Role of various agencies in ensuring ethics in corporations

1. Role of Various Agencies in Ensuring Ethics in
Corporations
by:- Pankaj Singh Chandel

2. Factors that ensure ethical practices in companies
1. Public opinion
2. Role of auditors
3. Role of Board of Directors in Ensuring Ethical Business
4. Media and business ethics
5. Role of Government Agencies in Ensuring Ethical Practices
6. Role of judiciary
7. Role of SEBI
8. Role of whistle-blowing

3. 1. Public Opinion
• Public opinion can initiate new requirements, help
crystallization of policy initiatives and force public
authorities to create an ethically conducive environment.
2. Defining Auditor
• An auditor is defined as a person appointed by a company to
perform an audit. He is required to certify that the accounts
produced by his client companies have been prepared in
accordance with normal accounting standards and represent
a true and fair view of the company. Usually, Chartered
Accountants are appointed as auditors.
• An auditor is a representative of the shareholders, forming a
link between the government agencies, stockholders,
investors and creditors.

4. Defining Audit
• The Institute of Chartered Accountants of India (ICAI) has
defined audit as, "...The independent examination of any
entity, whether profit oriented or not and irrespective of its
size or legal form, when such an examination is conducted
with a view to expressing an opinion thereon”.
• Auditing is the process by which a competent independent
person objectively obtains and evaluates evidence
regarding assertions about an economic activity or event
for the purpose of forming an opinion about and reporting
on the degree to which the assertion conforms to an
identical set of standards.

5. There are three types of auditors:
Internal Auditors
• Internal auditors are employed by the organization for
which they perform audits. Their responsibilities vary and
may include financial statement audits, compliance
audits and operational audits. They may assist the external
auditors in completing the financial statement audit or
perform audits for use by management within the entity.
• An organization may have a small or very large internal
audit staff. They cannot be independent as long as the
employer– employee relationship exists.

6. Independent Auditors
• Independent auditors are usually referred to as CPA
(Certified Public Accountants) firms. The opinion of an
independent auditor about financial statements makes
the statements more credible to such users as
investors, bankers, labour unions, government
agencies and the general public.

7. Government Auditors
• Government auditors work in various local, state and federal
or Central government agencies performing financial,
compliance and operational audits. Local and state
governments, for example, employ auditors to verify that
businesses collect and remit sales taxes and excise duties as
required by law.

8. DUTIES OF AN AUDITOR
The duties of an auditor are defined under section 227 (1A) of
the Companies Act 1956.
It says that an auditor can enquire
1. whether loans and advances made by the company on the
basis of security have been properly secured ;
2. whether transactions of the company which are represented
merely by book entries are not prejudicial to the interests of
the company ;

9. DUTIES OF AN AUDITOR (contd.)
3. where the company is not an investment company within
the meaning of Section 372 or a banking company,
whether so much of the assets of the company as consist of
shares, debentures and other securities have been sold at a
price less than that at which they were purchased by the
company ;
4. whether loans and advances made by the company have
been shown as deposits ; and
5. whether personal expenses have been charged to revenue
account.

10. RESPONSIBILITIES OF AUDITORS
As per the Standard Auditing Practices (2), the auditor
• Is responsible for forming and expressing his opinion on the
financial statements. He assesses the reliability and
sufficiency of the information contained in the underlying
accounting records and other source data by making a
study and evaluation of accounting systems and internal
controls.
• Determines whether the relevant information is properly
disclosed in the financial statements by comparing the
financial statements with the underlying accounting
records and other source data to see whether they
properly summarize the transactions and events recorded.

11. RESPONSIBILITIES OF AUDITORS (contd.)
• Has to ensure that his work involves exercise of judgment,
as for example, in deciding the extent of audit procedures
and in assessing the reasonableness of the judgments and
estimates made by the management in preparing the
financial statements.
• Is not expected to perform duties which fall outside the
scope of his competence. For example, the professional
skill required of an auditor does not include that of a
technical expert for determining physical condition of
certain assets.

12. AUDIT FAILURES LEADING TO CORPORATE SCAMS
The Enron debacle
• In May 2001, Arthur Andersen connived with its client,
Sunbeam Corporation for financial fraud and fudging of
accounts.
• In June 2001, an American Superior Court fined Arthur
Andersen towards damages to shareholders for certifying
false statements of accounts of Waste Management Inc.
Three of Arthur Andersen's partners were fined between $
30,000-50,000 each and banned from auditing work for 3–
5 years.

