Corporate Governance

[By Anupam Verma & Navtej Vatsa] The authors are students of National Law University Odisha.   Introduction India has witnessed a significant number of white-collar crimes (bribery, corporate fraud, etc.) in recent decades, because of which, and rightly so, questions have been raised on the competency of the country’s financial and corporate regulators. It is true that regulators should proactively employ all the resources at their disposal to prohibit such crimes, but should it happen, it is equally important for the investigative agencies to effectively and efficiently prosecute an erring organisation and associated individuals. In India, the investigative agencies, in dealing with white-collar crimes, primarily work on the detection-prosecution mechanism, i.e., upon detection of crimes or frauds, they investigate them and prosecute the offenders in court. In this article, the authors will be vouching for the addition of the United Kingdom (UK) Styled Deferred Prosecution Agreements (hereinafter “DPA”) mechanism to the country’s anti-white collar crime framework, which is based on the ‘carrot’ principle rather than the ‘stick’ one, as is being followed by the Indian agencies currently. The article will first explain the concept of DPAs and then move forward to have a comparative analysis between the UK’s and the United States’ (US) versions of DPAs in order to find the model framework for India to build upon. This will be followed by case analyses that will prove the supremacy of DPAs and the need for an Indian DPA, respectively. At last, the authors will provide suggestions for formulating a DPA mechanism suited to Indian needs. What is DPA? A DPA is a way to settle a case against a corporation accused of fraudulent practices. It lets the authorities frame charges against the erring company while also agreeing not to pursue the charges. In exchange, the company undertakes to comply with specified obligations as laid down in the agreement. The mechanism for DPAs can be traced back to the 60s in the US, where it was used to mitigate minor offences by making the signatory admit his or her guilt and pay fines, and in exchange, no proceedings were instituted against such persons. In the case of Salomon Brothers in the US, this mechanism was extended for the first time in the corporate world. The US and the UK are the two major jurisdictions around the world that actively use this mechanism. The UK DPA In the UK, DPAs were introduced for the first time in 2014, under Schedule 17 of the Crime and Courts Act, 2013. The Serious Fraud Office (SFO) and the Crown Prosecution Service (CPS) are the key agencies when it comes to its implementation. A UK DPA is an agreement between a prosecutor and an erring organisation under the oversight of a judge who makes sure that the terms and conditions of the agreement are just, equitable, and reasonable. If the organisation complies with the conditions, the agreement permits a trial to be postponed for a specific amount of time. After the successful conclusion of the agreement, charges are dropped. Thus, it allows an organisation to fully atone for illegal activity without suffering negative effects like insolvency proceedings, loss of jobs, monetary setbacks to investors, etc. DPAs are applicable to various kinds of corporate offences like bribery, fraud, embezzlement, etc. Furthermore, at least in the UK, it is only applicable to organisations and not individuals. Moreover, not every organisation can come to the authorities and demand a DPA. Only those companies that properly assist and cooperate in investigations will be considered by the authorities for the same. The US DPA One of the most prominent distinctions within the regulatory frameworks of the United Kingdom and the United States lies in the fact that, in the latter, even an individual, for example, an erring director or officer, can enter into a DPA. Secondly, the judiciary has a limited role in the determination of the terms of the agreement and usually grants approval to the agreement reached between the authorities and the wrongdoers, be it a company or an individual. This is in contrast to the UK, where judicial sanction is required even for beginning the negotiations and later the court also has full authority to modify it. Why the UK’s Framework is Best for India As mentioned above, only organisations are allowed to use the DPA mechanism under the UK’s framework, unlike in the US, where individuals can also enter into a DPA. Furthermore, under the UK’s framework, the judiciary has more power and an active role in formulating and executing the DPA. There is also a growing voice in the US to put DPAs under judicial oversight, which shows the supremacy of judicially induced DPAs. Considering the factors that (a) allowing an individual to use the DPA mechanism may not resonate well with the Indian public and (b) India’s robust judicial system, it is preferable that the UK’s framework be used as a model on which the Indian DPA should be built. Effectiveness of the DPAs: The Standard Banks Case In 2015, The Standard Bank (hereinafter “the bank”) became the first entity to enter into a DPA since the mechanism’s incorporation into the UK’s anti-corruption framework. The bank was alleged to have violated Section 7 of the Bribery Act, 2010, which provides for liability in cases of failure in the prevention of bribery. The bank, as per the terms of the DPA, was mandated to pay a total of US $32.2 million in fines, including US $7 million to the Government of Tanzania. In parallel with paying the fine, the bank also committed to submitting its current anti-bribery and corruption controls, rules, and protocols to an external review. Just after three years, i.e., in 2018, the SFO announced that the bank had successfully complied with and fulfilled all the conditions as laid down in the terms of the DPA, thus marking the successful culmination of UK’s first DPA. Need for an Indian DPA In 2017, Rolls Royce PLC entered into a DPA with the SFO

