Introduction to Corporate Governance

Corporate Governance refers to the system, process, and set of rules through which a company
is directed, controlled, and managed so that it functions in a fair, transparent, and responsible
manner. In simple words, corporate governance explains how decisions are taken in a company,
who takes those decisions, and how the interests of everyone connected with the company are
protected. The main purpose of corporate governance is to ensure that a company performs
well in the long run while also protecting the interests of all those who are affected by its
activities, such as shareholders, employees, customers, creditors, the government, and society
at large.
MUST WRITE IN EXAM: Corporate governance ensures sustainable corporate performance
while protecting stakeholder interests through fairness, transparency, accountability, and
responsibility.

Why Do We Need Rules of Corporate Governance

Rules of corporate governance are necessary because companies do not exist only to make
profit for shareholders but also to serve the interests of various stakeholders who depend on
the company for employment, services, financial returns, and social development. Without
proper rules, companies may be mismanaged, leading to fraud, misuse of power, and loss of
trust among stakeholders. Corporate governance rules ensure fairness by treating all
stakeholders equally, accountability by making decision-makers answerable for their actions,
transparency by ensuring open and honest disclosure of information, and responsibility by
promoting ethical management practices. These rules help in building trust, improving
company reputation, and ensuring long-term growth and stability.
MUST WRITE IN EXAM: Corporate governance is based on fairness, accountability,
transparency, and ethical responsibility.

Meaning and Concept of Corporate Governance

Corporate governance refers to the actions taken by organisations to improve relationships and
interactions with various stakeholders of the corporation. It includes a set of rules, procedures,
and an operational structure that guides both the short-term and long-term actions of
companies. These actions include establishing codes of conduct for employees, balancing the
interests of shareholders and other stakeholders, and ensuring ethical decision-making.
Corporate governance also functions as a system through which the organs of a company, such
as the board of directors, managers, shareholders, and other stakeholders, define the rules and
procedures for making decisions on corporate matters. Thus, corporate governance provides a
structured framework that ensures companies are managed in a disciplined, transparent, and
accountable manner.
MUST WRITE IN EXAM: Corporate governance is a system by which companies are
directed and controlled through defined rules, procedures, and institutional structures.

Definitions of Corporate Governance

The Committee on the Financial Aspects of Corporate Governance, 1992, also known as the
Cadbury Committee headed by Sir Adrian Cadbury, defined corporate governance as the
system by which companies are directed and controlled. This definition highlights the role of
management and the board of directors in ensuring effective control over corporate affairs.
The OECD Principles of Corporate Governance define corporate governance as a set of
relationships between a company’s management, its board, its shareholders, and other
stakeholders. It also provides the structure through which company objectives are set, the
means of achieving those objectives are determined, and performance is monitored. This
definition emphasises the relationship-based nature of corporate governance.
James D. Wolfensohn of the World Bank, in 1999, described corporate governance as
promoting corporate fairness, transparency, and accountability, thereby highlighting its ethical
and moral foundations.
The SEBI Committee on Corporate Governance, chaired by Kumar Mangalam Birla in 2000,
defined corporate governance as the acceptance by management of the inalienable rights (rights
that cannot be taken away) of shareholders as the true owners of the corporation and the
recognition of management’s role as trustees (persons who manage property on behalf of
others) for shareholders.
MUST WRITE IN EXAM: Any one authoritative definition such as Cadbury Committee or
OECD definition.

Corporate Stakeholders
Corporate stakeholders are those groups without whose support the corporate organisation
would not be able to survive. Stakeholders are broadly classified into internal and external
stakeholders. Internal stakeholders are those who engage in direct economic transactions with
the company, such as shareholders, employees, and managers. External stakeholders are those
who do not engage in direct economic transactions but whose actions can significantly affect
the company, such as the government, suppliers, creditors, customers, and the community. Each
stakeholder group has different expectations and concerns, and corporate governance seeks to
balance these competing interests.
MUST WRITE IN EXAM: Stakeholders are persons or groups whose interests are affected
by corporate actions.

Main Stakeholders and Their Concerns

Shareholders are concerned with value maximisation, profitability, liquidity, growth, and
market price of shares. Employees focus on benefit maximisation, job security, and quality of
work life. The government expects tax compliance, employment generation, true reporting, and
diversity. Creditors are concerned with liquidity and timely servicing of debt. Customers expect
quality products, reasonable prices, and proper care. The community looks for employment
opportunities, environmental protection, and social equity. Trade unions focus on improving
the quality of workers’ lives, while competitors expect fair play and ethical business practices.

Problem of Corporate Governance

The core problem of corporate governance arises due to the separation of ownership and
control. Shareholders, who are the owners of the company, delegate the management of the
company to managers, who control daily operations. This separation creates the risk that
managers may act in their own self-interest rather than in the interest of shareholders. Corporate
governance seeks to address this problem by creating effective internal structures such as
independent boards, disclosure requirements, transparent decision-making processes, and
strong control mechanisms to ensure that management acts responsibly and in the best interests
of the company.
MUST WRITE IN EXAM: Corporate governance addresses problems arising from
separation of ownership and control.

Principles of Corporate Governance

Principle of Fairness
The principle of fairness requires that the corporate governance framework ensures equitable
treatment of all shareholders, including minority and foreign shareholders, as well as other
stakeholders such as employees, customers, and the community. Minority shareholders must
have effective remedies in case their rights are violated. All shareholders belonging to the same
class should be treated equally. Practices such as insider trading and abusive self-dealing must
be strictly prohibited. Directors and key managerial personnel must disclose any transaction or
matter that directly or indirectly affects the corporation.
MUST WRITE IN EXAM: Equal treatment of shareholders and protection of minority
interests.

Principle of Transparency
Transparency means openness and the willingness of a company to provide clear, accurate, and
timely information to shareholders and other stakeholders regarding its business activities. It
includes proper and effective financial reporting and disclosure of risks involved in business
operations. The board of directors must disclose the assumptions and estimates used in
preparing financial results so that investors can understand management decisions.
Transparency also requires clear disclosure of roles and responsibilities of the board and
management, thereby ensuring accountability and trust in corporate decision-making.
MUST WRITE IN EXAM: Transparency builds trust through disclosure and openness.