13. AUDIT FAILURES LEADING TO CORPORATE SCAMS (Contd.)
• Deloitte & Touche also landed in trouble in 2002 for applying a
valuation model for fast-food franchisees, which misled bankers
into extending credit to unworthy clients and incurring a
colossal bad debt of $ 10 billion.
• In 1999, another reputed US based accounting firm, Ernst &
Young paid $ 335 million to a client to settle a lawsuit related
to accounting problems.
• Another American auditing firm, KPMG attracted censure from
SEC for engaging in improper professional practice. While
serving as an audit firm for Short Term Investment Trust, it also
made substantial investments in it. Its money-market account,
opened in May 2000 with an initial deposit of $ 25 million,
constituted 15 of the fund's net assets at one point of time.

14. THE US LAW GOVERNING AUDITORS’ RESPONSIBILITIES
• Sarbanes Oxley Act (SOX) was passed by the US Congress in
2002 with an aim to protecting investors from the fraudulent
accounting practices of corporations.
• Establishment of Public Company Accounting Oversight
Board (PCAOB)

15. INDIAN ATTEMPTS TO PREVENT FRADULUENT AUDITING
PRACTICES
• Till date, four committees played a vital role in framing the
responsibilities of the auditors and the audit committees:
the R.D. Joshi Committee, the Kumar Mangalam Birla
Committee, the Naryana Murthy Committee and the Naresh
Chandra Committee. All these committees'
recommendations focused mainly on the following aspects
of auditing: Formation of the audit committee, their
responsibilities, rotation of auditors, prohibition of non
audit services and the transparency of financial statement.

16. Audit Committee
• An audit committee is a committee made up of
independent directors. It is responsible for the
appointment, fixing of fees and oversight of the work of
independent auditors. The committee is also responsible for
establishing and reviewing the procedures for the receipt,
treatment of accounts, internal control and audit
complaints

17. Audit Committee (contd.)
The audit committee, according to the afore-mentioned four
committees, should review the following information.
• Financial statements and draft audit reports, including
quarterly/half-yearly information;
• Management discussion and analysis of financial conditions
and the results of operations;
• Report relating to compliance with laws and risk
management ;
• Management letters/letters of internal control weakness issued
by statutory and internal auditors; and
• Records of related pay transactions.

18. Audit Partner Rotation
• These committees have also recommended the mandatory
rotation of lead audit partner and partner reviewing audit
every five years.

19. Prohibition of Non-Audit Services
• Auditors are prohibited from providing non-audit services
concurrently with audit review services. Non-audit services
include book-keeping, financial and information system
design, internal audit, HRD services, investment advice,
investment banking services, legal advice, appraisal,
valuation and actuarial services.

20. Disclosures
• Full disclosures of accounts and decisions of management
involving the funds of the company to all its stakeholders is
a desiderata of good corporate culture. The R.D. Joshi
Committee has suggested the imposition of responsibility on
auditors to check and, report diversion, under utilization or
misappropriation of funds by companies. The Naresh
Chandra Committee has recommended that the auditors
should disclose implications of contingent liabilities so that
the investors and shareholders have a clear picture of these
liabilities.

21. Penalties
• Under section 539 of the Companies Act 1956, if an
auditor is found to be involved in unethical practices, he
will be punishable with imprisonment for a term which may
extend to seven years and shall also be liable to a fine.
• Under Section 21 of the Chartered Accountants Act, it is
said that the auditor will be prevented from exercising his
duty and his license will be cancelled by ICAI.

22. 3.Role of Board of Directors in Ensuring
Ethical Business
 The separation of ownership from active direction and
management is an essential feature of the company form of
organization. To manage the affairs of the company,
shareholders elect their representatives called the
“Directors” of the company.
 A number of such directors constitutes the “Board of
Directors”. The board generally has only part-time
directors.

23. Who is a Director?
• Section 2 (13) of the Companies Act defines a director as
follows: “A director includes any person occupying the
position of director by whatever name called. The
important factor to determine whether a person is or is not a
director is to refer to the nature of the office and its duties.
It does not matter by what name he is called, if he performs
the functions of a director.
• Section 2(6) of the Companies Act states that directors are
collectively referred to ‘Board of Directors’ or simply the
‘board’.

24. Legal Position of a Director
• They have been described variously as agents, trustees, or
managing partners of the company.
• The legal position of the directors as agents and trustees
emanate from the fact that a company being an artificial
person cannot act in its own person.
• It has become a well-settled fact now that directors are not
only agents but also act as trustees as a result of several
court decisions in India and England.

25. Duties and Responsibilities of Directors
• The directors have certain duties to discharge. These are:
(i) fiduciary duties (ii) duties of care, skill and diligence;
(iii) duties to attend board meetings; (iv) and duties not to
delegate their functions except to the extent authorized by
the Act or the constitution of the company and to disclose
his interest.