[By Basil Gupta] The author is a student of National Law University, Jodhpur.   Introduction The idea of Corporate Social Responsibility (‘CSR’) was introduced to the Indian corporate world to include social and environmental issues in their business practices. Initially, CSR was a popular topic in corporate law and governance, but recently there has been a shift towards Environmental, Social, and Governance (ESG) factors. This change occurred as “sustainability” became a major focus in corporate and financial law. Companies now aim to have portfolios that have taken the ESG factors into consideration, including environmental (such as climate change), social (such as human rights), and governance. The environmental factor refers to how a company manages its impact on the environment, such as its carbon emissions, resource consumption, and waste management practices. The social factor refers to how a company manages its impact on society, such as its labour practices, human rights record, and community engagement. The governance factor refers to how a company is managed, including its leadership structure, transparency, and accountability to shareholders. Professor MacNeil and Esser introduced the concept of the financial model of ESG, which puts emphasis on the role of capital and investors and reduces the attention on the responsibilities of directors while broadening the interests of stakeholders by focusing on sustainability. The shift from CSR to ESG can be attributed to three main reasons. First, CSR was given a prescriptive status through the Companies Act, 2013, which emphasized the stakeholder vs. shareholder debate in the context of CSR, with proponents on both sides arguing for their perspectives. However, there is growing recognition that a stakeholder-centric approach to CSR can be beneficial for both the corporation and the broader community. Second, with the amendment of CSR regulations in 2019, CSR became legally binding and turned into a form of corporate philanthropy. Finally, the CSR regime in India failed to address negative externalities due to being too broad, a lack of monitoring and enforcement mechanisms, and a reliance on philanthropy, leading to dissatisfaction with CSR, which paved the way for ESG to gain prominence. In this article, the author discusses the current framework of ESG norms in India, the ESG principles adopted in the European Union (EU), and the recommended solutions for the proper implementation of ESG in India. The author has also analysed through statistics whether corporate India is doing enough in ESG. ESG and Corporate India Although Indian companies and investors have come to recognize the significance of “sustainability” in their operations, ESG is still in its early stages in India. The government of India has implemented policies to promote sustainability reporting, such as the introduction of “Voluntary Guidelines” by the Ministry of Corporate Affairs (MCA) in 2011. This was later transitioned into a regulatory requirement by the Security and Exchange Board of India (SEBI) in 2012, which mandated “the top 100 listed companies based on market capitalization” to include Business Responsibility Reports (BRR) in their annual company reports. Then in 2020, SEBI went a step further by mandating companies to not only to report their financial compliance but also to disclose the social and environmental impact of their business operations in their annual report, replacing BRR with Business Responsibility and Sustainability Report (BRSR) for the top 1000 listed companies based on market capitalization for the financial year 2022-23. In India, where there are over 1.45 million registered companies, the requirements set by SEBI only apply to a small fraction of companies that comply with ESG norms, which is less than 0.1%. When discussing ESG in India, a question often arises: is Corporate India doing enough? While it is difficult to make generalizations about ESG compliance across all Indian businesses as it varies by company and industry, Indian businesses have been working to improve their ESG performance in recent years. For example, CRISIL, a leading analytical company in India, conducted a risk assessment across 53 sectors for the fiscal year 2021 and found that Indian companies have improved their ESG score and better disclosed ESG information compared to previous years. It has been discovered that complying with ESG standards can result in value creation for a company. Adherence to ESG norms by companies can improve their public image, attract more investment, and allow them to raise capital at a lower cost. On the other hand, investing in a company that does not follow ESG standards has been found to expose investors to 28% more risk compared to investing in a company which is ESG compliant. ESG in the European Union (EU): Comparative Analysis In India, while the BRSR requirement mandates companies to disclose information on their sustainable practices, there is no other mandatory legislation in place to ensure compliance with ESG norms, thus providing little incentive for integrating ESG factors into their operations. However, in EU they adopted a mechanism through which ESG became a central part of their economy. They did that by formulating an Action plan on “sustainable financing”. Sustainable financing is the practice of considering the impact on the environment and society in the investment decision-making process, which results in increased investment in sustainable and long-term initiatives, which also partakes ESG investing. In order to increase financial strength of the companies based on sustainability, the EU Commission developed a unified classification system known as EU taxonomy, creation of EU ECO labels and a green bond standard. Through EU Taxonomy, the investors and the stakeholders could know whether the company’s profits are from sustainable activities or not. EU ECO labels protect the companies trust in the sustainable financial market. Currently, there are no rules that mandate an issuer to clarify the reason for issuing a green bond, or any requirement for regular reporting. Therefore, the European Union Green Bond Standard (EU GBS) is a prospectus regulation that provides guidance on a standard for green bonds. Recommended Solutions for the Proper Incorporation of ESG Standards in Corporate India Whether the Indian corporate system could incorporate the above-mentioned mechanisms in order for the companies to