Principle of Accountability
Corporate accountability refers to the obligation of the board and management to explain and
justify their decisions and actions. The board is responsible for determining the level of risk
the company is willing to undertake and must maintain sound risk management and internal
control systems. The board should establish transparent arrangements for corporate reporting
and maintain appropriate relationships with auditors. It must regularly communicate to
stakeholders a fair and understandable assessment of the company’s performance and
achievements.
MUST WRITE IN EXAM: Board accountability to stakeholders.

Fiduciary Principle
The fiduciary principle requires directors, who act as agents of shareholders, to perform their
duties with trust, loyalty, diligence, and honesty. Directors must not misuse their position for
personal gain at the expense of shareholders. Law imposes a duty on fiduciaries to exercise the
highest degree of care and good faith in protecting the assets and rights of shareholders, and
failure to do so can result in compensatory and punitive damages.
MUST WRITE IN EXAM: Directors owe fiduciary duties to shareholders.
Principles of Reliability, Dignity, and Propriety
The reliability principle emphasises that directors must honour their commitments and
promises made to stakeholders. The principle of dignity requires respect for the rights and
privileges of all stakeholders, particularly minority shareholders who are often vulnerable. The
propriety principle focuses on protecting property rights, especially those of shareholders, who
are the ultimate owners of corporate property.

Principle of Responsiveness
The principle of responsiveness requires corporate governance systems to respond effectively
and efficiently to societal needs. Decision-making should be timely, well-considered, and based
on careful evaluation of all possible alternatives. While speed is important, decisions should
not be taken hastily, as delay or inaction in critical situations can have serious consequences
for the company.
MUST WRITE IN EXAM: Responsive governance balances speed with careful decision-
making.

Theories of Corporate Governance

Agency Theory
Agency theory examines the relationship between principals, who are shareholders, and agents,
who are managers. Shareholders delegate the responsibility of managing the company to
managers with the expectation that managers will act in the best interests of shareholders.
However, when managers act out of self-interest, corporate governance failure occurs. The key
feature of agency theory is the separation of ownership and control. The theory suggests using
monitoring mechanisms, incentives, rewards, and punishments to align managerial behaviour
with shareholder interests.
MUST WRITE IN EXAM: Agency theory is based on separation of ownership and control.

Stewardship Theory
Stewardship theory presents an alternative view to agency theory by assuming that managers
are trustworthy and motivated to act in the best interests of shareholders. Managers, referred to
as stewards, derive satisfaction from organisational success and therefore work diligently to
maximise shareholder wealth. This theory supports greater autonomy for managers and
believes that empowering executives leads to improved firm performance.
MUST WRITE IN EXAM: Managers act as stewards, not self-interested agents.
Stakeholder Theory
Stakeholder theory expands the accountability of management beyond shareholders to include
all stakeholders such as employees, suppliers, customers, and communities. It recognises that
all stakeholders have intrinsic value and that no single group’s interest should dominate. Unlike
agency theory, which prioritises shareholder wealth, stakeholder theory promotes balanced
decision-making that considers the welfare of all stakeholders.
MUST WRITE IN EXAM: Management owes duties to all stakeholders, not only
shareholders.

Resource Dependency Theory

Resource dependency theory focuses on the role of the board of directors in securing essential
resources required for organisational survival and performance. Directors provide access to
information, skills, external networks, legitimacy, and key stakeholders such as suppliers,
buyers, and policymakers. By linking the company to its external environment, directors
enhance organisational effectiveness. Directors may include insiders, business experts, support
specialists, and community influencers.
MUST WRITE IN EXAM: Board provides critical resources and external linkages.

Corporate Governance Code and Standards

Corporate Governance Codes and Standards are formal frameworks that lay down rules,
principles, and best practices to ensure that companies are managed in a fair, transparent,
accountable, and responsible manner. These codes developed gradually over time in response
to the growing size of corporations, separation of ownership and control, financial scandals,
and the need to protect investors and other stakeholders. Corporate governance codes aim to
guide boards of directors, management, and shareholders in maintaining ethical conduct,
proper disclosure, effective control, and long-term sustainability of companies.
MUST WRITE IN EXAM: Corporate governance codes evolved to ensure transparency,
accountability, and protection of shareholder and stakeholder interests.
History of Corporate Governance Code
The history of corporate governance can be traced back to the early seventeenth century with
the establishment of the Dutch East India Company in 1609. This company is considered the
first publicly traded company where ownership was separated from management. Since
investors were not involved in day-to-day operations, they needed assurances from the board
of directors that their interests would be protected. The company’s charter contained provisions
to safeguard shareholder interests, which laid the foundation for future corporate governance
structures.
During the nineteenth century, the Industrial Revolution led to the formation of large
corporations that required huge capital investments. As a result, corporate governance started
taking a more structured form, and laws were introduced to protect shareholders. In the United
Kingdom, the Joint Stock Companies Act of 1844 made it mandatory for companies to disclose
financial information, thereby laying the groundwork for transparency and accountability.
In the twentieth century, corporate governance principles expanded significantly, particularly
in the United States. After the 1929 stock market crash, the Securities and Exchange
Commission was established in 1934 to regulate the securities market and protect investors.
This period highlighted the importance of disclosure and regulatory oversight in corporate
governance.
The late twentieth and early twenty-first centuries witnessed major corporate scandals such as
Enron and WorldCom, which exposed serious governance failures like fraud, weak board
oversight, and misleading disclosures. These events led to stricter regulations, most notably the
Sarbanes-Oxley Act, aimed at improving corporate accountability and preventing fraud. At
the global level, the Organisation for Economic Co-operation and Development developed
its Principles of Corporate Governance to promote uniform governance standards worldwide.
MUST WRITE IN EXAM: Corporate governance evolved due to investor protection needs,
corporate scandals, and separation of ownership and control.

