-grinding judicial processes will take its own time and if past experience is any indication, it will take another decade or so at the fastest, to get the judgement. Even then, there is no guarantee, that the guilty will be convicted and the poor investors’ money returned. This is the state of affairs that has caused untold misery to the poor Indian shareholder/investor.

Guidelines for Investors/Shareholders

The Securities and Exchange Board of India (SEBI), the Indian capital market regulator in its guidelines to investors/shareholders, titled “A Quick Reference Guide for Investors” published recently makes it known that a shareholder of a company enjoys the following rights:

 

Rights of a Shareholder, as an Individual

• To receive the share certificates on allotment or transfer, as the case may be, in due time.
• To receive copies of the abridged annual report, the balance sheet and the Profit & Loss Account and the auditors’ report.
• To participate and vote in general meetings either personally or through proxies.
• To receive dividends in due time once approved in general meetings.
• To receive corporate benefits such as rights, bonus etc. once approved.
• To apply to Company Law Board (CLB) to call or direct the convening the annual general meeting.
• To inspect the minute books of the general meetings and to receive copies thereof.
• To proceed against the company by way of civil or criminal proceedings.
• To apply for the winding-up of the company.
• To receive the residual proceeds.

Besides these rights one enjoys as an individual shareholder, one also enjoys the following rights as a group of shareholders:

• To requisition an extraordinary general meeting.
• To demand a poll on any resolution.
• To apply to the Company Law Board to investigate the affairs of the company.
• To apply to the Company Law Board for relief in cases of oppression and/or mismanagement.

Rights of a Debenture-holder

• To receive interest/redemption in due time.
• To receive a copy of the trust deed on request.
• To apply for winding up of the company if the company fails to pay its debt.
• To approach the debenture trustee with the debenture holder’s grievance.

However, one should note that the above mentioned rights may not necessarily be absolute. For example, the right to transfer securities is subject to the company’s right to refuse transfer as per statutory provisions.

Shareholders’ Responsibilities

While a shareholder may be happy to note that one has so many rights as a stakeholder in the company, it should not lead one to complacency because one also has certain responsibilities to discharge, such as

• To remain informed.
• To be vigilant.
• To participate and vote in general meetings.
• To exercise one’s rights on one’s own, or as a group.

Trading of Securities

A shareholder has the right to sell securities that he holds at a price and time that he may choose. He can do so personally, with another person or through a recognised stock exchange. Similarly, he has the right to buy securities from anyone or through a recognised stock exchange at a mutually acceptable price and time.

Whether it is a sale or purchase of securities, affected directly by him or through an exchange, all trades should be executed by a valid, duly completed and stamped transfer deed.

If he chooses to deal (buy or sell) directly with another person, he is exposed to counter party risk, i.e. the risk of non-performance by that party. However, if he deals through a stock exchange, this counter party risk is reduced due to trade/settlement guarantee offered by the stock exchange mechanism. Further, he also has certain protections against defaults by his broker.

 

When one trades through an exchange, one has the right to receive the best price prevailing at that time for the trade and the right to receive the money or the shares on time. He also has the right to receive a contract note from the broker confirming the trade and indicating the time of execution of the order and necessary details of the trade; he also has the right to receive good rectification of bad delivery. If he has a dispute with his broker, he can resolve it through arbitration under the aegis of the exchange.

If an investor decides to trade through an exchange, he has to avail the services of a SEBI-registered broker/sub-broker. He has to enter into a broker-client agreement and file a client registration form. Since the contract note is a legally enforceable document, he should insist on receiving it. He has the obligation to deliver the shares in case of sale or pay the money in case of purchase within the time prescribed. In case of bad delivery of securities by the shareholder, he has the responsibility to rectify them or replace them with good ones.

Transfer of Securities

Transfer of securities means that the company has recorded in its books a change in the title of ownership of the securities effected either privately or through an exchange transaction. To effect a transfer, the securities should be sent to the company along with a valid, duly executed and stamped transfer deed, duly signed by or on behalf of the transferor (seller) and transferee (buyer). It would be better to retain photocopies of the securities and the transfer deed when they are sent to the company for transfer. It is essential that one sends them by registered post with acknowledgement due and watch out for the receipt of the acknowledgement card. If one does not receive the confirmation of receipt within a reasonable period, one should immediately approach the postal authorities for confirmation.

Sometimes, for a shareholder’s own convenience, he may choose not to transfer the securities immediately. This may facilitate easy and quick selling of the securities. In that case, he should take care that the transfer deed remains valid. However, in order to avail the corporate benefits such as dividends, bonus or rights from the company, it is essential that he gets the securities transferred in his name.

 

On receipt of the shareholder’s request for transfer, the company proceeds to transfer the securities as per the provisions of the law. In case it cannot effect the transfer, the company returns the securities giving details of the grounds under which the transfer could not be effected. This is known as “Company Objection”.

When a shareholder happens to receive a company objection for transfer, he should proceed to get the errors/discrepancies corrected. He may have to contact the transferor (the seller) either directly or through his broker for rectification or replacement with good securities. Then he can resubmit the securities and the transfer deed to the company for effecting the transfer. In case he is unable to get the errors rectified or get them replaced, he has recourse to the seller and his broker through the stock exchange to get back his money. However, if one had transacted directly with the seller originally, one has to settle the matter with the seller directly.

