Wednesday, September 18, 2013

Manufacturing excellence on board agenda - Ranbaxy, a case in hand

As reported in the Business Standard in its September 18, 2013, issue, The US Food and Drug Administration (FDA) has extended the ongoing consent degree with the company for its Paonta Sahib (Himachal) and Dewas (Madhaya Pradesh) units to its third and newly commissioned manufacturing facility at Mohali (close to Chandigarh),which had attracted an import alert from the regulator on Friday. As a result  three major units of Ranbaxy are now barred from supplying drugs to the US. Ranbaxy gets more than 40 per cent sales from that country.The decisions of the FDA will hurt the company hard and shareholders will lose value.

Japan's Daiichi Sankyo owns 63.5 percent shares of Ranbaxy. Daiichi acquired Ranbaxy in June 2008. Thus, Ranbaxy is being controlled by the Japanese company for  five years now. The problem of failure to compply with good manufacturing standards could not be sorted out by the new owner during this period. This shows how deep rooted is the culture of accepting small deviations from the standard operationg procedures (SOP). If that approach is prevalent in an industry which is under the surveillance of a strict regulator, it may not be incorrect to assume that such deviations are not uncommon in other manufacturing companies.

Penalty and loss of contribution from lost sales are not the only costs of  deviating from SOP. Deviations from SOP always increases the cost of operations due to increase in waste in many forms. Companies, often do not calculate the same and allow such deviations to be reported and settled at the lower level of management. This 'chalta hai' ( it is OK) approch costs India dear in terms of low productivity of resources and in many other ways. For example, US ban on the import of drug from three facilities of Ranbaxy is not only a loss to the company but a loss to the country in terms of lost opprtunity to earn foreign exchange, lower utilisation of productive capacity and incresing concerns about quality of India's products.

This 'chalta hai' approach might become a major road block in achieving the mission of achieving manufacturing excellence even when India will create right infrastructure and manufactiring facilities.

Board of directors should own up the responsibility to change the ;chalta hai' culture at the shop floor. Board members should look back to see how many times 'achieving manufacturing excellence' was on the Board agenda and how many hours were spent on this issue in the Board meetings.

Independent Director - Is he/she required to blow whistle before the government?

The Companies Act 2013 has introduced certain provisions to strengthen the vigil mechanism. Section 143 (12) requires the auditor to blow whistle if he/she, during the course of audit, finds that a fraud is being or has been committed against the company by the officers and employees of the company. The auditor is required to report the matter to the Central Government.

Section 177 (9) requires that every listed company and certain other specified companies shall install a vigil mechanism for directors and employees to report genuine concerns. The vigil mechanism should provide adequate safeguard agains the victimisation of the whistle blower and should provide direct access to the chairperson of the Audit Committee in appropriate and exceptional cases.

One of the duties of the independent directors as par the Code For Independent Directors under the Companies Act 2013 [Schedule IV, clause (III)(11)] is to report concerns about unethical behaviour, actual or suspected fraud, or violation of the company's code of conduct or ethics policy. The Code does not mention to whom the independent director shall report.

Reading the Code with section 177 (9) gives the impression that the indpendent director should report the matter to the chairperson of the Audit Committee. As per the Companies Act 2013, the chairperson of the Audit Committee should not necessarily be an independent director. Therefore,  an executive director or the CEO, if he/she is a Board member, can be appointed as the chairperson of the Audit Committee. This mechanism is not effective to correct a situation where a senior executive, in connivance with the CEO or with the consent of the CEO, violates the code of conduct or code of ethics or perpetrates fraud.

Therefore, it should be be clarified that whether an independent director should blow the whistle before the governmnet or a regulator or any other governmnet authority if he/she believes that blowing the whistle before the chairperson of the Audit Committee will not be effective. The second question is whether the governmnet expects independent dorectors to report such matters to the governmnet and/or a regulator. If that is the expectation, what is the penalty if an independent director fails to do so.

The governmnet should clarify the position.

A danger of imposing penalty on indpendent directors if they fail to blow the whistle is that they will adopt policing approach rather than focusing on improving the performance of the company. Perhaps, it was enough to make the auditor accountable for informing the central governmnet of frauds that comes to his/her notice in the course of audit.