USA Model of Corporate Governance

The United States follows a disclosure-based and shareholder-centric model of corporate
governance. This model is primarily governed by the Securities and Exchange Commission
Act, 1934, the Sarbanes-Oxley Act, 2002, and various state laws, especially those of Delaware.
Under this system, managers are required to prepare accurate disclosures, which are
authenticated by the board of directors, and severe penalties are imposed for misrepresentation.
The model ensures shareholder participation through voting rights and allows the appointment
of proxies, often skilled institutional investors, to safeguard shareholder interests. It also
provides strong state protection against market manipulation, fraud, misrepresentation, and
insider trading.
MUST WRITE IN EXAM: US model is disclosure-based and shareholder-centric.

The Sarbanes–Oxley Act, 2002 (SOX)

The Sarbanes–Oxley Act, 2002 significantly strengthened corporate governance in the United
States by enhancing the oversight role of the board of directors. It emphasised independent
directors, active monitoring of financial reporting, independence from management, and
responsibility for ethical conduct and legal compliance.
A key feature of SOX is the central role assigned to the Audit Committee, which must consist
entirely of independent directors and include at least one financial expert as required under
Section 407. The Audit Committee has direct authority to appoint, compensate, and oversee
external auditors, resolve disputes between management and auditors, and establish
whistleblower mechanisms under Section 301.
Section 302 of the Act mandates that senior corporate officers personally certify that financial
statements comply with disclosure requirements and fairly present the company’s financial
condition. Any false certification attracts criminal liability, including imprisonment. Section
404 requires management and auditors to establish effective internal control systems. Section
802 deals with recordkeeping, including prohibition of destruction or falsification of records,
mandatory retention periods, and maintenance of electronic communications. The Act also
places obligations on IT departments regarding electronic record management.
MUST WRITE IN EXAM: SOX strengthened board oversight, audit committee
independence, and financial accountability.

COSO Model of Corporate Governance

The COSO Model, developed by the Committee of Sponsoring Organizations of the
Treadway Commission, provides a comprehensive framework for internal control and risk
management within organizations. It consists of five interrelated components: the control
environment, control activities, risk assessment, information and communication, and
monitoring activities.
The control environment focuses on ethics, integrity, organizational structure, board
independence, and leadership tone at the top. Control activities include policies, approvals,
reconciliations, and segregation of duties to prevent misuse of power. Risk assessment involves
identifying and analysing risks, including fraud risks. Information and communication ensure
timely and relevant internal and external information flow. Monitoring activities include
internal audits, ongoing evaluations, and corrective actions to ensure system effectiveness.
MUST WRITE IN EXAM: COSO provides an internal control and risk management
framework.

Dodd–Frank Wall Street Reform and Consumer Protection Act, 2010

The Dodd–Frank Wall Street Reform and Consumer Protection Act was enacted to prevent
another financial crisis and reduce excessive risk-taking by corporations, particularly financial
institutions. The Act aims to strengthen transparency, accountability, shareholder protection,
and consumer protection.
It introduced shareholder empowerment mechanisms such as “say-on-pay,” mandated
clawback policies to recover executive compensation in cases of misconduct, required the
formation of board-level risk committees for large companies, introduced stress testing, and
strengthened whistleblower protection.
MUST WRITE IN EXAM: Dodd-Frank focuses on risk control, accountability, and
shareholder empowerment.

OECD Principles of Corporate Governance

Post-1990s globalization led to interconnected capital markets, with investors investing across
borders. Differences in governance systems, weak shareholder protection, poor disclosure, and
insider dominance resulted in major corporate crises such as the Asian Financial Crisis and the
BCCI scandal. To address these issues, the OECD Principles of Corporate Governance were
developed as internationally accepted guidelines.
These principles promote transparency, accountability, fairness, and responsible board
oversight, thereby enhancing investor confidence and ensuring sustainable corporate
performance across jurisdictions.
MUST WRITE IN EXAM: OECD principles provide global governance standards.

United Kingdom and Corporate Governance

Before the Cadbury Report of 1992, corporate governance in the UK relied mainly on the
Companies Act and market-based practices. Corporate failures such as the collapse of the Bank
of Credit and Commerce International and Maxwell Communications exposed weak board
oversight, dominant CEOs, poor financial reporting, and ineffective auditors.
The Cadbury Report, 1992 recommended separation of the roles of Chairman and CEO, a
strong role for non-executive directors, creation of audit committees, and emphasis on board
accountability and transparency. Following Cadbury, several reports such as the Greenbury
Report, Hampel Report, Turnbull Guidance, and Combined Code collectively shaped the UK
Corporate Governance Code, 2010.
MUST WRITE IN EXAM: Cadbury Report laid the foundation of UK corporate governance.

Greenbury Committee Report, 1995

After improvements in financial governance, concerns arose regarding excessive executive
remuneration. The Greenbury Committee observed that director pay was rising rapidly, lacked
performance linkage, and was influenced by CEOs themselves. It recommended the
establishment of an independent Remuneration Committee to determine executive pay, link
remuneration to performance, promote long-term success, and disclose remuneration reports
to shareholders.

Hampel Committee Report, 1998

The Hampel Committee responded to criticism that governance had become a rigid “tick-the-
box” exercise. It emphasized that governance is not an end in itself but exists to promote long-
term shareholder value, encourage innovation, and ensure accountability without stifling
management. The report endorsed earlier recommendations and led to the formation of the
Combined Code on Corporate Governance, 1998.

CII Desirable Code of Corporate Governance, 1998

The CII Desirable Code of Corporate Governance, introduced by the Confederation of Indian
Industry, was India’s first structured governance initiative. After economic liberalization in
1991, Indian companies sought global capital, and foreign investors demanded transparency,
accountability, and board independence. The code addressed governance weaknesses such as
promoter-dominated boards and poor minority shareholder protection.
The code recommended optimum board size, inclusion of independent directors, formation of
audit committees, separation of Chairman and CEO, improved disclosures, and ethical
responsibility. However, it was voluntary and carried no penalties. Its immediate impact was
the introduction of SEBI’s Clause 49, later incorporated into the Companies Act, 2013 and
SEBI LODR Regulations, 2015.
MUST WRITE IN EXAM: CII Code was India’s first corporate governance initiative.

