Directors' duties and responsibility: The duties and responsibilities of directors are presently based on a series of court judgements. The Task Force set up in the UK to modernise its company law has noted the pressing need to rearticulate certain laws in order to redirect law from case law precedents to the desired direction.
Most of other jurisdictions, eg, Canada, New Zealand, Australia and South Africa have now articulated directors' duties and responsibilities in the act.
UK'S COMPANIES ACT IS ALSO BEING AMENDED TO INCLUDE DIRECTORS' DUTIES AND RESPONSIBILITIES. DIRECTORS SHOULD BE MADE DIRECTLY RESPONSIBLE FOR CERTAIN OFFENCES: The Ordinance does not hold directors directly responsible for any action as is evident from the fact that it imposes no fine on directors for any offence. The company is a legal fiction. It does what the directors do or bid it do. Not holding them responsible for any lapse is per se a great legal anomaly. The Ordinance needs to be upgraded like other jurisdictions have. E.g., the New Zealand Companies Act provides penalties for 46 offences in cases of failure by board or company to comply with certain provisions of the Act and provide penalties on directors for such acts of over Rs 250,000 ($5,000 at the exchange rate of NZ$= Rs 50) and Rs 500,000 ($10,000).
It is interesting in this context to note, the Swedish law states that there is no collective liability for the board of directors as such. An individual assessment must be made regarding each member of the board. However, when the board as such is under a duty to act in some way, and fails to do so, all the directors may be (but not necessarily) liable.
DIRECTORS' SPENDING: Despite abundance of information to the contrary the Ordinance yet continues to be based on the 19th century assumption that the directors would be as watchful for shareholders' money as they would with their own money. It therefore, imposes no regulation to evaluate the financial propriety of expenditure incurred by them other than that it was spent for the purpose of the company.
The courts also following the settled case, law shows a proper reluctance to enter into the merits of commercial decisions. Per se the directors thus, have all the opportunities to use company money as 'casino money' as the corporate scandals, recent and past testify. A comparison of the expenditure on perks and bonuses of directors gifts and gives away etc by listed companies and the wealthiest of ownership companies should highlight it.
The poignant irony is that we all know that "being the managers of other people's money than of their own", as pointed out by Adam Smith, "it cannot be expected that the directors should watch over it with the same vigilance as their own money and negligence and profusion therefore should always prevail, more or less, in the management of the affairs of a company."
It is interesting to note that the governments have been fully cognisant since ages both of the human dispositions and Adam Smith's truism. Rule 10 of the General Financial Rules that the Government of Pakistan inherited from the colonial days requires its functionaries to exercise the same vigilance as a person of ordinary prudence would in respect of expenditure of his own money and mandates the expenditure should not be more than the occasion demands (emphasis added).
True, unlike government, business involves taking of risks. But great deal of expenditure is of routine nature and not risk-related. Moreover, the element of risk only adds a dimension to the 'occasion.'
It should be pointed out that Enron, Ahold or Parmalat etc were not the end. Scandals are taking place under our nose and before our eyes even today. Restatement of earlier disclosed income is one such event. It reflects poor documentation of transactions, the wrong choice of accounting treatment, lack of transparency, recognising revenue when it was in fact not earned or camouflaging expenditure in order to conceal the true state of the company so as to deliberately misrepresent to the capital market, cheat the investors and shareholders, both present and prospective, and to pocket fabulous bonuses and perks.
The statutory auditors' scope of audit should be enhanced to review, whether the expenditure,' given the added dimension, was or was not more than the occasion. The logic demands that the government should be as anxious of citizen's as it is with its own - what is sauce for the goose should be the sauce for the gander too!
CORPORATE OFFENCES: The Ordinance considers very few corporate lapses as offence. The acts that the Ordinance considers offences are in single digit, which is woeful as compared to other jurisdictions: eg, Australia, New Zealand and South Africa regulations/acts declare 346, 170 and 119 actions respectively as offences. The Ordinance needs to be upgraded on priority basis.
CORPORATE PENALTIES: The object of penalties is to encourage compliance and to deter non-compliance. The penalties provided by the Ordinance, however, are palpably inadequate and peanuts vis-à-vis the seriousness of the lapse, for instance, the penalty for wilful making of false statement ranges from Rs 2,000 to Rs 100,000. For obvious reasons, it provides no deterrence, rather it encourage doing as they may want.
Comparison with other jurisdictions highlights the enormity of inadequacy. For instance, as compared with Ordinance's range of penalties from Rs 2000 to Rs 100,000, the New Zealand companies act provides penalty of Rs 10 million (NZ$200,000 at 1NZ$= Pak. Rs 50) plus imprisonment up to 5 years for false statement.
The UK also is in the process of amending section 233 (5) of its Companies Act to provide 7 years imprisonment or a fine or both on indictment and 12 months imprisonment and maximum of the statutory fine or both on summary trial for every director if the accounts are approved that do not comply with the requirements of the Act and who knew that the accounts did not comply or was reckless as to whether they complied or failed to take reasonable steps to prevent them from being approved.