Monday, September 16, 2013

Kill the CSR - Chattisgarh Government Policy

The Hindu in its September 16, 2013 edition published a story on the CSR policy of the Chattisgarh government under the title 'Chattisgarh wants all CSR spending to go to CM Development Fund'. According to the report, the Chattisgarh government has advised all the private sector companies that are covered under the CSR provisions in the Companies Act 2013 not to undertake CSR activities on their own. They have been asked to contribute the amount (two-percent of the average net profit of past three years) to the CM's Development Fund. Such a contribution will be considered as CSR spending for the purpose of the Companies Act 2013. But the policy is ridiculous.

A directive to contribute to a fund created by the governmnet tentamounts to imposition of tax. This is not the spirit of CSR.

When a company executes CSR projects, either using its own resources or in partnership with another organisation that has experience in executing social projects, it derives number of benefits. It can use CSR projects to develop skills that are required in its business, which serve the both the community and the business. It can build social and relationship capital and earn the goodwill of the local community through developmental projects. Through engagment with stakeholders it can feel the social undrcurrents and social needs that help in identifying business opportunities and threats. It can involve employees in deciding CSR projects and executing them. This helps to sensitise employees to social issues and to develop leadership qualities in them. There are numerous other benefits that flow from CSR initiatives. The Chattisgarh CSR policy robs companies of those benfits.

Companies also should control the temptation to include purely business expenditure in CSR spending. Companies should also not include in CSR that are simply business initiatives. For example, engaging village women to sell company's products cannot be considered a CSR initiative, although it enhances earnings of women and to an extent, empower them by providing a kind of financial independence. Similarly, activities that benefit employees and their families are not CSR.

There is a great need to develop common understanding of CSR.

Sunday, September 15, 2013

Celebrate the creation of National Financial Reporting Authority

Today I have watched the Bengali movie 'Alik Sukh' based on the novel with the same title authored by Suchitra Bhattacharya.

'Alik Sukh' means 'fleeting happiness'. The protagonist of this film is a well known and very successful gynaecologist. He had failed to reach his patient in time when she was sinking after cesarean delivery causing her death. He was busy in signing an agreement with a real estate developer to buy an apartment to gift  his wife on the occasion of their marriage anniversary. This was the first occasion when his patient died. The protagonist could rationalise the death through intelligent arguments to himself and his wife. His wife was not convinced. She could not make the doctor husband realise that the patient had to die due to his professional negligence in spite of her best efforts. In the climax, the doctor relaised his negligence when his wife needed immediate surgery and the arrival of the anaesthetist was getting delayed exposing his wife to the risk of losing life due to delayed surgery.

Although the story of the movie is about the medical profession, this phenomenon of negation and rationalisation of actions through intelligent arguments is common among professionals of every hue. While this is true, in many occasions, what appears to be a professional negligence to the affected person and non-specialists, is not actually so. Only specialists can rightly evaluate cases which do not involve blatant violation of professional standards. Therefore, most professions are self-regulated. Unfortunately, self-regulation has an important limitation. Professionals are not god. They are human beings. Therefore, they sometime err in judgement in discharging their professional duties.  It is quite possible that those who are assigned the task of deciding a case of professional negligence, at some time or the other, might have rationalised some of their professional negligence. This obscure their objectivity. Moreover, they might be biased in favour of their professional colleague in order to protect the credibility of the profession. Complaints of professional negligence that fall in the grey zone are often decided in favour of the member of the profession. This adversely affects the credibility of the profession. Credibility is also lost as non-specialists perceive bias in almost every judgement which goes in favour of the member because of the real possibility of bias creeping in the decision-making process. The auditing profession is no different.

In recent times, globally, the credibility of the auditing prfoession has taken a beating due to detection of significant number of accounting frauds. India is no different. In USA, the Sarbanes-Oxley Act 2002 created the Public Company Accounting Oversight Board (PCAOB) to restore investors' confidence in the auditing profession. The formation of the National Financial Reporting Authority (NAFRA) under the Companies Act 2013 is also an initiative in the same direction. It should not be viewed as a judgement against the capability of the Institute of Chartered Accountants of India to enforce  professional standards. It is the right initiative by the government to improve the perceived audit quality. Moreover, it addresses the  inherent weakness in the mechanism of self-regulation.  