Kumar Mangalam Birla Committee on Corporate Governance,

2000
The Kumar Mangalam Birla Committee on Corporate Governance was constituted by
Securities and Exchange Board of India in 1999 with the objective of developing a
mandatory and enforceable corporate governance framework for listed companies in India.
Until this point, corporate governance in India was largely voluntary in nature, particularly
under the CII Desirable Code of Corporate Governance, 1998. However, with the increasing
participation of Foreign Institutional Investors (FIIs) and retail investors in the Indian capital
market, the need was strongly felt to introduce binding governance standards.
The committee recognised that Indian corporate structures were largely promoter-driven,
which often resulted in weak protection of minority shareholders, inadequate disclosures, and
limited board independence. There was also a need to align Indian corporate governance
standards with global best practices such as those followed in OECD countries and the United
Kingdom.
The committee made detailed recommendations relating to board composition by prescribing
an optimum balance between executive and non-executive directors. It provided that where the
Chairman of the board is an executive director, at least fifty percent of the board should consist
of independent directors. Where the Chairman is a non-executive director, at least one-third of
the board should be independent. Independence was clearly defined to ensure that independent
directors had no material pecuniary (financial) relationship with the company and were not
related to promoters or management.
A major contribution of the committee was the mandatory constitution of an Audit Committee
consisting of at least three directors, with two-thirds being independent and the Chairman also
being independent. The committee further mandated that at least one member of the Audit
Committee must possess financial expertise so that financial statements could be effectively
scrutinized.
The committee also strengthened disclosure norms by mandating quarterly financial results,
disclosure of related party transactions, accounting treatment followed by the company, risk
management practices, and director remuneration. In order to enhance accountability, the
committee introduced a CEO and CFO certification system, requiring senior management to
certify the accuracy and completeness of financial disclosures. Importantly, the
recommendations of the committee gave legal validity to Clause 49 of the Listing Agreement,
thereby making corporate governance compliance mandatory for listed companies.
MUST WRITE IN EXAM: Kumar Mangalam Birla Committee made corporate governance
mandatory through Clause 49 and strengthened board independence, audit committees, and
disclosures.

Naresh Chandra Committee, 2002

The Naresh Chandra Committee was constituted by the Government of India in 2002 in the
backdrop of several financial scams, particularly those involving manipulation of financial
statements and auditor failure. The committee was entrusted with examining issues related to
auditor independence, credibility of financial reporting, and accountability of the board of
directors.
The primary objectives of the committee were to strengthen the independence of auditors,
reduce conflicts of interest, improve the quality of financial disclosures, enhance the
effectiveness of the board and audit committees, and align Indian corporate governance
standards with global best practices.
The committee recommended that auditors should be prohibited from providing non-audit
services such as internal audit, bookkeeping, and consultancy services to the same client, as
such services compromise auditor independence. It further recommended mandatory rotation
of audit firms every five years to prevent long-term familiarity threats. The committee also
endorsed CEO and CFO certification of financial statements and introduced the concept of a
cooling-off period (mandatory gap) before an auditor or audit firm employee could be
employed by the same client. Enhanced disclosures relating to related party transactions and
conflicts of interest were also recommended.
MUST WRITE IN EXAM: Naresh Chandra Committee focused on auditor independence and
financial reporting credibility.

SEBI Narayan Murthy Committee, 2003

The Narayan Murthy Committee was constituted by SEBI in 2003 to review the actual working
of Clause 49 and to recommend further measures to strengthen corporate governance in India.
The committee observed that mere formal compliance was not sufficient and emphasized the
need for ethical, disclosure-driven governance.
The committee redefined the concept of an independent director and prescribed tenure limits
to ensure true independence. It reaffirmed the central role of the Audit Committee in corporate
governance and mandated that CEO and CFO certification should form part of the company’s
Annual Report. Governance of subsidiary companies was strengthened by recommending the
induction of at least one independent director on the board of material subsidiaries. The
committee also recommended the establishment of a formal whistleblower mechanism to
encourage reporting of unethical practices without fear of retaliation.
MUST WRITE IN EXAM: Narayan Murthy Committee strengthened Clause 49 and
promoted ethical and disclosure-based governance.

J. J. Irani Committee, 2005

The J. J. Irani Committee was constituted by the Ministry of Corporate Affairs to
comprehensively examine the corporate regulatory framework under the Companies Act, 1956.
The committee aimed to modernize and simplify company law while balancing regulation with
self-governance.
The committee focused on enhancing shareholder democracy, strengthening board
accountability, protecting minority shareholders, supporting economic growth, and
encouraging entrepreneurship. Its recommendations played a crucial role in shaping the
Companies Act, 2013, which adopted a principle-based approach to corporate governance
rather than excessive procedural regulation.
MUST WRITE IN EXAM: J. J. Irani Committee laid the foundation for Companies Act, 2013
reforms.

SEBI Kotak Committee on Corporate Governance, 2017

The Kotak Committee was constituted by SEBI in 2017 to review corporate governance
practices in light of India’s resilient and mature capital markets. Despite the existence of the
Companies Act, 2013 and SEBI (LODR) Regulations, 2015, governance issues such as
promoter dominance, weak board independence, and ineffective disclosures continued to
persist.
The committee aimed to reduce promoter influence, strengthen board independence, improve
disclosure quality, enhance the role of institutional investors, strengthen board oversight, and
align Indian governance standards with global best practices.
The committee recommended strengthening board composition by mandating fifty percent
independent directors for listed companies. It emphasized qualifications and active roles of
independent directors in Audit Committees, Nomination and Remuneration Committees
(NRC), and Risk Management Committees. It also recommended stricter related party
transaction rules, enhanced disclosure requirements for listed companies and their subsidiaries,
and a shift from a promoter-driven system to a board-driven governance framework. The
committee further emphasized a transition from a compliance-based approach to an outcome-
based governance system.
MUST WRITE IN EXAM: Kotak Committee focused on reducing promoter dominance and
strengthening board independence.