26. Qualifications of Directors
• No body corporate, association or firm can be appointed
directors of a company. A director must: (a) be an
individual; (b) be competent to enter into a contract; and
(c) hold a share qualification if so required by the Articles
of Association.

27. Powers of the Board
The Board of Directors of a company which includes all the
directors elected by shareholders to represent their interests is
vested with the powers of management which are:
(a) make calls on shareholders in respect of money unpaid on
their shares;
(b) issue debentures;
(c) borrow moneys otherwise (for example, through public
deposits);
(d) invest the funds of the company; and
(e) make loans.

28. Liabilities of Directors
Directors of a company may be held liable under the
following situations:
1.Directors of a company may be liable to third parties in
connection with the issue of a prospectus, which does
not contain the particulars required under the
Companies Act or which contains material
misrepresentations;
2.Directors may also incur personal liability under the
Act

29. Liabilities of Directors (contd.)
a. on their failure to repay application money if minimum
subscription has not been subscribed;
b. on an irregular allotment of shares to an allottee (and
likewise to the company) if loss or damage is sustained;
c. on their failure to repay application money if the
application for the securities to be dealt in on a
recognized Stock Exchange is not made or refused ;and
d. on failure by the company to pay a bill of exchange,
hundi, promissory note, cheque or order for money or
goods wherein the name of the company is not
mentioned in legible characters.

30. The Directors’ Liability to the Company
1. Ultra vires Acts: Directors are personally liable to the company in
matters of illegal acts.
2. Negligence: A director may be held liable for negligence in the
exercise of his duties.
3. Breach of Trust: They are liable to the company for any material
loss on account of the breach of trust.
4. Misfeasance: Directors are liable to the company for
misfeasance, i.e, willful misconduct.

31. Liability for Breach of Statutory Duties
The Companies Act imposes penalty upon the directors for not
complying with or contravening the provisions of the Act, which
include sections on criminal liability for misstatements in
prospectus, penalty for fraudulently inducing persons to invest
money, purchase by a company of its own shares, concealment
of names of creditors entitled to object to reduction of capital,
penalty for default in filing with the registrar for registration of
the particulars of any charge created by the company.

32. Disabilities of Directors
In order to protect the interest of a company and its
shareholders, the Companies Act has placed the following
disabilities on the directors:
1. Any provision in the Articles or an agreement which exempts
a director (including any officer of the company or an
auditor) from any liability on account of any negligence,
default, misfeasance, breach of duty or breach of trust by
him shall be wholly void.
2. An undischarged insolvent shall not be appointed to act as
director of any company, or in any way to take part in the
management of any company.

33. Disabilities of Directors (Contd.)
3. No person shall hold office at the same time as director in
more than 15 companies.
4. A company shall not without obtaining the previous approval
of the Central Government in that behalf, directly or
indirectly make any loan to
a. any director of the lending company or of a company
which is its holding company or any partner or relative of
any such director;

34. Disabilities of Directors (Contd.)
a. any firm in which any such director or relative is a
partner;
b. any private company of which any such director is a
director or member;
c. any body corporate at a general meeting of which not
less than 25 per cent of the total voting power may be
exercised or controlled by any such director; or
d. any body corporate, the board of directors, managing
director, or manager whereof is accustomed to act in
accordance with the directions or instructions of the
Board, or of any director or directors of the lending
company.

35. Disabilities of Directors (contd.)
5. Except with the consent of the board of directors of a
company, a director of the company or his relative, a
firm in which such a director or relative is a partner, any
other partner, in such a firm, or a private company of
which the director is a member or director, shall not
enter into any contract with the company.
a. for the sale, purchase or supply of any goods,
materials or services; or
b. for underwriting the subscription of any shares in, or
debentures of, the company.
6. A director shall not assign his office. If he does, the
assignment shall be void.

36. Effectiveness of the Board of Directors
The realistic functions of the board are:
a. Confirming management decisions on company matters;
b. Providing constructive advice to the executives on business
outlook, new governmental legislation, wage policy etc.;
c. Selecting the chief executives and confirming the selection
of the other executives in the company made by chief
executives; and
d. Reviewing the results of current operations.

37. RESPONSIBILITIES OF DIRECTORS
1. An efficient and independent board should be conscious of
protecting the interests of all stakeholders and not be
concerned too much with the current price of the stock.
2. Another important function of the director is to set
priorities and to ensure that these are acted upon.

38. RESPONSIBILITIES OF DIRECTORS (Contd.)
3. A director is also expected to have the courage of
conviction to disagree.
4. Directors have great responsibility in the matter of
employment and dismissal of the CEO.
5. One of the toughest challenges confronted by boards arises
while approving acquisitions.