As for penalties other than false, reckless statements, against the flat range of Rs 2,000-Rs 100,000, the penalties provided by New Zealand Companies Act range from over Rs 250,000 to Rs 2.50.million (NZ$5,000 to NZ$50,000 depending upon the nature of the offence (at purchasing power basis 1NZ$= Rs 50). There is a pressing urgency to make the penalties biting.
CATEGORISATION OF COMPANIES: The Ordinance prescribes regulations according to the legal category of a company, which, presently, are listed, non-listed-public and private companies. It extends many concessions and exemptions to non-listed public companies and still more to private companies; eg, corporate governance regulations do not apply to them and private companies are not bound to follow International Accounting Standards. It has serious economic consequences; it has reduced the size of the market from its potential peak.
Whether, and what exemptions or concessions from regulations should be extended to a company should depend on factors other than what its sponsors may have opted, namely, the size of its assets, number of its employees, and turn-over.
Other jurisdictions, eg, the UK, Australia, New Zealand and Canada etc, have already moved away from this unrealistic approach and extend exemptions and concessions on the basis of balance sheet, size, turnover and number of employees.
Section 77 of the UK's act before the select committee of the parliament mandates all companies beyond the criteria of SMEs to be treated as big companies and require them to fully comply with the accounting standards, companies' act and its schedules. So does the New Zealand act: Paragraph 3.9, ED 98, cited above states: Size- 3.9-An entity is large, if it exceeds any two of the defined criteria relating to total income, total assets and the number of employees.
The Companies Ordinance needs to redefine companies accordingly in the context of the local conditions and the non-listed companies whose balance sheet total etc, exceed the prescribed limit should be treated as big companies and required to follow accounting standards and other regulations for listed companies.
FINE - TUNING PROVISIONS REGARDING FINANCIAL STATEMENTS: "Many people think", Joseph Berardino, Arthur Andersen's former chief executive, said in his congressional testimony on the Enron collapse, "accounting is a science, where one number, namely earnings per share, is the number, and it's such a precise number that it couldn't be two pennies higher or two pennies lower. I come from a school that says it really is much more of an art." "There is no true number in accounting," observed Harvey Pitt, former Chairman, the US's Securities Exchange Commission. Change the assumption and the numbers shown would be different.
Presently, it is possible to interpret information in different ways, eg, what's an investment; what's an expense; and when should revenue be recognised, are all open to different interpretations' and as we know, unfairness could prosper wherever there is the possibility of interpreting information in different ways.
The financial standards also presently allow more than one treatment of an event each option entails differing bottom line. It looks imperative therefore, to put some control on it. One way could be to require directors to quantify and disclose and the statutory auditors to verify the results were different assumptions or interpretations were made.
THE AUDITORS' REPORT: It may in passing be mentioned that the Swedish Company Law requires the auditors to state (in addition to IFAC's prescribed report) that "I (we) have examined significant decisions, actions taken and circumstances of the company in order to be able to determine the liability, if any, to the company of any board member or the managing director. I (We) also examined whether any board member or the managing director has, in any other way, acted in contravention of the Companies Act, ... or the Articles of Association."
Moreover, the Swedish law requires the statutory auditors to "recommend to the general meeting of shareholders" that the financial statements "be dealt with in accordance with the proposal in the administration report and that the members of the board of directors and the managing director be discharged from liability for the financial year" and "the financial statements be adopted." So doing should greatly improve matters.
NOTE
NEW YORK STATE - SECTION 706. REMOVAL OF DIRECTORS
a) Any or all of the directors may be removed for cause by vote of the shareholders. The certificate of incorporation or the specific provisions of a by-law adopted by the shareholders may provide for such removal by action of the board, except in the case of any director elected by cumulative voting,...
(b) If the certificate of incorporation or the by-laws so provide, any or all of the directors may be removed without cause by vote of the shareholders.
(c) The removal of directors, with or without cause, as provided in paragraphs (a) and (b) is subject to the following:
(1) In the case of a corporation having cumulative voting, no director may be removed when the votes cast against his removal would be sufficient to elect him if voted cumulatively at an election at which the same total number of votes were cast and the entire board, or the entire class of directors of which he is a member, were then being elected;
CALIFORNIA STATE - SECTION 303
(a) Any or all of the directors may be removed without cause if the removal is approved by the outstanding shares (Section 152), subject to the following:
(1)Except for a corporation to which paragraph (3) is applicable, no director may be removed (unless the entire board is removed) when the votes cast against removal, or not consenting in writing to the removal, would be sufficient to elect the director if voted cumulatively at an election at which the same total number of votes were cast (or, if the action is taken by written consent, all shares entitled to vote were voted) and the entire number of directors authorised at the time of the director's most recent election were then being elected
CANADA - SECTION 107. WHERE THE ARTICLES PROVIDE FOR CUMULATIVE VOTING, (A) TO (F)...
(g) a director may not be removed from office if the votes cast against his removal would be sufficient to elect him and such votes could be voted cumulatively at an election at which the same total number of votes were cast and the number of directors required by the articles were then being elected.
Concluded
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