SEBI Consultation Paper, 2023

In 2023, SEBI issued a consultation paper titled “Strengthening Corporate Governance at
Listed Entities by Empowering Shareholders.” SEBI observed that shareholders lacked
effective mechanisms to challenge certain arrangements and agreements affecting governance.
It also noted that special rights attached to certain share classes were being granted without
adequate oversight and that board permanence and major asset decisions lacked sufficient
governance checks.
SEBI proposed enhanced disclosure and shareholder approval mechanisms for agreements
such as strategic partnerships and management arrangements that could impact governance or
shareholder rights, as seen in cases like BOB World and Kirloskar. It further proposed that
special shareholder rights, including enhanced voting or veto powers, should be subject to
periodic shareholder approval to prevent entrenchment and ensure fairness. SEBI also proposed
extending governance oversight to major asset transactions undertaken outside formal schemes
of arrangement under the Companies Act.
MUST WRITE IN EXAM: SEBI Consultation Paper, 2023 focused on shareholder
empowerment and governance transparency.

SEBI (LODR) Amendments, 2024

Based on the 2023 consultation paper, SEBI introduced amendments to the SEBI (Listing
Obligations and Disclosure Requirements) Regulations, 2015 in 2024. These amendments
revised the materiality test for disclosures under Regulation 30(4), shortened disclosure
timelines, and introduced standardized disclosure formats.
The amendments significantly enhanced the role of the Compliance Officer by mandating that
the officer must be full-time and report directly to the board of directors. Shareholders were
given a stronger role in key appointments by requiring shareholder approval for independent
directors within three months of appointment. The amendments also mandated disclosure of
Key Performance Indicators (KPIs), converted annual and half-yearly disclosures into
quarterly compliance certifications, and revised norms relating to director tenure and
independence.
MUST WRITE IN EXAM: 2024 LODR amendments strengthened disclosures, compliance,
and shareholder participation.

Corporate Governance Mechanism

Corporate Governance Mechanism refers to the institutional arrangements, legal structures, and
internal processes through which companies are directed, controlled, and held accountable.
These mechanisms determine how power is distributed within a corporation, how decisions are
made, and how the interests of shareholders and other stakeholders are protected. Different
countries follow different governance mechanisms depending on their economic systems,
ownership structures, cultural values, and legal frameworks. Broadly, corporate governance
mechanisms are reflected through models such as the Anglo-American model, the German
model, the Japanese model, and the Indian model.
MUST WRITE IN EXAM: Corporate governance mechanisms define how companies are
controlled, supervised, and made accountable.

Theoretical Foundation of Governance Models

The modern understanding of corporate governance mechanisms can be traced to the work of
The Modern Corporation and Private Property by Adolf A. Berle and Gardiner C. Means
(1932). This work highlighted the separation of ownership and control in modern corporations
and laid the foundation for different governance models.
Under the authority model, the board of directors is regarded as the supreme authority in
corporate management. Directors exercise powers that are delegated to them by shareholders
and are expected to act in the best interests of the company. In contrast, the managerial model
recognizes that real power often lies with professional managers rather than shareholders or
even the board. In this model, the board largely performs a monitoring and legitimizing role,
while managers control both daily operations and long-term strategic decisions.
MUST WRITE IN EXAM: Separation of ownership and control is the theoretical basis of
governance mechanisms.

Corporate Governance Framework

The corporate governance framework explains how a business is structured, operated, and held
accountable. It emphasizes transparency, ethical conduct, and respect for stakeholder interests.
While factors such as product quality, brand strength, and leadership charisma contribute to
corporate success, the real foundation of trust lies in corporate governance. Governance
dictates how decisions are taken, how authority is distributed, and how companies remain
aligned with their objectives. It acts as an invisible mechanism that builds stakeholder
confidence, protects shareholder interests, and ensures that companies can survive and grow
even in challenging circumstances.
MUST WRITE IN EXAM: Corporate governance is the invisible foundation of trust and
accountability.

The Anglo-American Model of Corporate Governance (Outsider Model)

The Anglo-American model, also known as the outsider model, is characterized by widely
dispersed share ownership held by individual and institutional investors who are not directly
affiliated with the corporation. This model is primarily shareholder-centric and is widely
followed in countries such as the United States and the United Kingdom. The central
assumption of this model is that companies exist primarily to maximize shareholder wealth,
and therefore, all major corporate decisions are evaluated based on their impact on shareholder
value.
This model relies heavily on market-based governance, meaning that corporate behavior is
regulated through market forces such as stock prices, investor confidence, and takeover threats.
Companies that fail to perform efficiently or engage in unethical practices risk losing investor
trust and market value. Independent boards of directors play a crucial role by monitoring
management and ensuring accountability. Transparency through regular disclosures, financial
reporting, and risk assessments is a defining feature of this model.
MUST WRITE IN EXAM: Anglo-American model is shareholder-centric and disclosure-
based.
Characteristics of the Anglo-American Model
The ownership structure under this model is dispersed, which prevents any single shareholder
from exercising dominant control. Governance is market-driven, meaning that corporate
discipline is enforced through capital markets rather than family or state control. Shareholder
value maximization is the guiding principle, and independent directors provide objective
oversight over management decisions. Regular disclosures ensure transparency and enable
shareholders to make informed decisions.

The German Model of Corporate Governance

The German model differs significantly from the Anglo-American approach by emphasizing a
balance between various stakeholders rather than prioritizing shareholders alone. This model
recognizes the interests of employees, customers, shareholders, and society at large. It is rooted
in principles of co-determination (participation of employees in governance), transparency, and
long-term planning, making it a stakeholder-oriented governance system.
MUST WRITE IN EXAM: German model follows stakeholder approach and co-
determination.

German Model: Two-Tier Board System

The German governance structure follows a two-tier board system. The first tier is the
Management Board (Vorstand), which is responsible for the day-to-day management, strategic
planning, and operational execution of the company. The second tier is the Supervisory Board
(Aufsichtsrat), which functions as an oversight body. It appoints and supervises the
Management Board, reviews its decisions, and ensures that corporate actions align with long-
term objectives. This clear separation of management and supervision minimizes conflicts of
interest and enhances accountability and transparency.
MUST WRITE IN EXAM: German model follows a two-tier board structure.

The Japanese Model of Corporate Governance

The Japanese model of corporate governance is deeply influenced by cultural values such as
loyalty, long-term relationships, collective responsibility, and organizational harmony. Unlike
Western models that prioritize shareholder primacy, the Japanese model focuses on balancing
stakeholder interests and maintaining stable employment and long-term business relationships.
A distinctive feature of this model is decision-making through consensus, known as the Ringi
system. Instead of decisions being imposed from the top, proposals are circulated among
various departments and stakeholders for discussion and approval. This consultative process
encourages collaboration, minimizes internal conflict, and promotes collective ownership of
decisions.
MUST WRITE IN EXAM: Japanese model emphasizes consensus-based decision-making.