[By Sourav Kumar and Jyotshna YashaswiI] Sourav is a student at the National Law School of India University, Bangalore and Jyotshna is a student at the Chanakya National Law University, Patna. Introduction In the previous few years, the country has witnessed several banks facing an extreme crisis due to the ballooning Non-Performing Assets (NPAs). In 2018, a fraud of almost $2 billion was discovered at the Punjab National Bank. PMC Bank, Yes Bank, and Lakshmi Vilas Bank have almost collapsed, necessitating an intervention from the RBI to control the situation. Although the reasons for these crises are different, there is one common point among all of them, i.e., lack of internal control. In this article, I argue that the overlap between the board of directors (Board) and the management of the bank deteriorates the corporate governance standards in a bank. This overlap may be in a formal sense (through numbers), or in a factual sense (through influence). I will support my claim by proving that recent bank crises in India were a result of the failure of corporate governance caused by an overlap between the Board and the management. I further argue that prevention of such failure of corporate governance requires the RBI to establish an internal pressure mechanism for all banks by appointing nominee directors to the board of banks, in addition to the external regulatory mechanism that RBI exercises currently through various regulations. Failure of Corporate Governance in the Recent Past In March 2020, an excessively large amount of NPAs and constant failure to secure fresh funding prompted the RBI to take over the charge of Yes Bank and supersede its Board. The bank was put under moratorium and the RBI formulated a bailout plan led by the SBI. This crisis at the Yes Bank had been plaguing the bank since 2015 and was concealed from the RBI.  The former CEO of the bank Rana Kapoor engaged in aggressive lending to entities like Reliance Industries, Essel Group, DHFL, etc. which were already stressed and could not secure credit from other banks.[i] This aggressive lending resulted in a large amount of NPA, which was flagged for the first time in 2017-18. In the case of Lakshmi Vilas Bank, directors having substantial shares interfered with the management leading to the granting of loans to the likes of Jet Airways, Religare, CCD, Nirav Modi, etc.[ii] who were already financially stressed. This resulted in the burgeoning of NPAs at the bank, leading to the crisis. In the case of PMC Bank, more than 70% of the loan amount was given to a single entity, HDIL, whose financial credibility was already in question.[iii] All these crises were a result of a very large amount of NPA. The NPA was accumulated as a result of the unethical lending by the banks without properly accounting for the risk factor involved in such lending. The risk appetite of a bank is decided by the Board, and the management runs the bank in line with the risk approach decided by the Board. Therefore, it is clear that such unethical risk-prone lending can only be possible if the corporate governance structure has collapsed. This collapse of corporate governance structure in Yes Bank could be understood from the fact that one of the independent directors of the bank Uttam Prakash Aggarwal had resigned from the board citing corporate governance failure. He stated that there was a complete failure of corporate governance at the Bank as the bank was being run by the managers and not the Board.[iv] The Problem of Overlap between the Board and the Management: Various directors appointed to the Board of a company are also senior management officials of the company. This overlap between the Board and the management allows the executive directors to control or influence the functioning of the board, which was also the case with Yes Bank. Rana Kapoor used his influence to control the independent directors of the Board. On the contrary, in the case of Lakshmi Vilas Bank, the flow of this influence had reversed, where the directors interfered with the management. With respect to PMC Bank, there is no concrete proof to show such influence. However, it is highly improbable for the management to extend 70% of its loans to a single entity without effectively controlling the Board. An overlap, either in a formal or a factual sense, between these two separate organs of a company contradicts the basic principles on which corporate governance of banks is based. The RBI attempts to ensure corporate governance standards in the banks through various regulations. The most important principles on which the RBI regulations are based are ‘Transparency and Disclosure’.[v] Accordingly, the management of a bank should disclose all material information to the Board and maintain transparency. However, if the Board and the management overlap significantly in any manner, then this principle is rendered futile leading to a collapse of the corporate governance structure. The Need for Proactive Engagement by the RBI According to Section 149(4) of the Companies Act, one-third of the directors on the Board of a listed public company should be independent directors (IDs). This requirement for the composition of the Board may be changed by the central government for special classes of companies. The RBI in a recent discussion paper has proposed to tackle this problem of overlapping in a formal sense by proposing that the majority of Board members should be independent directors. It also proposes that the Audit Committee and the Risk Management Committee, the two most important committees of a bank, should comprise of at least two-thirds of independent directors. This proposal will certainly reduce the influence of the management over the Board and its important committees. However, the independence of the Board cannot still be ensured as there would still be some scope to influence the independent directors. This is because the director’s duties are often followed only in letter and not in spirit. The Yes Bank episode is a perfect example to show