Sometimes, one’s securities may be lost or misplaced. One should immediately request the company to record a “stop transfer” of the securities and simultaneously apply for issue of duplicate securities. For effecting stop transfer, the company may require him to produce a court order or the copy of the FIR filed by him with the police. Further, to issue duplicate securities to him, the company may require him to submit indemnity bonds, affidavit, sureties, etc. besides issue of a public notice. He has to comply with these requirements in order to protect his own interest.

Sometimes, it may so happen that the securities are lost in transit either from the shareholder to the company or from the company to him, he has to be on his guard and write to the company within a month of his sending the securities to the company. The moment it comes to his notice that either the company has not received the securities that were sent or he did not receive the securities that the company claims to have sent to him, he should immediately request the company to record stop transfer and proceed to apply for duplicate securities.

Depository and Dematerialisation

Shares are traditionally held in physical or paper form. This method has its own inherent weaknesses such as loss/theft of certificates, forged/fake certificates, cumbersome and time consuming procedure for transfer of shares, etc. Therefore, to eliminate these weaknesses, a new system called “Depository System” has been established.

A depository is a system which holds shares in the form of electronic accounts in the same way a bank holds one’s money in a savings account.

Depository system provides the following advantages to an investor:

• His shares cannot be lost or stolen or mutilated.
• He never needs to doubt the genuineness of his shares, i.e., whether they are forged or fake.
• Share transactions such as transfer, transmission, etc. can be effected immediately.
• Transaction costs are usually lower than on the physical segment.
• There is no risk of bad delivery.
• Bonus/rights shares allotted to the investor will be immediately credited to his account.
• He will receive the statement of accounts of his transactions/holdings periodically.

When a shareholder decides to have his shares in electronic form, he should approach a Depository Participant (DP) who is an agent of depository and open an account. He should surrender his share certificates in physical form and his DP will arrange to get them sent to and verified by the company and on confirmation credit his account with an equivalent number of shares. This process is known as de-materalisation. One can always reverse this process if one so desires and get his shares reconverted into paper form. This reverse process is known as “re-materialisation”.

 

TABLE 4.1 Redressal of grievance mechanism

Nature of grievance	To be taken up with
In case of any public Issue, non-receipt of
▪ Refund order	- SEBI
▪ Interest on delayed refund	- Dept. of Corporate Affairs
▪ Allotment advice	- Dept. of Corporate Affairs
▪ Share certificates	- Stock Exchange
▪ Duplicates for all of the above	- Registrars to the Issue
▪ Re-validations	- Registrars to the Issue
In case of a listed security, non-receipt of the certificates after
▪ Transfer	- SEBI
▪ Transmission	- SEBI
▪ Conversion	- SEBI
▪ Endorsement	- Dept. of Corporate Affairs
▪ Splitting	- Dept. of Corporate Affairs
▪ Duplicates of securities	- Dept. of Corporate Affairs
Regarding listed debentures, non-receipt of
▪ Interest due	- SEBI
▪ Redemption proceeds	- Dept. of Corporate Affairs
▪ Interest on delayed payment	- Debenture Trustees Stock Exchange
▪ Regarding bad delivery of shares	- Bad Delivery Cell of the Stock Exchange
Regarding shares or debentures in unlisted companies	- Dept. of Corporate Affairs
▪ Deposits in collective investment schemes such as plantations etc.	- SEBI
Units of mutual funds	- SEBI
▪ Fixed deposits in banks and finance companies	- Reserve Bank of India
Fixed deposits in manufacturing companies	- Dept. of Corporate Affairs

 

Share transactions (such as sale or purchase and transfer/transmission, etc.) in the electronic form can be effected in a much simpler and faster way. All one needs to do is that after confirmation of sales/purchase transaction by one’s broker, one should approach his DP with a request to debit/credit his account for the transaction. The depository will immediately arrange to complete the transaction by updating his account. There is no need for separate communication to the company to register the transfer.

Grievance Redressal Process

There will be occasions when an investor has a grievance against the company in which one is a stakeholder. It may be that one has not received the share certificates on allotment or on transfer; it may be that one did not receive the dividend/interest warrant or refund order; perhaps one did not receive the Annual Accounts etc. While one would first approach the company in that regard, one may not be satisfied with the company’s response thereto and one would like to know whom he should turn to get his grievance redressed. Table 4.1 provides an investor the guidance in this regard.

Inventory Information Centres have been set up in every recognised stock exchange which in addition to the complaints related to the securities traded/listed with them, will take up all other complaints regarding the trades effected in the exchange and the relevant member of the exchange.