Keiretsu Networks and Cross-Shareholding

A defining feature of the Japanese model is the Keiretsu network, which refers to groups of
interlinked companies connected through cross-shareholding arrangements. These networks
create strong alliances between manufacturers, suppliers, and financial institutions. Cross-
shareholding reduces vulnerability to hostile takeovers and short-term market pressures,
thereby promoting stability and long-term planning. However, while this structure provides
insulation from market volatility, it also reduces transparency for external investors and limits
shareholder influence.
MUST WRITE IN EXAM: Keiretsu networks promote stability but reduce transparency.

The Indian Model of Corporate Governance

India’s corporate governance framework represents a blend of traditional family ownership and
modern regulatory mechanisms. Indian companies are often characterized by promoter or
family-controlled ownership structures, combined with professional management. Family
ownership ensures continuity, long-term vision, and control, while professional management
introduces expertise, efficiency, and innovation.
The core characteristics of the Indian model include strong promoter control, close-knit
leadership structures, and an emphasis on intergenerational succession planning. Governance
reforms in India aim to balance family influence with board independence and regulatory
oversight.
MUST WRITE IN EXAM: Indian model balances family ownership with professional
management.

Challenges in the Indian Model of Corporate Governance

The Indian governance model faces several challenges. Conflicts of interest frequently arise
when personal and business interests overlap within family-controlled companies.
Professionalization remains a challenge as companies transition from informal management
styles to structured corporate systems. Succession planning is another critical issue, as
leadership transitions across generations often involve competing family priorities and
governance risks.
MUST WRITE IN EXAM: Conflicts of interest and succession planning are major Indian
governance challenges.

Board of Directors under the Companies Act, 2013

Under the Companies Act, 2013, directors occupy a central position in corporate governance.
The Act recognizes different categories of directors, including independent directors, nominee
directors, and women directors, each playing a specific role in ensuring balanced decision-
making and accountability. Independent directors are expected to provide unbiased judgment,
nominee directors represent specific stakeholders such as financial institutions, and women
directors promote diversity and inclusive governance.
SEBI regulations further strengthen board composition requirements by prescribing board
independence, committee structures, and disclosure obligations for listed companies.
MUST WRITE IN EXAM: Board of Directors is the core governance mechanism.

Indian Issues Related to Corporate Governance

India faces several governance-related issues, including agency problems arising from
separation of ownership and control, limited shareholder participation in decision-making,
challenges in corporate capital procurement, and weak enforcement of property rights.
Minority shareholders often lack effective voice, while promoters retain substantial control
over corporate decisions. Governance reforms seek to empower shareholders, enhance
disclosures, and strengthen regulatory enforcement.

Comparison of Sarbanes–Oxley Act and Clause 49 (SEBI LODR, 2015)

The Sarbanes–Oxley Act in the United States adopts a strict, rule-based approach with criminal
penalties for non-compliance, focusing heavily on financial reporting accuracy, auditor
independence, and board accountability. In contrast, Clause 49 under the Securities and
Exchange Board of India LODR Regulations, 2015 follows a principle-based approach
emphasizing disclosures, board composition, and committee oversight. While SOX is
enforcement-driven, Clause 49 promotes compliance through transparency and regulatory
supervision.
MUST WRITE IN EXAM: SOX is rule-based; Clause 49 is principle-based.
Board of Directors: Meaning, Role and Importance
The Board of Directors is the highest decision-making authority in a company and acts as the
central pillar of corporate governance. It represents the collective body entrusted with directing,
controlling, and supervising the affairs of the company. The board acts as a bridge between the
shareholders, who are the owners of the company, and the management, which runs the day-
to-day business. Through its powers, duties, and responsibilities, the board ensures that the
company is run in a lawful, ethical, transparent, and accountable manner, while protecting the
interests of shareholders and other stakeholders.
MUST WRITE IN EXAM: The Board of Directors is the apex governance body responsible
for direction, control, and accountability of the company.

Statutory Framework Governing the Board of Directors

Chapter XI of the Companies Act, 2013 prescribes provisions relating to the appointment,
qualifications, composition, duties, and responsibilities of directors. Section 149 of the Act
mandates that every company must have a Board of Directors consisting only of individuals.
The minimum number of directors required is three in the case of a public company, two in the
case of a private company, and one in the case of a One Person Company. The maximum
number of directors permitted is fifteen, although a company may appoint more than fifteen
directors by passing a special resolution. The Act further mandates that certain prescribed
classes of companies must have at least one woman director, thereby promoting diversity and
inclusive governance.
MUST WRITE IN EXAM: Section 149 Companies Act, 2013 lays down minimum,
maximum, and gender diversity requirements.

Composition of the Board of Directors

The composition of the board is designed to ensure a balance between executive decision-
making and independent oversight. A properly constituted board includes executive directors
who are involved in daily management and non-executive directors who provide strategic
guidance and independent judgment. The law emphasizes the inclusion of independent
directors and women directors to ensure objectivity, transparency, and balanced governance.
SEBI regulations further strengthen board composition norms for listed entities by prescribing
independence requirements, committee structures, and disclosure obligations.
MUST WRITE IN EXAM: Balanced board composition ensures effective governance and
independent oversight.

