The 'three' in second line of corporate hierarchy

12 Feb, 2018

The Companies Act-2017 (Act) is on the statutes book, inter alia, to promote development of corporate sector and to regulate corporate entities for protecting relevant interests, to provide principles of governance and to cater mechanism for expeditious resolution of corporate disputes.
Listed Companies (Code of Corporate Governance) Regulations (code), husbanded by the Act, aims to provide written version of etiquettes for companies. Concept of the code is not articulated by the Act. On the subject of 'Compliance of Corporate Governance' (code), section 156 of the Act reads: "The Commission may provide for framework to ensure good corporate governance practices, compliance and matters incidental and auxiliary for companies or class of companies in a manner as may be specified". Corporate Governance is the principal arm by which companies under the Act are directed and controlled. It is different from day to day functioning of companies' employees.
Corporate governance is the system by which companies are directed and controlled. The purpose of corporate governance is to facilitate effective, entrepreneurial and prudent management that can deliver long-term success to the companies. Many academic studies conclude that well-governed companies perform better in commercial terms.
Shareholders' role in governance is to appoint directors and auditors to satisfy themselves that an appropriate governance structure is in place. Boards of directors are responsible for governance of their companies. Responsibilities of the boards include setting the company's strategic aims and providing leadership to put these into effect, supervising management of the business and reporting to shareholders on the stewardship. Corporate governance is about what the board of a company does and how it sets values of the company. It is to be distinguished from day to day operational management of a company by full-time executives.
The code specifies rights and obligations of different stakeholders in companies eg board of directors, management and equity. It also spells out rules and procedures for decision-making and puts in place an edifice for setting company objectives and monitoring performance. In the process are issues of transparency, accountability, regulatory environment and information flows. Underlying is target that decision makers in a company viz. directors and management set in best interest of the company's stakeholders.
To achieve its vision, the Securities and Exchange Commission of Pakistan (SECP) has presented the code to develop and run a dynamic regulatory system that fosters principles of good governance in corporate sector, ensures risk management procedures in the capital market, protects investors through responsive policy measures and effective enforcement practices.
The Act defines Chief Financial Officer (CFO) and Company Secretary. Internal Auditor does not feature in the main Act, leaving the code to do that. The three are in second line of corporate hierarchy, while first line is adorned by the chief executive. Company Secretary and CFO qualifications, etc., along with the same in respect of Internal Auditor are respectively provided under rules 23, 25 and 24 of the code. On 'qualification of company secretary', rule 25 reads: "No person shall be appointed as the Company Secretary unless he holds the qualification as specified under the relevant Regulations by the Commission."
Rule 28(1) of the code provides a minimum of three directors in an Audit Committee, comprising non-executive directors plus at least one independent director. Directed is that Chairman of the Committee, not being Chairman of the Board, shall be an independent director. Rule 28(1)(c) emphasizes presence of a 'financial literate' amongst members of an audit committee. At least one of its members is required to be 'financial literate', qualified (plausibly) in accordance with parameters given in the code for CFO or Internal Auditor as the code does not have a clue in respect of so stated 'financial literacy'. This takes one to surmise that for due / smooth working of an audit committee, besides (at least) one financial literate member of the committee, another 'financial literate' could be secretary of the audit committee.
Rule 28(1)(c) uses both 'financially literate' and 'financial literate'. Not only this should be removed, SECP should give thought to use a more acceptable phraseology to give its mind.
Under the head: 'Audit Committee', rule 28(1)(d) of the code reads: "The Audit Committee of a company shall appoint a secretary of the committee who shall either be the company secretary or head of internal audit."
Rule 24 aptly takes care of qualification and exposure requirements of 'internal auditor' at the time of his induction as such in a listed company. The law does not touch upon credentials of audit committee secretary. The law and rules do not mandate a company secretary to be financial literate. Also eligible for audit committee secretary position is 'head of internal audit', a person versed in accounting.
Assignments of an audit committee secretary include circulation of the committee's minutes. With the 'circulation', in all likelihood, travels responsibility for clarification, elaboration, interpretation or expounding the minutes containing matters having ado with finance and accounting coached in accounting jargons. At times, the audit committee secretary may be called upon to spontaneously act as such. Accordingly, desirable would be to have a person knowing accounting/finance as secretary of the audit committee. However, as stated hereinabove, under the Act or the rules, knowledge of accounting is not a pre-requisite for the position of a company secretary or secretary of audit committee.
First provision in rule 28(2)(c) of the code directs that the chief executive officer and chief financial officer shall not attend a meeting of the audit committee in their own right. However, they may do so by 'invitation'. To signify law makers' intention and emphasis on this point, the word 'invitation' in the rule is followed by the word "only". Rule-12 makes incumbent chairman of the board responsible that minutes of board of directors meetings shall be kept in keeping with the requirement of the Act. No such requirement or direction the code has in relation with minutes of the audit committee.
Like chief financial officer and company secretary, the head of internal audit can be removed with the approval of the board of directors: ".... head of internal audit may be removed upon recommendation of the audit committee", so spells the code. It means that the board can remove head of internal audit only when so recommended by the audit committee. Explanation provided after rule-22 draws home that the term "removal" includes "non-renewal of contract".
The code provides that a head of internal audit could also be acceptable choice for 'secretary of audit committee' in a listed company.
Coming to FAQ's (Frequently Asked Questions) on SECP website, in realm of the code, at S. No. 13 & 14 one finds:
Question (S. No. 13) "Can the same person be appointed as the CFO and the Company Secretary of a listed company?
Answer
No. The terms of reference of the two positions are distinct. Therefore, separate persons should handle the functions of the CFO and Company Secretary within a listed company."