Moreover, two other avenues always available to the investor to seek redressal of his complaints are as given below

1. Complaints with Consumers Disputes Redressal Forums;
2. Suits in a Court of Law.

• Grievance redressal process
• Guide for protection of investors and shareholders
• Poor track-record
• Rights of shareholders
• Theoretical basis of agency costs

1. What do you understand by agency costs? How could these costs be minimised by corporations?
2. What are the rights and privileges of shareholders as enumerated by the Indian Companies Act 1956 and the amendments made thereto?
3. Critically comment on the recommendations of the Kumar Mangalam Birla Committee 1999.
4. Spell out the major issues addressed by the Naresh Chandra Committee. What were the major recommendations of the committee to ensure corporate governance amongst companies?
5. Discuss briefly the recommendations of the Narayana Murthy committee on corporate governance.
6. What is the need and justification for postal ballot? Do you think it will offer better prospects for ensuring corporate governance?
7. Critically analyse the poor track record of investor protection in India. In this context, what are the guidelines offered by SEBI to ensure investor protection?

• A Cadbury Report of the Committee on the Financial Aspects of Corporate Governance, London (1992).
• Report of the SEBI’s Kumar Mangalam Birla Committee on Corporate Governance (7 May 1999).
• Report of the Naresh Chandra Committee on Corporate Audit and Governance (23 December 2002).
• Report of SEBI’s N. R. Narayana Murthy Committee on Corporate Governance (2003).
• Report of the Task Force on Corporate Excellence through Governance (2000).
• Securities and Exchange Board of India, “A Quick Reference Guide for Investors”.
• The Confederation of the Indian Industry, Desirable Corporate Governance: A Code (April 1998).

 

 

Case Study

The Tussle over Corporate Governance at Reliance

(This case is based on reports in the print and electronic media. The case is meant for academic purpose only. The writer has no intention to sully the reputations of corporates or executives involved.)

A Brief Note on Ambani’s Entry into Indian Industrial Scenario

Dhirubhai Ambani was the second son of a poor school teacher from Chorward village in Gujarat. He studied up to 10th standard and decided to join his elder brother, Ramniklal, who was then working in Aden. The first job Dhirubhai held was that of an attendant in a gas station. Half a century later, he would become chairman of Reliance Petroleum Limited, a company that owned the largest oil refinery in India. When he died in Bombay after a stroke on 6 July 2002 aged 69, the Reliance group of companies that Dhirubhai established had a gross annual turnover of Rs. 75,000 crore or close to US$ 15 billion. The group’s interests include the manufacture of synthetic fibres, textiles and petrochemical products, oil and gas exploration, petroleum refining, tele-communications and financial services. Before the split took place between his progenies, Mukesh and Anil, the Reliance group had total revenues of over Rs. 99,000 crore (US $22.6 billion) and net profit of Rs. 6,200 crore (US $1.4 billion). Its revenue was equivalent to 3.5 per cent of the country’s GDP. It contributed 10 per cent of India’s indirect tax revenues. Its exports to more than 100 countries constituted over 6 per cent of the country’s exports. The Reliance Group has also India’s largest number of investors in the country at 3.1 million that constitutes about one-fourth of the country’s total investing public.

Reliance Industries Ltd—A Mammoth Corporate

In its website, Reliance Industries Limited (RIL) asserts that it is India’s largest private sector company on all major financial parameters with a gross turnover of Rs. 74,418 crore (US $17 billion), cash profit of Rs. 9,197 crore (US $2.1 billion), net profit of Rs. 5,160 crore (US $1.2 billion), net worth of Rs. 34,452 crore (US $7.9 billion) and total assets of Rs. 71,157 crore (US $16.3 billion). RIL emerged as the only Indian company in the list of global companies that create most value for their shareholders, published by Financial Times based on a global survey and research conducted by Price Waterhouse Coopers in 2004. RIL features in the Forbes Global list of world’s 400 best big companies and in FT Global 500 list of world’s largest companies.

RIL was adjudged the “Best Managed Company” in India in a study by Business Today and AT Kearney in 2003. The company also bagged the credit for being “India’s biggest wealth creator” in the private sector over a 5-year period in a study by Business Today—Stern Stewart in 2004. RIL alone accounts for:

• 17 per cent of the total profits of the private sector in India.
• 7 per cent of the profits of the entire corporate sector in India.
• 6 per cent of the total market capitalisation in India.
• Weightage of 13 per cent in the BSE Sensex.
• Weightage of 10 per cent in the Nifty Index.

Reliance was Mired in Controversies Since its Inception

The textile tycoon’s meteoric rise was not without its fair share of controversy. In the days of the licence control raj, Dhirubhai, more than any of his fellow industrialists, understood and appreciated the importance of “managing the environment,” a euphemism for keeping politicians and bureaucrats happy. However, no one can deny the fact that he was more than a legend in his own lifetime. He successfully convinced more than three million investors—most of whom, belonged to the middle class—to invest their hard-earned money in his group companies. Much of the credit for the spread of the so-called “equity cult” in India in recent years should rightfully go to Dhirubhai, even if the Reliance group was often accused of manipulating share prices.

In 1958, after trading in a range of products, primarily spices and fabrics, for about 8 years, Dhirubhai achieved the first of the many goals he had set for himself when he became the owner of a small spinning mill at Naroda, near Ahmedabad. In 1977, Reliance Industries went public and raised equity capital from tens of thousands of small investors. From then onwards, Dhirubhai started promoting with a single-minded purpose his company’s textile brand name, “Vimal.” He did not look back since then.

