Wednesday, September 18, 2013

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.

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