39. RESPONSIBILITIES OF DIRECTORS (Contd.)
6. An efficient board should be able to anticipate business
events that would spell success or lead to disaster if proper
measures are not adopted in time.
7. The directors have a duty to act bona fide for the benefit of
the company as a whole.
8. In recent times, those who advocate reform of laws
governing corporate practices stress the importance of
reformulation of the concepts behind these laws.

40. FAMILY-OWNED BUSINESSES AND BUSINESS ETHICS
• The board of directors, including chairmen and managing
directors, consisted of family members with a couple of
directors from funding financial institutions and perhaps a
couple of outside passive directors.
• In such cases the Board nods its head for all decisions of
the CEO who may promote his/his family interests and may
not be interested in promoting long-term share-holder value.

41. 4. Media and Business Ethics
The media can play a role in ensuring ethical business by
affecting reputation in at least three ways.
1.It can drive politicians to introduce corporate law reforms
or enforce corporate laws.
2.It could affect reputation through the standard channel
that most economic models emphasize.
3.It affects managers' and board members' reputations in the
eyes of shareholders and future employers, and society at
large.

42. Corporate Ethics and the Press
• Shareholder Activists and the Press
• Institutional Investors
• Private and Government regulators
• The Press vs. Other Mechanisms For Addressing Ethical
Problems

43. ETHICS IN ADVERTISING
• A number of humanities and social science scholars view
advertising as intrusive and environmental and its effects as
inescapable and profound. They see it as reinforcing
materialism, cynicism, irrationality, selfishness, anxiety,
social competitiveness, sexual preoccupation,
powerlessness and loss of self respect. These are strong
indictments which imply that advertising is a powerful
force.

44. Defenders of advertising argue that it has a beneficial effect
on several basic areas :
• Information.
• Values and life-styles.
• Creative experience.

45. Adverse effects of advertising :
• Deception
• Fear factor
• Advertising to children
• Materialism
• Promoting stereotypes
• Advertising alcoholic beverages
• Competitive advertising
• Increasing costs
• Exploiting visual appeals
• I’m the best
• Absence of full disclosure
• Use of celebrities
• Fantasy and reality

46. ADVERTISING STANDARDS
The code of the Advertising Standards Council of India expects,
inter alia, that there will be :
a. No offence to generally accepted norms of public decency
b. Truthfulness and honesty in claims and representations
c. No indiscriminate use of advertising for products which are
hazardous to society or to individuals.
d. References to eminent personalities/political figures and the
use of national emblems are not normally permitted.
e. Comparative advertising should respect the principles of fair
competition generally accepted in business.

47. 5. Role of Government Agencies in Ensuring
Ethical Practices
In India, the Department of Company Affairs (DCA), the
Ministry of Finance, the Commerce and Industry ministries have
powers to oversee corporate activities and take corrective
action against corporate misdemeanors. Additionally, there
are regulators such as SEBI, RBI, TRAI, IRDA, which as public
authorities have the power and responsibility to monitor and
supervise companies.

48. 6. Role of Judiciary
• One of the areas in which the judiciary has been very
active is to find out whether any legislation that is passed or
practised, is in tune with the basic structure of the
Constitution.

49. 7. Role of SEBI in Ensuring Ethical Corporate
Governance
Establishment of SEBI: set up on 12 April 1988 by the
Government of India; given legal status by the Securities and
Exchange Board of India Ordinance 1992.
Basic objectives:
• protection of investors' interests in securities
• promotion of the development of the securities market and
• regulation of the securities market

50. 7. Role of SEBI in Ensuring Ethical corporate
governance (Contd.)
SEBI has been clothed with the following powers:
a. To promote fair dealing by the issuers of securities and
ensure a marketplace where companies can raise funds at
relatively low cost;
b. To provide a degree of protection to investors and safeguard
their rights and interests and
c. To regulate and develop a code of conduct and fair
practices by intermediaries

51. 7. Role of SEBI in Ensuring Ethical corporate
governance (Contd.)
Initiatives of SEBI in the following areas:
• pricing of preferential share allotments
• take-overs
• Insider trading
• Information disclosure
• promoter’s contribution and lock-in
• Need for corporate governance for security markets
• Appointment of committees
• Clause 49

52. 8. Role of whistle-blowing
Grounds for whistle-blowing:
• Internal: to make the product safe or change the process
• Governmental: faulty design, decisions, which will affect the
public
• External: Individual user who runs the risk

53. WHEN IS WHISTLE BLOWING PERMITTED?
1. Motives are moral
2. Exhausted all existing internal procedures and failed to get
the moral error corrected
3. Employee has reached the last and sixth stage of
Kohlbergh’s six stages of evolution – the stage of universal
ethical principles.