The initial stimulus for corporate governance reforms came after the South-East and East Asian crisis of 1997-98. Governments, multilateral institutions, banks and companies recalled that the devil lay in the details - the nitty-gritty of transactions among companies, banks, financial institutions and capital markets; corporate laws, bankruptcy procedures and practices; the structure of ownership and crony capitalism; stock market practices; poor boards of directors with scant fiduciary responsibility; poor disclosures and transparency; and inadequate accounting and auditing standards.

India has not been in the middle of this global and Asian reform movement, as a reaction to corporate and financial crises. First, unlike South-East and East Asia, this movement did not start because of a national or region-wide macroeconomic and financial collapse. Indeed, the Asian crisis barely touched India. Secondly, unlike other Asian countries, the initial drive for better corporate governance and disclosure, perhaps as a result of the 1992 stock market "'scam", ', and the onset of international competition consequent on the liberalisation of economy that began in 1990, came from all-India industry and business associations, and in the Department of Company Affairs. Thirdly, from April 2001, listed companies in India need to follow very stringent guidelines on corporate governance, which rank among some of the best in the world. Sadly, there is a wide gap between prescription and practice. Worse, adverse legal consequences, for the defaulters, almost always get caught in the web of inefficiency, corruption and the intricate, dilatory legal system. Thus, while corporate governance reforms in India far outstrips that of many other countries, the performance in either lags very much behind.

After the Enron debacle of 2001, came other scandals involving large US companies such as WorldCom, Qwest, Global Crossing, and the auditing lacunae that eventually led to the collapse of Andersen. These scandals triggered another phase of reforms in corporate governance, accounting practices and disclosures - this time more comprehensive than ever before. In July 2002, less than a year from the date when Enron filed for bankruptcy, the Sarbanes-Oxley Bill (popularly called SOX) was enacted. The Act brought with it fundamental changes in virtually every area of corporate governance - and particularly in auditor independence, conflicts of interest, corporate responsibility, enhanced financial disclosures, and severe penalties, both fines and imprisonment, for wilful default by managers and auditors. It is fair to predict that the SOX Act will do more to change the contours of board structure, auditing, financial reporting and corporate disclosure than any other previous law in US history.

On 21 August 2002, the Department of Company Affairs (DCA) under the Ministry of Finance and Company Affairs appointed this High Level Committee to examine various corporate governance issues. Among others, this Committee has been entrusted to analyse and recommend changes, if necessary, in diverse areas such as:

• the statutory auditor-company relationship, so as to further strengthen the professional nature of this interface;

• the need, if any, for rotation of statutory audit firms or partners;

• the procedure for appointment of auditors and determination of audit fees;

• restrictions, if necessary, on non-audit fees;

• independence of auditing functions;

• measures required to ensure that the management and companies actually present 'true and fair' statement of the financial affairs of companies;· the need to consider measures such as certification of accounts and financial statements by the management and directors;

• the necessity of having a transparent system of random scrutiny of audited accounts;

• adequacy of regulation of chartered accountants, company secretaries and other similar statutory oversight functionaries;

• advantages, if any, of setting up an independent regulator similar to the Public Company Accounting Oversight Board in the SOX Act, and if so, its constitution; and

• the role of independent directors, and how their independence and effectiveness can be ensured.

As is evident, the terms of reference to this Committee (Appendix 1) lie at the heart of corporate governance. Given below are the recommendations of the Committee.

The Committee believes that the propriety of auditors rendering non-audit services is a complex area which needs to be carefully dealt with, keeping in view the twin objectives of maintaining auditor's independence and ensuring that clients get the benefit of efficient, high quality services.

Having said this, the Committee believes that certain types of non-audit services could impair independence of the auditor and possibly affect the quality of audit. It also believes that, given the times and the well-publicised failure of an auditing firm as large as Andersen, some judicious prohibitions are in order.

An auditor who depends upon a single audit client for a sizeable portion of annual revenues, risks compromising his independence. The Committee, therefore, concluded that certain recommendations in this regard were also in order.