However, if there was a positive side to the founder of India’s largest industrial empire, there was a negative side too, which people with an ethical bent of mind abhorred. Reliance group of companies was mired in endless series of controversies right from its inception. In 1985 a series of articles written by Arun Shourie and an RSS-sympathiser and chartered accountant, Gurumurthy, in the Indian Express, meticulously detailed a host of ways in which the government of the day bent backwards to help the Ambanis. One article was on the subject of how the Reliance group imported “spare parts”, “components” and “balancing equipment” of textile manufacturing machinery to nearly double its production capacities. The article claimed that the Ambanis had ‘smuggled’ in a complete textile plant. Another story detailed how companies registered in the tax haven, the Isle of Man, with ludicrous and unimaginable names such as Crocodile Investments, Iota Investments, and Fiasco Investments had purchased Reliance shares at one-fifth their market prices. Curiously, most of these firms were controlled by a bunch of non-resident Indians who had the same surname, Shah. In 1990, when the Ambanis wanted to acquire managerial control of one of India’s largest construction and engineering companies, Larsen & Toubro, government-owned financial institutions such as LIC and GIC stonewalled its attempts as the V. P. Singh government did not approve of Reliance’s tactics. Ambanis had to beat a hasty retreat after incurring huge losses and suffering a loss of face. More than 11 years later, the Reliance group suddenly sold its stake in L & T to Grasim Industries headed by Kumara Mangalam Birla. This transaction too attracted adverse attention. Questions were raised about how the Reliance group had increased its stake in L & T a short while before the sale to Grasim had taken place. The Securities and Exchange Board of India (SEBI) instituted an inquiry into the transactions following allegations of price manipulation and insider trading. Reliance had to later cough up a token fine imposed by SEBI.

There were other controversies involving the Reliance group. Two senior executives of the Reliance group were accused of violating the Official Secrets Act after a cabinet note was found in their office during a police raid. Earlier, there had been a major uproar in the stock exchanges over alleged cases of “switching” of shares and the issue of duplicate shares by the company. In 2002, Raashid Alvi, a member of the parliament, levelled a large number of allegations against the Reliance group and distributed voluminous bunch of photocopied documents to journalists that included the letter in which a Reliance group company had sought to “buy peace” with the income tax department. The MP accused the Reliance group companies of manipulating their balance sheets and annual statements of accounts. A week after Dhirubhai’s death, the Department of Company Affairs (DCA) confirmed that there was indeed a basis to some of the allegations raised by Alvi and that there were certain discrepancies in the balance sheet issued by Reliance Petroleum 7 years earlier. The DCA subsequently confirmed that different Reliance group companies had transferred interest income to one another in a questionable manner. More recently, the government of India accused Reliance Infocomm of violating its license norms by illegally routing international calls as local calls to avoid payment of levies to the telecom PSUs. The company was ordered to pay Rs. 150 crore in penalty for this violation. In February 2005, Reliance Infocomm came in for adverse publicity when a New Delhi City Court told the Delhi Police to file a status report by 15 March as the company had been accused of violating provisions of the law against pre-natal sex determination by depicting such information of foetus on its website.

The Puzzle over the Absence of Dhirubhai’s Will

The phenomenal growth of Reliance group of industries in a short span of less than three decades (1977–2004) has become nothing short of the country’s industrial folklore. Dirubhai Ambani used every means available to him to build a world class company. In a short period of its existence, Ambanis’ Reliance has overtaken the venerable 100 year old Tata Group Companies. Reliance had its ups and downs in its chequered history, more ups than downs, thanks to Dhirubhai’s policy of playing a politically correct role and ensuring that public policies do not stand in the way of his company’s fast-track growth.

When Dhirubhai Ambani died in 2002 leaving his then Rs. 60,000 crore industrial empire to his sons, Mukesh and Anil, it was thought he had left a well-laid system of working arrangement between the brothers and perhaps a will. But it is now known—after Anil started spilling the beans publicly about lack of corporate governance practices in Reliance—that there has been no will. Reliance-watchers are puzzled as to why the shrewd and extraordinarily methodical Dhirubhai Ambani who deftly crafted one of India’s most celebrated business empires, did not leave a will. People who know him confirm that it was not in Dhirubhai’s character to overlook something so fundamental. Perhaps, he did not leave a Will as it would have exposed the complex shareholdings of the Group through the maze of investment companies, in the opinion of Bala V. Balachandran, J. L. Kellogg distinguished professor, Northwestern University. Dhirubhai Ambani ensured that other people funded his business, but he and his progenies controlled it. “Dhirubhai knew that. He also knew that without a will you can’t see the transparency of the complex shareholding of hundreds of investment companies. But without the will, you can control the whole thing,” adds Balachandran. It is an irrefutable fact that the Ambanis built Reliance through sweat and toil and through enterprise and ingenuity. They also built Reliance through a maze of investment companies. It is how the family controls 34 per cent of the equity in Reliance Industries, even as it continues to raise and invest thousands of crores in equity and debt (Businessworld, 10 January 2005, p. 41).