Independent Directors
Section 149(4) of the Companies Act, 2013 mandates that every listed public company must
have at least one-third of its total number of directors as independent directors. The Central
Government is also empowered to prescribe minimum independent director requirements for
certain classes of public companies.
An independent director is a director other than a managing director, whole-time director, or
nominee director. Such a director must be a person of integrity and possess relevant expertise
and experience, as assessed by the board. An independent director must not be a promoter of
the company or its holding, subsidiary, or associate company, and must not be related to
promoters or directors of such entities.
The law strictly restricts financial relationships to preserve independence. An independent
director must not have any pecuniary relationship (financial relationship) with the company or
its related entities, other than permissible remuneration, during the two immediately preceding
financial years or the current financial year. Relatives of independent directors are also subject
to restrictions regarding shareholding limits, indebtedness, guarantees, or other financial
transactions exceeding prescribed thresholds.
Further, an independent director or their relatives must not have held key managerial positions
or been employees of the company or its related entities in the preceding three financial years.
They must also not be associated with audit, legal, consulting, or advisory firms that have
significant transactions with the company. The law also restricts voting power, nonprofit
associations receiving substantial funding, and other relationships that may compromise
independence.
Section 149(9) provides that independent directors are not entitled to stock options. Their
remuneration is limited to sitting fees, reimbursement of expenses, and profit-related
commission approved by shareholders, subject to Sections 197 and 198 of the Act.
MUST WRITE IN EXAM: Independent directors ensure objectivity, protect minority
shareholders, and strengthen governance.

Appointment and Disqualification of Directors

Section 162 of the Companies Act, 2013 provides that each director must be appointed
individually by voting, thereby preventing bundled or collective appointments that dilute
shareholder choice. Section 164 lays down disqualifications for appointment of directors,
including insolvency, conviction, and non-compliance with statutory obligations. Section 165
restricts the number of directorships a person may hold to a maximum of twenty companies,
out of which not more than ten can be public companies, in order to ensure effective discharge
of responsibilities.
MUST WRITE IN EXAM: Sections 162, 164, and 165 regulate appointment,
disqualification, and limits on directorships.

Duties of Directors under Section 166 of the Companies Act, 2013

Section 166 codifies the duties of directors and places them under a statutory obligation to act
in good faith for promoting the objects of the company and for the benefit of its members as a
whole. Directors must act in the best interests of the company, its employees, shareholders, the
community, and for the protection of the environment. They are required to exercise due and
reasonable care, skill, and diligence and to apply independent judgment in decision-making.
Directors must avoid situations involving direct or indirect conflicts of interest with the
company and are prohibited from assigning their office to any other person. Any violation of
these duties attracts monetary penalties ranging from one lakh rupees to five lakh rupees.
MUST WRITE IN EXAM: Section 166 imposes fiduciary and statutory duties on directors.

General Duties of the Board under SEBI (LODR) Regulations, 2015

Under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015,
members of the board and key managerial personnel are required to disclose any material
interest, whether direct or indirect, in transactions affecting the listed entity. The board and
senior management are expected to maintain operational transparency while safeguarding
confidential information, thereby fostering informed and ethical decision-making.
MUST WRITE IN EXAM: LODR mandates disclosure of material interests and ethical
conduct.

Key Functions of the Board of Directors under SEBI (LODR) Regulations, 2015
The board is responsible for reviewing and guiding corporate strategy, approving major plans
of action, risk policies, annual budgets, and business plans. It sets performance objectives,
monitors implementation, and oversees major capital expenditures, acquisitions, and
divestments. The board also monitors the effectiveness of governance practices and makes
improvements where necessary.
The board selects, compensates, monitors, and replaces key managerial personnel and oversees
succession planning. It aligns executive remuneration with the long-term interests of the
company and shareholders and ensures a transparent and merit-based nomination process that
promotes diversity of thought, experience, knowledge, and gender.
The board must monitor and manage conflicts of interest involving management, directors, and
shareholders, including misuse of corporate assets and related party transactions. It ensures
integrity of financial reporting systems, independent audits, and effective risk management,
compliance, and internal control mechanisms. Oversight of disclosures, communications, and
board evaluation frameworks also forms part of its core functions.
The board provides strategic guidance, ensures effective monitoring of management, and
remains accountable to shareholders. It sets corporate culture and ethical values, acts on an
informed basis, and encourages continuous training of directors. It treats all shareholders fairly,
maintains high ethical standards, exercises independent judgment, and assigns non-executive
directors to areas involving conflicts of interest.
The board must be capable of stepping back to challenge management assumptions regarding
strategy, acquisitions, risk appetite, and exposure. Committees of the board must have clearly
defined mandates, composition, and procedures. Directors must commit sufficient time and
have access to accurate, timely, and relevant information. The board and senior management
must facilitate independent directors in effectively performing their roles.
MUST WRITE IN EXAM: The board’s role under LODR covers strategy, oversight, ethics,
risk management, and shareholder protection.

Corporate Fraud and the Responsibilities of the Board of Directors

Corporate fraud refers to any act, omission (failure to act), concealment (hiding facts), or abuse
of position by a person who is in charge of the affairs of a company, done with the intention to
deceive others, gain undue advantage (unfair benefit), or cause harm to the interests of the
company, its shareholders, creditors, or the public at large. Corporate fraud undermines trust in
the corporate system and therefore corporate governance law places strict responsibilities on
directors and senior management to prevent, detect, and respond to such misconduct.
MUST WRITE IN EXAM: Corporate fraud involves deception or abuse of position causing
harm to company, shareholders, creditors, or public.
Duties of Directors in Preventing Corporate Fraud
Section 166 of the Companies Act, 2013 clearly lays down the duties of directors, which form
the foundation of their responsibility in preventing corporate fraud. Directors are required to
act in good faith, meaning they must act honestly and sincerely, for the benefit of the company
as a whole. They must also act in the best interests of shareholders, employees, the community,
and the environment. Directors are further required to exercise due and reasonable care, skill,
and diligence, which means they must apply their mind carefully and cannot act negligently or
blindly rely on others.
Directors must avoid situations where their personal interest conflicts, or may possibly conflict,
with the interest of the company, and they are prohibited from achieving any undue gain or
advantage either for themselves or for their relatives. Section 166(7) provides that if a director
contravenes these duties, such director shall be punishable with a fine which shall not be less
than one lakh rupees and may extend to five lakh rupees.
MUST WRITE IN EXAM: Section 166 imposes fiduciary duties and penalties on directors
for breach.