In line with international best practices, the Committee recommends an abbreviated list of disqualifications for auditing assignments, which includes:

1. Prohibition of any direct financial interest in the audit client by the audit firm, its partners or members of the engagement team as well as their 'direct relatives'. This prohibition would also apply if any 'relative' of the partners of the audit firm or member of the engagement team has an interest of more than 2 per cent of the share of profit or equity capital of the audit client.· Prohibition of receiving any loans and/or guarantees from or on behalf of the audit client by the audit firm, its partners or any member of the engagement team and their 'direct relatives'.· Prohibition of any business relationship with the audit client by the auditing firm, its partners or any member of the engagement team and their 'direct relatives'.· Prohibition of personal relationships, which would exclude any partner of the audit firm or member of the engagement team being a 'relative' of any of key officers of the client company, i.e. any whole-time director, CEO, CFO, Company Secretary, senior manager belonging to the top two managerial levels of the company, and the officer who is in default (as defined by section 5 of the Companies Act). In case of any doubt, it would be the task of the Audit Committee of the concerned company to determine whether the individual concerned is a key officer.· Prohibition of service or cooling off period, under which any partner or member of the engagement team of an audit firm who wants to join an audit client, or any key officer of the client company wanting to join the audit firm, would only be allowed to do so after two years from the time they were involved in the preparation of accounts and audit of that client.

2. Prohibition of undue dependence on an audit client. So that no audit firm is unduly dependent on an audit client, the fees received from any one client and its subsidiaries and affiliates, all together, should not exceed 25 per cent of the total revenues of the audit firm. However, to help newer and smaller audit firms, this requirement will not be applicable to audit firms for the first five years from the date of commencement of their activities, and for those whose total revenues are less than Rs.15 lakhs per year.

This recommendation has to be read with Recommendation 2.3 below.

Note: A 'direct relative' is defined as the individual concerned, his or her spouse, dependent parents, children or dependent siblings. For the present, the term 'relative' is as defined under Schedule IA of the Companies Act. However, the Committee believes that the Schedule IA definition is too wide, and needs to be rationalised for effective compliance.

Section 201 of the SOX Act has disallowed eight types of non-audit services, with the provision to disallow more as may be determined by the newly legislated Public Company Accounting Oversight Board. Most of these restrictions exist in India. For example, the ICAI prohibits its members as auditing firms from offering services such as bookkeeping, maintaining accounts, internal audit, designing any information system which is a subject of audit or internal audit, brokering, investment advisory and investment banking services. Even so, the Committee believes that it is necessary to provide an explicit list of prohibited non-audit services

The Committee recommends that the following services should not be provided by an audit firm to any audit client:

1. Accounting and bookkeeping services, related to the accounting records or financial statements of the audit client.

2. Internal audit services.

3. Financial information systems design and implementation, including services related to IT systems for preparing financial or management accounts and information flows of a company.

4. Actuarial services.

5. Broker, dealer, investment adviser or investment banking services.

6. Outsourced financial services

7. Management functions, including the provision of temporary staff to audit clients.

8. Any form of staff recruitment, and particularly hiring of senior management staff for the audit client.

9. Valuation services and fairness opinion.

Further in case the firm undertakes any service other than audit, or the prohibited services listed above, it should be done only with the approval of the audit committee.

The Committee has no qualms per se about audit firms having subsidiaries or associate companies engaged in consulting or other specialised business services. It makes a great deal of sense for good auditors to widen their horizons by occasionally engaging in business consulting, just as it does for business consultants to occasionally get involved in the nitty-gritty of auditing. However, it is also a fact that such affiliations could cause potential threats to auditor independence and, therefore, it would be prudent to create realistic safeguards against such contingencies. Hence, the following recommendation.

1. Prohibition of undue dependence. Where an audit firm has subsidiary, associate or affiliated entities, yardstick of no more than 25 per cent of revenues coming from a single audit client stated in Recommendation 2.1 should be widened to accommodate the consolidated entity. Thus, no more than 25 per cent of the revenues of the consolidated entity should come from a single corporate client with whom there is also an audit engagement.

2. The other prohibitions listed in Recommendation 2.1 should also apply in full to all affiliated consulting and specialised service entities of any audit firm that are either subsidiaries of the audit firm, or have common ownership of over 50 per cent with the audit firm. And all the tests of independence outlined in Recommendation 2.1 should be carried over to the consolidated entity.

3. Therefore, this recommendation has to be read with Recommendation 2.1.Consolidation tests should test fully, line-by-line, for all subsidiaries, whether the audit firm, or its partners, own over 50 per cent of equity, or share of profit.