Corporate Governance at Reliance—Claim and the Reality

Reliance Industries Limited (RIL) on its Corporate Web site (http:www.ril.com/aboutus/about_corpgover.html) has this claim to make on the corporate governance practices adopted by the company: “Reliance is one of the pioneers in the country in implementing the best international practices of corporate governance. In recognition of this pioneering effort, the Institute of Company Secretaries of India has bestowed on the company the National Award for Excellence in Corporate Governance for the year 2003.…” Reliance’s corporate governance principles uphold its global standing at the forefront of corporate governance best practice. Reliance continues to review its corporate governance practices to ensure that they continue to reflect domestic and international developments to position itself to conform to the best corporate governance practices. It takes feedback into account in its periodic reviews of the guidelines to ensure their continuing relevance, effectiveness and responsiveness to the needs of local and international investors and all other stakeholders.”

Anil’s Accusations

However, after the Ambani siblings started a public tussle over “ownership issues,” the younger scion of the Ambanis sought the group flagship company’s board meeting to discuss corporate governance issues. As the rift widened with the media playing the proverbial role of the monkey acting as an arbiter adding to the sibling rivalry, more and more details of corporate governance failures at Reliance came to light. On 13 December 2004, the Securities and Exchange Board of India (SEBI), the Indian capital market regulator directed the Stock Exchanges to look into corporate governance issues at Reliance Industries Ltd. SEBI also claimed that it was looking into the buy-back controversy at RIL (Businessworld, 10 January 2005, p. 38).

Apart from these murky issues which became public knowledge, Anil sent a 500-page missive to RIL Board on corporate governance issues on 15 December 2004, which highlighted several lapses. The bulky note sent to the Corporate Governance Committee of the board of the flagship company RIL, of which Mukesh is the chairman and Anil the vice-chairman, deals extensively with what the younger brother regards as flaws in corporate governance within the group. Anil is reported to have made specific allegations about irregularities and improprieties being committed by the company. According to him the company’s accounts did not provide the necessary explanations, details and disclosures and there was silence on related party transactions, specially those involving Infocomm group (L. C. Gupta, “An unusual whistle-blower,” Economic Times, 10 May 2005”).

Anil has, in fact, made an issue of what he perceived to be a conflict of interest between the business interests of Anand Jain, a close associate of Mukesh, and various key positions he holds in the group. Anil had even resigned as vice-chairman and director from the board of Reliance group company IPCL, saying he would not share a seat on it with Jain, whom he accused of conspiring to divide the family. Anil had virtually turned down IPCL’s request to reconsider his resignation, saying various issues, including corporate governance and disclosure need to be resolved before any rethinking on his decision. Requesting “appropriate steps” in the interest of RIL’s 3 million shareholders, Anil expressed “deep concern that RIL has failed to adhere to highest standards of corporate governance, transparency and disclosure.” The extensive note is understood to have covered various issues, including questioning the manner of RIL’s investment of Rs. 12,000 crore in Reliance Infocomm. Anil also disagreed with the Reliance board over the buy-back proposal as a response to falling share prices ever since the differences between the Ambani brothers became public. In the perception of the board, the precipitous fall of 12 per cent in RIL stock price was inexplicable as nothing had fundamentally changed in terms of business strategy, operational efficiency or future outlook. Hence buy-back arrangement would act as a corrective measure to restore the share prices to normalcy.

There were also other questions such as Rs. 50 crore sweat equity allotted to Mukesh in Reliance Infocomm constituting 12 per cent of the company’s stocks. (Valued notionally at Rs. 70,000 crore which he annulled at the board meting on 27 December 2004) and the conversion of Rs. 8100 crore preference capital held by Rliance Industries in Reliance Infocomm, which Anil wanted to be converted into equity. Generally, it is believed that Anil was unhappy with some share transfers that had taken place after Dhirubhai’s death.

Response of the Corporate Governance Committee

The Corporate Governance Committee headed by Y. P. Trivedi, an independent director, when being questioned about Anil Ambani’s 500-page note on issues relating to corporate failure at RIL commented that there was no breach of governance norms at RIL. He said that eminent retired judges had endorsed the corporate governance practices, thus virtually giving a clean chit to the company. He further asserted that the Vice-Chairman and MD Anil Ambani’s refusal to sign financial results at the board meeting had no implications on the company. It was not necessary for the company to inform the Exchanges, that Anil Ambani did not sign the financial results, Trivedi said after the board meeting (PTI). The corporate governance committee did not find any violations on issues referred to it.

RIL Board Passes Corporate Governance Committee Report

Belying expectations of a stormy affair, Reliance Industries transacted all its business including passage of about 25 resolutions peacefully. “The board passed all the resolutions although some of these were not unanimous,” RIL board sources told PTI immediately after the 2-hour long meting. Besides approval of financial results, the board accepted the report of its Corporate Governance Committee. Sources indicated that on many of the resolutions, Anil either abstained or dissented, but did not give details. The board meeting demonstrated without any ambiguity that Mukesh was in total control of RIL and its affairs, and Anil’s attack had been dented. “There is little that 1 person can do against 11 persons who are not ready to listen,” one of Anil’s close aides was reported to have said.

