Clause 49 – Background, Provisions and Recent Amendments

• By: Staff Editor
• Date: July 22, 2010

The Securities Exchange Board of India (SEBI) added Clause 49 to the Listing Agreement in 2000. The clause was enacted with the aim of improving corporate governance of all companies listed on the Indian stock exchanges including the NSE and BSE. Clause 49 was revised in 2004 to bring it more in line with the Sarbanes-Oxley Act enacted by the United States government.

Background:

Clause 49 was added to the Listing Agreement on the recommendations of the Kumaramangalam Birla Committee on Corporate Governance instituted by SEBI. The clause initially recommended basic corporate governance practice for Indian companies and made key changes in the areas of governance and disclosures. It made the following requirements mandatory:

• Minimum number of Independent Directors on their boards
• Institution of Audit, Shareholders’ Grievance Committees and so on
• Annual reports to include Management’ Discussion and Analysis (MD&A) section and Corporate Governance report
• Fees paid to non-executive directors to be disclosed
• Limited the number of committees on which a director could serve

2004 Amendments to Clause 49 by the Narayana Murthy Committee

To further strengthen the clause and make it more in line with the Sarbanes Oxley Act implemented in the United States following a series of corporate governance failures, SEBI constituted the Narayana Murthy Committee to review the clause and its effectiveness. The committee was also tasked with formulating improvements to the clause.  Clause 49 was amended by SEBI to include the following changes as suggested by the committee on October 29, 2004 and came into effect in January 2006:

• Major changes and clarifications in the definition of Independent Directors
• Responsibilities of audit committees strengthened
• Financial disclosures to be more comprehensive and include those relating to party transactions and proceeds from public/rights/preferential issues
• Boards to adopt formal codes of conduct
• CEO/CFO to certify financial statements
• Disclosures to shareholders to include more comprehensive information

Among the non-mandatory clauses are a whistleblower policy and restriction of terms of independent directors.
 

Further amendments

SEBI further amended Clause 49 in 2008 to extend the requirement for at least 50% of boards to include independent directors to all boards where the non-executive chairman is a promoter of the company or related to the promoters of the company.
 

Highlights of Clause 49 and its sections:
 

Provisions

Following are the highlights of Clause 49’s provisions:

Company Board of Directors
The clause defines an Independent Directors as a non-executive director of the company who:

• Receives only director’s remuneration and should have no other pecuniary relationships or transactions with the company or its promoters
• Is not related to promoters or management at the board level
• Has not been an executive of the company in the immediately preceding three financial years
• Has had no associations in three preceding years with audit firms, legal or consulting firms associated with the company
• Does not hold substantial shares in the company

The compensation paid to non-executive directors including independent directors will be fixed by the board and should have prior approval of shareholders.

The Board should meet at least four times a year, with a maximum time gap of three months between any two meetings.

A Board director should not be a member of more than 10 committees or act as Chairman of more than five committees across all companies of which he is a director.

Code of Conduct:
The board should lay down a code of conduct for all its members and senior management of the company. All the members and senior management personnel have to affirm compliance with the code every year. The annual report of the company should contain a declaration stating this signed by the CEO.

Audit Committees
The audit committee should comprise:

• A minimum of three directors as members
• Two thirds of the members should be independent directors
• All members have to be financially literate
• At least one member should have accounting or related financial management expertise

The committee should meet at least four times in a year. The gap between each meeting should not exceed four months.

CEO/CFO Certification
The CEO/CFO should certify to the board that:

• They have reviewed financial statements and cash flow statements for the year
• The company has not entered into fraudulent or illegal transactions to the best of their knowledge and belief
• They accept responsibility for establishing, maintaining and evaluating internal controls
• They have informed the auditors and the audit committee about the significant changes to internal control and accounting policies as well as instances of fraud.

Subsidiary Companies
Regarding subsidiary companies, Clause 49 stipulates that:

• At least one independent director on the board of the holding company should be a director on the board of a material non listed Indian subsidiary company.
• The audit committee of the listed holding company should review the financial statements, in particular, the investments made by the unlisted subsidiary company.
• The management should present the board of the listed holding company a statement of all significant transactions and arrangements entered into by the unlisted subsidiary company.

Corporate Governance Report
According to Clause 49, annual reports of listed companies should contain a separate section on corporate governance. This section should contain:

• A detailed compliance report. Non-compliance of mandatory requirements of Clause 49 should be explained with reasons.
• The extent to which non-mandatory requirements have been adopted and implemented should be highlighted

Companies should submit quarterly compliance report to stock exchanges. These reports should be signed either by the compliance officer or CEO of the company.

Additional Resources:

To read the full text of the revised Clause 49, click here
To know more of SEBI regulations, please visit: http://www.sebi.gov.in/sebiweb/home/list/1/3/0/0/Regulations