The Committee deliberated, at length, the issue of rotation of auditors. It heard the views of two distinct schools of thought: the minority, which believed in the compulsory rotation of audit firms (a notable proponent being the office of CAG); and the majority, which was against it. Given international practice, and the fact that there is no conclusive proof of the gains while there is sufficient evidence of the risks, the Committee decided does not to recommend any statutory rotation of audit firms. However, in line with the SOX Act, the Committee is in favour of compulsory rotation of audit partners.

1. There is no need to legislate in favour of compulsory rotation of audit firms.

2. However, the partners and at least 50 per cent of the engagement team (excluding article clerks and trainees) responsible for the audit of either a listed company, or companies whose paid paid-up capital and free reserves exceeds Rs.10 crore, or companies whose turnover exceeds Rs.50 crore, should be rotated every five years.

3. Also, in line with the provisions of the European Union and the IFAC, persons who are compulsorily rotated could, if need be, allowed to return after a break of three years.

In ensuring rectitude, nothing works like disclosures. The guidance, "When in doubt, disclose" is probably the simplest and best yardstick for evaluating good corporate governance. The Committee felt that while amendments to the Companies Act, clause 49 of the Listing Agreement, and other regulations laid down by the SEBI and the DCA have significantly enhanced disclosures in recent times, more can be done in the interests of shareholders, other investors, stakeholders and the community at large without diluting the flexibility of needed managerial initiative. Hence the following recommendation.

It is important for investors and shareholders to get a clear idea of a company's contingent liabilities because these may be significant risk factors that could adversely affect the corporation's future health. The Committee recommends that management should provide a clear description in plain English of each material liability and its risks, which should be followed by the auditor's clearly worded comments on the management's view. This section should be highlighted in the significant accounting policies and notes on accounts, as well as, in the auditor's report, where necessary.

A qualification can be a serious indictment of the financial affairs and management of a company. Yet, far too few shareholders really understand what a qualification means, and companies are hardly ever questioned by regulators such as the SEBI and the DCA regarding such qualifications. The Committee believes that this must change - and the only way of doing so is by mandating disclosures to a greater degree.

Qualifications to accounts, if any, must form a distinct, and adequately highlighted, section of the auditor's report to the shareholders.· These must be listed in full in plain English - what they are(including quantification thereof), why these were arrived at, including qualification thereof, etc.· In case of a qualified auditor's report, the audit firm may read out the qualifications, with explanations, to shareholders in the company's annual general meeting.· It should also be mandatory for the audit firm to separately send a copy of the qualified report to the ROC, the SEBI and the principal stock exchange (for listed companies), about the qualifications, with a copy of this letter being sent to the management of the company. This may require suitable amendments to the Companies Act, and corresponding changes in The Chartered Accountants Act.

The Companies Act makes it more difficult to replace an auditor than to reappoint one. While this is as it should be, the Committee felt that corporate governance would benefit from disclosing the reasons for replacement. The Committee felt that if the management were to be more accountable to the shareholders and the audit committee, in the matter of replacing auditors, this is likely to make the auditors more fearless.

Section 225 of the Companies Act needs to be amended to require a special resolution of shareholders, in case an auditor, while being eligible to re-appointment, is sought to be replaced.

The explanatory statement accompanying such a special resolution must disclose the management's reasons for such a replacement, on which the outgoing auditor shall have the right to comment. The Audit Committee will have to verify that this explanatory statement is 'true and fair' 15. The Committee felt that it will be good practice for the audit firm to annually file a certificate of independence to the Audit Committee and/or the board of directors of the client company. This will help in ensuring that the auditors have retained their independence throughout their period of engagement.

Before agreeing to be appointed (along with 224(1)(b)), the audit firm must submit a certificate of independence to the Audit Committee or to the board of directors of the client company certifying that the firm, together with its consulting and specialised services affiliates, subsidiaries and associated companies:

1. are independent and have arm's length relationship with the client company;

2. have not engaged in any non-audit services listed and prohibited in Recommendation 2.2 above; and

3. are not disqualified from audit assignments by virtue of breaching any of the limits, restrictions and prohibitions listed in Recommendations 2.1 and 2.3.

In the event of any inadvertent violations relating to Recommendations 2.1, 2.2 and 2.3, the audit firm will immediately bring these to the notice of the Audit Committee or the board of directors of the client company, which is expected to take prompt action to address the cause so as to restore independence at the earliest, and minimise any potential risk that might have been caused.

The Committee felt that audit committees should be allowed to be true to their name by ensuring that they have a larger role with regard to audit. In fact, this should be the starting point in empowering audit committees.