Govt gets its act together

New Delhi, Dec. 18: The 56-year-old companies act has been overhauled.

The Lok Sabha today passed the Companies Act 2012 that tightens disclosure norms for companies, makes it mandatory to rotate auditors every five years and seeks to regulate related-party transactions to check corporate frauds.

The new legislation also attempts to provide better protection to minority shareholders and makes it mandatory for companies to spend every year at least 2 per cent of their average net profits made during the three immediately preceding financial years on corporate social responsibility (CSR) projects.

The CSR proviso will apply to companies that have a net worth in excess of Rs 500 crore, or a turnover of Rs 1,000 crore or more, or a net profit of Rs 5 crore or more.

If a company fails to spend the amount, its board of directors will have to spell out why it couldn't do so.

The provision is hugely controversial since it is the first time that any government anywhere in the world has tried to make CSR spending mandatory, sparking a debate over ethics, social obligations and the basic principle of voluntarism in the act of giving. Many governments do, however, insist on mandatory CSR reporting.

The legislation does not precisely define what constitutes CSR though it does give companies the freedom to make the desired spending in the local areas where they operate.

Among other things, the act also proposes to tighten the laws for raising money from the public ' a move that could especially hit chit funds. Only banking companies, NBFCs and other companies allowed by regulators will be permitted to accept deposits from the public.

Deposits may be accepted only after (a) obtaining credit rating; (b) providing deposit insurance; and (c) depositing at least 15 per cent of the amount of deposits maturing during the current and next financial year in a scheduled bank

The legislation also grants statutory powers to the Serious Fraud Investigation Office (SFIO) which will look into acts of malfeasance, big corporate frauds and other corporate shenanigans. The SFIO, which has already started investigations into illegal chit funds operating in Bengal, will get a big fillip once the legislation comes into force.

Replying to the debate on the bill, minister of state for company affairs Sachin Pilot said though "chit funds are regulated by state governments, wherever we find that they have been using fraudulent means, we will take strict action".

Surprisingly, the act was supported by Trinamul Congress's MP Saugata Roy who made a case against chit funds and raised questions about the Sahara group's spending. "I want the bill to be stronger … I support giving the SFIO even more powers," Roy added.

The act also comes several years after the first version was introduced in Parliament. Hectic lobbying by top corporate honchos saw the bill get delayed and watered down over the years. However, with the Rs 7,000-crore Satyam fraud bursting upon the Indian corporate scene, the bill was reworked to build proper defences against large-scale frauds.

The act provides that: "Shareholders associations or group of shareholders are to be enabled to take legal action in case of any fraudulent action on the part of company and to take part in investor protection activities and class action suits."

It also seeks to treat insider trading by company directors as a criminal case. In the Satyam case, it was alleged that the promoters had rigged profits to ramp up share prices and make windfall gains on stock sales.

The new law also aims to strengthen corporate governance in firms and makes it mandatory for independent directors to constitute at least one-third of the board.

In case a company has one or more subsidiaries, it shall in addition to stand-alone financials, prepare a consolidated financial statement of all subsidiaries.

Pilot also made it clear that the new law would mandate that a director's remuneration would be capped at 5 per cent of profits

It also bans buy back of shares within one year of the last buyback of shares.

The number of layers of subsidiaries a firm can have will normally be restricted. Section 186 of the legislation says a company ought not to make investments through more than "two layers of investment companies" but some exceptions have been built in.

It also facilitates joint ventures and relaxes restriction on the number of partners in entities such as partnership firms and banks.

Audit firms cannot take up more than 20 assignments at any time.

Independent directors will no longer be eligible for stock options but will get fees and profit linked commission, subject to rules.

The new Act also provides for a new corporate entity in the form of one-person company (OPC). It also gives powers to the government to bring a simpler compliance regime for small companies.

Officials said the new Act has drafted a single comprehensive legal framework that would govern everything corporate - from incorporation to liquidation and winding up - to be administered by the Centre. The bill also harmonises the company law framework with the imperative of specialised sectoral regulation, an official release said.

The new law has also modified provisions for audit of government companies by Comptroller and Auditor General of India (CandAG). The modification has been made to enable CandAG perform such audits more effectively.