Disturbing Questions on Corporate Governance

The report of the Corporate Governance Committee, headed by Y. P. Trivedi, was the bone of contention with Anil questioning the credentials of the members even before the meeting of the board saying that it did not even bother to consult him while raising the issues by him. Among the issues raised by Anil included non-disclosure of the marketing agreement between RIL and Reliance Infocomm and elder brother Mukesh’s conflict of interest as CMD of RIL, Reliance Communications and Infrastructure and Reliance Infocomm. These murky goings-on in the RIL board have raised some disturbing questions on corporate governance practices adopted at RIL, especially the wide differences that existed between the principles highlighted and practices followed in the company.

Independent Directors—Were They Really Independent?

It has also been reported in the Press that three independent directors on the Reliance Indutries Ltd (RIL) Board—D. V. Kapur, S. Venkitaramanan and Y. P. Trivedi—or their relatives have had a pecuniary relationship with the company and its associate companies like Reliance Capital and Reliance Infocomm. According to Clause 49 of the Listing Agreement of RIL, “An independent director means a non-executive director who, apart from his director’s remuneration, does not have any material pecuniary relationship or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associate companies.” It also says that an independent director is one “who… for the last 3 years… is not a partner or executive of a consulting firm that has a material association with the entity.” If such a relationship exists, a director cannot be independent. As RIL has an executive chairman, Mukesh Ambani, the Companies Act requires that at least 50 per cent of the directors on its board should be independent. Kapur, Venkitaramanan and Trivedi make up three of the six independent directors on the RIL board, whose credentials as independent directors were being questioned. Trupai, a fourth independent director, died on 26 January. The penalty for not complying with the Listing Agreements is a fine of up to Rs. 25 crore and imprisonment of up to 10 years, according to the Securities Contract (Regulation) Act, 1956.” (Independent Directors Had Financial Ties with RIL, Business Standard, New Delhi, 30 January 2005.)

New Norms of Corporate Governance and its Compliance

With so many serious doubts about RIL’s governance practices having been brought to light in the wake of the rift between the Ambani siblings, a pertinent question remains to be answered. Did RIL keep up with the new and vastly changed governance norms? Today’s definition of “good” corporate governance is very stringent compared to what it was during the days Dhirubhai built Reliance. Arun Maira, Chairman, Boston Consulting Group (India), explains the two fundamental differences between governance then and governance now. “A decade ago, it was enough to manage efficiently and produce results. That is what the Ambanis excelled at. They produced superlative results, almost always. Delighted shareholders, be it government institutions, foreign investors or retail shareholders, never questioned the means. Today, it is not enough to manage efficiently and produce results. Values and (the) means by which things are done, are as important,” Also then, corporate governance was all about protecting shareholders’ interests. But that has changed now. “In recent times, the power of corporations has increased vis-à-vis other organs of society, including governments. There is danger in this if business corporations see their responsibility only towards their shareholders, and not more broadly towards society. Therefore, the board, the prime organ for corporate governance, must be held responsible for the broader role and responsibility of the corporation to society.”

The Role of the RIL Board is Being Questioned

Under these changed circumstances and value systems, his board was finding itself in unfamiliar territory 2 years after Dhirubhai’s demise. Probing questions are being asked about its role. The independence of independent directors is coming under scrutiny. Incriminating documents, which have never left Reliance’s vaults, are now being thrown around freely. Even public documents are now pointing to the board’s calpability. Dhirubhai, who built Reliance through a maze of investment companies, also built the board of Reliance Industries. And the board is only as good as the chairman and CEO allow it to be. The result of the controversial board meeting is, therefore, no surprise. At the meeting, all board members, barring Anil, backed Mukesh. They gave a clean chit to the investments in Reliance Infocomm, expressed faith in Mukesh’s leadership, and made some genial remarks about corporate governance. The board would have done the same thing had similar allegations come up during Dhirubhai’s days (Business World, January 10 2005, p. 44).

For instance, in the 2004 annual report of RIL, the board had signed a statement under the statutory section on corporate governance that “None of the transactions with any of the related parties were in conflict with the interests of the company” (p. 42). In the light of revelations in the aftermath of Anil’s taking cudgels against governance issues at RIL, the statement implies that the board saw nothing wrong in Mukesh acquiring Rs. 50 crore worth of shares in Reliance Infocomm at par, while RIL itself paid Rs. 8100 crore for shares worth only Rs. 84 crore. The board, reaffirmed this at its controversial meeting in January 2005.

Did the RIL board think twice before it signed that statement? The Indian Companies Act, Caluse 49 of the Listing Agreement that companies sign with the Stock Exchanges (as prescribed by Securities and Exchange Board of India) and Accounting Standards 18 of the Institute of Chartered Accountants of India (ICAI) together prescribe a five-point check for the board and the statutory auditors, before such a statement is signed.

1. As per Section 299 of the Companies Act, “Every director of a company who is in any way, whether directly or indirectly concerned or interested in a contract or arrangement, shall disclose the nature of his concern or interest at a meeting of the board…” “The exact nature, extent and manner have to be clearly submitted in a prescribed format.” Now the important question is: Did Mukesh disclose the full extent of his interest to the board? It is widely known that a complex maze of companies controlled by Mukesh was used to set up Reliance Infocomm. Reliance Industries’ investments and Mukesh’s sweat equity^∗ of Rs. 50 crores were routed through this channel.