Saturday, September 14, 2013

CSR: India Moving Away From Philanthropic Approach

The Companies Act 2013 and the Draft Rules on CSR are over emphasizing the nexus between CSR and business. Section 135 of the Companies Act 2013, which requires large and profitable companies to spend two percent of the average profit of previous three financial years in CSR activities, says that a company should carry out CSR activities in the area where it operates and in areas closer to that area.
The Draft Rules explains the nature of CSR. It says: “CSR is not charity or mere donations.” It further explains: “CSR is a way of conducting business, by which corporate entities visibly contribute to the social good. Socially responsible companies do not limit themselves to using resources to engage in activities that increase only their profits. They use CSR to integrate economic, environmental and social objectives with the company’s operations and growth.”
I fail to understand how an organisation that is created to make money by servicing some social needs can have environmental and social objectives. Yes it has responsibilities in ensuring that natural capital will be available and affordable in distant future and that it is not adversely impacting the social fabric in general and the social fabric of the local community by its operation or the product or service. It also has the responsibility to adequately compensate outside stakeholders who bear the cost imposed on them by the company through unavoidable negative externalities. Perhaps, lawmakers in their zeal to establish that CSR is a business case used the term ‘objective’ instead of ‘responsibility’. I believe that CSR makes a business case when it is considered as a risk management tool.
By over emhasising the nexus between CSR and business, we are taking away the touch of philanthropy that was inherent in CSR activities of Indian business houses. If, we look at past records of business houses that are engaged in CSR activities, of course not as a PR initiative, much of those activities were guided by the urge to do some thing voluntarily in our ‘love for humanity’. Now, we are directing companies not to take up activities only for the ‘love of humanity’. The CSR Committee shall be accused of failing in applying due diligence process if it fails to establish the nexus between CSR and the business. 

Friday, September 13, 2013

Death sentence to Delhi gang rape case convicts - a sad day for me

Delhi rape case verdict is out. It is death sentence to all the four rape accused. Considering the brutality of the case, the vardict is not a surprise. Perhaps, we all wanted that the convicts be hanged. We all felt that the punishment should be deterrent against such crimes. Therefore, we all should be happy with the verdict. But, I do not know why a melancoly has gripped me. Any loss of human life pains me, particularly when it is lost through murder by the State or otherwise.

I understand the emotions of the victim's family. It is natural for them to express happiness.  But I get worried when the learned judge says  "This is the time when serious crime agains a woman has come to the fore and now its judiciary's responsibility to instil confidence among the women." (Quoted in Times of India.) Can a murder for a murder stop the crime of murder in the society? Can the judiciary bring social reforms by handing over strictest punishments to criinals? In most rape cases, which are not perpetrated by the a family member or friend of the victim, either the rapists belong to the socially marginalised class or the victim belongs to that class. This raises the question whether, the increase in such crimes has anything to do with the increase in the gap in living standards of the middle class and the marginalised class.

I do not have an answer. I am not cometent to seriously enquire into social and economic issues. However, I strongly feel that deterrent pinshments to perpetrators of such crimes will not stop such crimes. Judiciary might feel happy about its contribution in instilling confidence in women by handing over death penalty. But it should appreciate that its contribution is marginal. There is a need to examine the issues deeply.

Although I desired death penalty to the convicts in this case, evan now I cannot think about a less severe punishment, but it is a sad day for me.

Wednesday, September 11, 2013

Importance of Dissenting Note in Companies Act 2013

The Companies Act 2013 privides immunity to an independent director in respect of the acts of ommission or commission by the company only if he/she had acted diligently, had no knowledge of such acts because there was no possibility of those coming to his/her notice through the board process and had not consented to or connived in such acts. One of the duties of the independent directors as par the Code For Independent Directors (Schedule IV to the Companies Act 2013) is to ensure that unresolved concern is recorded appropriately in the minutes of the meeting. Therefore, if an independent director fails to ensure that his/her dissent is recorded in the minutes, it will be assumed that he/she had consented to such acts.

It is important for independent directors to act diligently and to get dessent, if any, recorded in the minutes. Those who do not go through the minutes diligently and considers approval of the minutes a routine item in board meetings will expose themselves to reputation risks and risks for being penalised for acts of ommission or commission of the company. If, most independent directors are risk-averse, these provisions will go a long way to reduce corporate fraud. However, there might be indpendent directors who are not that risk averse. Unscrupulous companies shall endeavour to identify those individuals for their induction in the Board. They may even informally agree to compensate them if liability arises in future.

Let us hope that most indeependent directors are risk averse.