Question (S. No. 14)
"Can the positions of company secretary and internal auditor be given to one person within a listed company?
Answer
No. The two positions carry minimal synergy and, therefore, should be performed by separate persons."
Not only financial literate, company secretary is a multifaceted executive deeply entrenched in the company's nucleus, more particularly with the board. Most likely he is possessed with strategies of the company as also background of its decisions and paraphernalia of the decision making process. The law does not provide an incumbent company secretary's having knowledge of accounting. This writer considers knowledge as such sine qua non for a person called upon or likely to be called upon to deal with pertinent accounting, audit issues in audit committee meetings.
Functions of a secretary and internal auditor cannot be joined into one person, SECP rules. At the same time, corporate culture pundits may hold that to opt a company secretary, per se, to also function as audit committee secretary may not be advisable. Because secretary of the company and secretary of the audit committee being the same person, is not good omen for a company. In strategic interest of the company, one should not have the dual charge, it is ruled. This takes 'the desirable' for the position of secretary of an audit committee to "head of internal auditor". Code's rule-32 has provisions with reference to direction and functional profile of internal auditor. Part of its sub-rule (1)(a) provides:
"There shall be an internal audit function in every company. The head of internal audit shall functionally report to the audit committee and administratively to the chief executive officer and his performance appraisal shall be done jointly by the Chairman of the audit committee and the chief executive officer."
In view of chief executive, main functionary of the company - being the real doer, in relation to whose functioning evaluation the audit committee is on the basis of internal audit report, the code's words in rule 32(1)(a): "to the", for the second time, after the word "administratively", should be replaced by words: ",routed through". Similarly advisable may be to rephrase the words "jointly by the Chairman of the audit committee and the chief executive officer", appearing at end of the sub-rule under reference, by the words: "Chairman of the audit committee".
Thus, sub-rule (1)(a) of rule-32, may be changed by SECP to read:
"There shall be an internal audit function in every company. The head of internal audit shall functionally report to the audit committee, administratively routing through the chief executive officer. His performance appraisal shall be done by Chairman of the audit committee."
Functional profile of head of internal audit is given in rule 32(2)(a) of the code. The same reads:
"The company shall ensure that head of internal audit is suitably qualified, experienced and conversant with the company's policies and procedures."
The head of internal audit is not an operations person. The doer in a company is chief executive officer and his command which includes company secretary. Enjoining a company secretary and audit committee's secretary amounts to mixing operating organs of the company with the audit committee. This does not serve the cause of accountability which presupposes that operating and quality ensuring functions of the whole mass should be separate. Joining these two - diametrically opposed, would be hamlet with hamlet out.
During portfolios allocation process of functional areas in the second line of a company hierarchy, efforts are made to balance the work load and authority span of company executives to avoid detested repercussions a dis-balance pushes in body politic of the company. Target is a friction avoided environment in which there is free and fair flow functioning. Given thought is to putting in a system which does away possibilities of enticing, luring, seduction or intimidation exercises by groups or individuals inter se acting.
A company secretary is key figure in a company. By virtue of his functional position, he comes to have information from different directions. He is normally the most informed person, at times, able to seek or motivate decisions which, but for the company secretary, their makers would not be making. A company secretary, also charged to act as secretary of the audit committee, may face overtures to disclose information, the committee may not be in the process of opting to disclose as such or the committee may be taking time to tailor presentation of the information to concerned quarters. Recalling in this connection would be that being part of the committee, a secretary to the audit committee would normally be seized with such information as may be disclosed only by or on the authority of the committee.
To guard against possible untimely outflow of classified information from an audit committee's fold and to take care of the possible impending unholy endeavors or hook from the concerned quarters for the company secretary (also acting as secretary, audit committee) is a point desirable to give due thought. A secretary of the audit committee, being also the company secretary may unwittingly tend to prejudice the audit committee on possible prompting from 'out of the committee'. Also to safeguard against such an eventually, it may be advisable to keep a person holding position as a company secretary out of the fold of audit committee would be in the company's interest. For transparent working, it may be advisable not to have the cited dual functioning to the company secretary. A company secretary may no longer be eligible to function as secretary to the audit committee. To this end, the code should better be amended by the SECP.
The company law defines 'chief financial officer' and 'company secretary'. The Act does not say what an 'internal auditor' is. The code describes qualifications of internal auditor and chief financial officer. In relation to company secretary, the company code says: "No person shall be appointed as the Company Secretary unless he holds the qualification as specified under the regulations by the Commission". The specification promised is to be delivered by the SECP.
Imminent appears specifying the qualification of a company secretary eg membership of the Institute of Corporate Secretaries (ICSP) plus, plus. This would be in line with the mode of description of chief financial officer and internal auditor by the law.
The SECP may take specific steps to revamp / strengthen ICSP which may include putting the Commission's nominees on the ICSP Council. In view of position on the ground, such nominees may better be drawn out of the old guards of ICSP, ICAP and ICMAP with loud credentials.
To avoid duplication and confusion, through appropriate SECP doing, sub-sections of the Act describing company secretary and CFO may be turned 'dormant', restricting reference in this behalf to the code to know what would these stand for. Effect of this would also be that SECP would be placed in a position to amend relevant descriptions to live with the time. For a change desired in descriptions of the corporate guards, required would not be reference to the legislature. SECP would be armed to do that. (The writer is Advocate & Corporate Counsel. E-mail: mufti1002001@yahoo.com)

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