   If RIL’s claims that the company follows international governance practices, then its CMD. Mukesh should have made a complete disclosure of all his interests, including the sweat equity to the board (which was bound to disclose it explicitly to shareholders). The same can be said of several other related-party transactions within the group.

2. The Securities and Exchange Board of India’s code on corporate governance prescribes that the board of every listed company set up an audit committee. This must be constituted entirely of non-executive directors and must be headed by an independent director. This is mandated by Section 292 A of the Companies Act and by Clause 49 of the Listing Agreement. Among other things, the audit committee has to “review any related party transactions, i.e. transactions of the company of material nature, with promoters or the management, their subsidiaries or relatives etc. that may have a potential conflict of interests with the company at large”. The audit committee also has powers to consult the statutory auditors of the company and demand clarifications regarding any area of concern.

   The Reliance Board too did set up such a committee—comprising four independent directors: Y. P. Trivedi (Chairman) Venkit-aramanan (Vice chairman), T. R. U. Pai and M. P. Modi. But this committee found no reason for any conflict of interest. It was on the basis of this finding that the board signed the above-mentioned statement. However, subsequent disclosures about the sweat equity and other questionable transactions within the group, open up the audit committee’s actions to scrutiny. (Businessworld, 10 January 2005, p. 44).

3. Section 301 of the Company’s Act prescribes that every company maintain a register of contracts in which its directors are interested in. It also has to specify details, including the date of the contract and the terms and conditions of the contract. Besides, Section 297 specifies that board approval is required for contracts in which directors are interested parties. In cases of business emergencies, such transactions may happen without board permission. But they have to be cleared by the board within 3 months of the transaction through a resolution. The significant point here is that under Section 301, the register has to be signed by every director, which implies that they are aware of and have approved these transactions. Moreover, this register has to be kept open for inspection by any shareholder. And if a minority shareholder feels that his interests have been prejudiced, he can approach the Company Law Board.
4. As an abundant caution, the Companies Act (Section 300) also declares that directors are not to participate in discussions or vote in resolutions in which they might be considered to be interested parties. For example, when the Reliance Industries Board was discussing Reliance Energy, Anil Ambani was not supposed to be present. Similarly, when Reliance Infocomm was being discussed, Mukesh should have stayed out. Reports suggest that Mukesh may have actively participated in such discussions.

   In contrast, in companies like Infosys which follow scrupulously such regulations, interested directors have stepped out when their boards discussed issues relating to them.

   The key question here is this: Did the RIL Board realise that Mukesh was an interested party? Did the Board recognise that his personal interests in Reliance Infocomm might be in conflict with the interests of Reliance Industries?

5. Apart from the board and the audit committee, the statutory auditors too have a clear responsibility with respect to related-party transactions. Accounting Standards (AS) 18 of the ICAI goes into great length in its definitions of related parties and the kind of disclosures required. It defines a party as related if the party has the ability to control or exercise significant influence over the other party (Mukesh clearly has influence over Reliance Infocomm and Reliance Industries). It also defines a related party transaction as a transfer of resources or obligations between related parties, irrespective of whether a price is charged. It goes to the extent of saying that a related-party relationship has to be disclosed irrespective of whether a transaction has taken place or not. And in the event of transactions, the auditors have to ensure: (a) full disclosure of all details of the transaction along with the amounts involved, and (b) any other elements of the related-party transactions necessary for an understanding of the financing transactions.

In the Reliance Industries annual report, detailed disclosures of transactions between Reliance Industries and other related parties have been made (though the sweat equity is not specifically mentioned). However, shareholders may feel that they were not given other details necessary for a correct understanding of the financial transactions.

Has the spirit of these laws been upheld? The answer is a clear no. If the actions of Reliance directors are compared to those of some of their peers from other companies, they fall short of standards set even within India, let alone international standards. Such standards have not been observed at Reliance, even at the concerned board meeting. According to press reports Mukesh was present and even voted on resolutions pertaining to Reliance Infocomm.

Related-party relationships are not peculiar to Reliance alone. ICAI’s AS 18 states: “Legally, there is nothing wrong in such transactions. The law does not restrict such transactions,” They are certainly well within the ambit of law, as long as: (a) the interested director makes full disclosures to the board, (b) the board exercises sound, independent judgement to determine whether these represent a conflict of interests with the company, and (c) the board makes full, clearly understandable disclosures to all shareholders.

In the case of Reliance, the directors and the board could be challenged on all the three counts.

A Corporate is a National Asset, and Not of a Family

“When an institution becomes very important to society, it no longer belongs only to its financial investors and promoters. It belongs to society. Thus, Reliance “belongs to” India now, not the Ambani family. Therefore, concepts of governance must encompass the role of trusteeship for society, and not merely questions about the interests of the owners,” says Maira of Boston Consulting Group.

Anil Ambani expected that everything in RIL should have been done by trust, rather than by the unscrambling of the investment structure, which would bring with it difficult problems of its own. The media war that Anil Ambani has unleashed against his brother is an attempt to force him to clarify the ownership structure to Anil’s satisfaction. In this, he seems to have the support of other members of his family too, who also want the ownership structure to be clarified, even while they accept that the control of the group to rest with Mukesh. The complaint of the Anil camp is that even the way dividends flow to these investment trusts and companies and then managed is not clear. Reliance paid out Rs. 733 crore in dividends last year alone, which means these Trusts and companies received a lot of money, approximately Rs. 249 crore.

The Final Settlement

After an acrimonious and festering feud between the brothers that lasted more than 8 months, what appears like an amicable settlement seems to have been arrived at thanks to the strenuous efforts of family friend M. V. Kamath, the CMD of ICICI Bank with the blessing of their mother Kokilaben Ambani.

At the AGM on August 3, Mukesh—who now controls RIL—gave out the details of how the Rs. 1,00,000-crore Reliance group will be split between himself and Anil. RIL’s holdings in the three firms (Reliance Capital, Reliance Energy and the Telecom ventures) that have landed in Anil’s lap will be transferred to three special purpose vehicles (SPVS). RIL shareholders will be allotted shares in the SPVS in the same proportion as their holdings in RIL. As per the arrangement, for every 100 shares held, the RIL shareholder will get 5 shares of Reliance Capital, 7 of Reliance Energy and 100 of Reliance Communications Ventures Ltd (RCVL), a new holding company for all its telecom ventures. In addition, the same RIL shareholder would get 100 shares of Global Fuel Management Services Ltd (GFMS), another new firm to handle natural gas supplies from RIL for Anil’s proposed power project in Uttar Pradesh.

The partition between the two brothers and the settlement to transfer all holdings of Reliance industries in Reliance Energy (55 per cent), Reliance capital (47 per cent) and Reliance Infocomm (45 per cent) into a holding company to be listed in the stock exchanges implies that all Reliance shareholders benefit by the unlocking of value in these companies, whose initial promoter was Reliance Industries Ltd. However, the so-called settlement brings to the fore several issues, which need to be investigated by the Department of Corporate Affairs and the SEBI. The controversial areas that ought to be investigated are:

1. Role and the quality of board of directors
2. The reliability or otherwise of disclosures by the company
3. Promoters’ cross-holdings and web of investment companies
4. Related-party transactions harmful to shareholders and
5. The Reliability of disclosures in the company’s financial statements.

On the face of it, Mukesh Ambani has a larger slice of the cake, with interests in the group spanning diverse fields such as oil &gas, petrochemicals, textiles, life science and healthcare. With the oil and gas prices on a roll and the matured business spinning cash profits, the group should do well. After the disinvestment of its other activities, the group will be more focussed and enjoy a better valuation in the stockmarkets. If oil and gas, exploration and production, as also the petrochemicals (after the likely merger of IPCL in RIL) were to be spun off into separate entities, the valuation may still be better.

Anil Ambani, on the other hand, will be in the new economy business of information technology, communications and entertainment (ICE). In the first 7 months since launch, the infocomm company was able to garner subscribers to the tune of one million every month. This is expected to grow at around 100 per cent every year over the next 5 years. The acquisition of Flag Telecom, offering a bouquet of products through its 55,000 km long cable network to international carriers, is expected to see a further ramp-up in the overall subscribers at the retail as well as the service providers’ levels.”

• “Anil sends governance note to RIL”,

  http://economictimes.com/corpambanishow/1002274.cms

• “Corporate Governance,” http://www.ril.com/aboutus/about_corpgover.html
• Gupta, L. C. “An unusual whistle-blower,” Economic Times, (5 October 2005).
• Maradia, Hemant, P. “It is Finally Over…….Or is it?”

  http://www.indiainfoline.com/nevi/itsf.html

• “Happier Times: The Ambani brothers after they took control of the Reliance group in 2002 in a smooth succession.” Intricate web, www.hinduonnet.com/the hindu/thscrip/forint
• No breach of governance norms: RIL

  http://www.rediff.com/money2005/apr/27ril7.htm

• Parikh, Daksesh “Dividing the Cake,” Business India (June 20-July 3).
• PTI - “Anil sends 500-page note to RIL board on Governance”

  http://www.tribuneindia.com/2005/20050124/biz.htm

• PTI - “Govt lays bare the facts on Reliance Info,” The New Indian Express, Chennai (2 May 2005).
• “RIL Board Passes Corporate Governance Committee Report” PTI

  http://www.outlookIndia.com/pti_news.asp?id=294929

• Roy, Pinto, “Anil XI,” Business India (August 1–14, 2005).
• Roy, Shubhrangshu “Rely on Corporate Integrity,” Economic Times (1 May 2005).
• Shankar, Prem “Rejoice, Reliance Has Split,”

  http://www.dancewithshadows.com/pub/reliance_split.asp

• “Showdown at Maker IV,” Businessworld (10 January 2005), p. 36–39.
• “Srinivas Alam”, Takes Two To Tangle,” Outlook (15 August 2005), p. 46–47.
• “The Governance Question,” Businessworld (10 January 2005), p. 40–46.