Criminal Liability of Directors under the Companies Act, 2013

As a general rule, criminal liability under the Companies Act, 2013 arises only against an
“officer who is in default” as defined under Section 2(60). This includes whole-time directors,
key managerial personnel, and any director who was aware of the contravention, consented to
it, connived (secretly agreed) in it, or failed to act diligently. This provision ensures that
directors are not automatically held liable merely because they hold office, but liability arises
where there is knowledge, consent, or negligence.
The Supreme Court of India, in Sunil Bharti Mittal v. CBI, clarified an important principle
relating to director liability. The Court held that the doctrine of alter ego (where a company
acts through controlling minds) can be used to make a company liable for acts of those who
control it, but it cannot be applied in reverse to automatically make directors liable for offences
committed by the company. The Court further clarified that directors can be held vicariously
liable only if the statute expressly provides for such liability.
MUST WRITE IN EXAM: Directors are liable only if statute provides or if they had
knowledge, consent, or lack of diligence.
Strict Liability Offences under the Companies Act, 2013
Certain offences under the Companies Act impose strict liability, meaning liability arises even
without proving intention or knowledge. These offences usually relate to procedural
compliance and disclosure requirements. For example, failure to file the annual return under
Section 92 attracts penalties on the company and every officer in default, including daily
penalties for continuing failure. Similarly, failure to file financial statements under Section 137
attracts penalties on the managing director, CFO, or other responsible directors, and in their
absence, all directors of the company.
These provisions emphasize that compliance with statutory filings and disclosures is a non-
negotiable responsibility of the board and senior management.
MUST WRITE IN EXAM: Certain offences impose strict liability for non-compliance with
filings and disclosures.

Liability for Misstatements and Fraud under the Companies Act, 2013
Section 34 of the Companies Act, 2013 imposes criminal liability for misstatements in a
prospectus. If a prospectus contains any statement that is untrue or misleading, or omits
material facts in a manner likely to mislead investors, every person who authorises the issue of
such prospectus is liable for fraud under Section 447. However, a defence is available if the
person proves that the statement was immaterial or that they had reasonable grounds to believe
it was true at the time of issue.
Section 447 defines fraud broadly to include deception, concealment of facts, or abuse of
position. Punishment for fraud includes imprisonment ranging from six months to ten years
and fine equal to the amount involved in the fraud. Section 448 deals with false statements
made in prospectus, financial statements, reports, or returns, and such offences are also
punishable under Section 447. Section 449 relates to suppression of material facts or giving
false evidence before authorities and is punishable with imprisonment up to seven years.
MUST WRITE IN EXAM: Fraud under Section 447 carries severe imprisonment and
monetary penalties.

Disclosure-Related Offences and Director Liability

Failure to disclose interest in contracts under Section 184 attracts imprisonment up to one year
and fine up to one lakh rupees. Unauthorized related party transactions under Section 188 can
also result in imprisonment up to one year and monetary penalties for directors. These
provisions ensure transparency and prevent misuse of position by directors.
However, special protection is provided to independent and non-executive directors under
Section 149(12). Such directors are liable only if the offence was committed with their
knowledge and if they failed to act diligently. This protection recognizes their limited
involvement in day-to-day management.
MUST WRITE IN EXAM: Independent directors are liable only on proof of knowledge and
lack of diligence.

Position of Statutory Auditors in Corporate Governance

Statutory auditors occupy a very special and independent position in the corporate governance
framework because they function as an external and objective check on the financial affairs of
a company. They are often described as the watchdogs of corporate finances because their
primary responsibility is to examine whether the financial statements of the company reflect
the true and fair financial position. Auditors act as independent professionals and are not agents
of the management but are agents of the shareholders, who rely on the auditor’s report to assess
the financial health and integrity of the company. By ensuring transparency and accountability
in financial reporting, statutory auditors play a gatekeeping role that prevents fraud,
misstatements, and manipulation of accounts.
MUST WRITE IN EXAM: Statutory auditors are independent watchdogs and agents of
shareholders, not management.

Appointment of Statutory Auditors

The appointment of statutory auditors is governed by Section 139 of the Companies Act, 2013,
which provides that auditors are appointed by the shareholders at the Annual General Meeting
(AGM). An individual auditor can be appointed for a term of five consecutive years, while an
audit firm can be appointed for a term of ten consecutive years. The law mandates compulsory
rotation of auditors for listed companies and such other prescribed classes of companies to
ensure independence and prevent long-term familiarity between auditors and management.
The statutory framework relating to auditors is spread across several provisions, including
Section 139 dealing with appointment, Section 140 dealing with removal and resignation,
Section 141 dealing with eligibility, qualifications, and disqualifications, Section 143 dealing
with powers and duties of auditors, and Section 147 prescribing punishment for contravention
of audit-related provisions.
MUST WRITE IN EXAM: Auditors are appointed by shareholders and are subject to
mandatory rotation.

Independence of Auditors
Auditor independence is the cornerstone of effective corporate governance. Section 141 of the
Companies Act, 2013 lays down detailed eligibility and disqualification criteria to ensure that
auditors remain independent in both fact and appearance. Auditors are prohibited from having
any direct or indirect financial interest in the company, entering into employment relationships
with the company, or providing certain non-audit services that may create conflicts of interest.
These restrictions ensure that auditors can perform their duties objectively without being
influenced by management or personal interests.
MUST WRITE IN EXAM: Auditor independence is ensured through strict eligibility and
disqualification norms under Section 141.

Powers of Statutory Auditors

Section 143(1) of the Companies Act, 2013 grants statutory auditors wide powers to enable
them to conduct an effective audit. Auditors have the right to access the books of accounts and
vouchers of the company at all times, to seek information and explanations from officers of the
company, to visit branch offices, and to obtain all documents necessary for the performance of
their audit functions. These powers are essential to ensure that auditors are not restricted or
obstructed while examining the financial affairs of the company.
MUST WRITE IN EXAM: Auditors have statutory right of access to books, records, and
information.

Duties of Statutory Auditors

Under Sections 143(2) and 143(3) of the Companies Act, 2013, auditors have a duty to report
whether the financial statements give a true and fair view of the company’s financial position
and performance. They must verify whether proper books of accounts have been maintained,
whether accounting standards have been complied with, and whether any director is
disqualified under Section 164(2). Auditors are also required to comment on the adequacy and
effectiveness of internal financial controls and to clearly report any qualifications,
observations, or adverse remarks in their audit report.
MUST WRITE IN EXAM: Auditor’s primary duty is to report on true and fair view and
compliance with law.
Auditor’s Responsibility in Reporting Fraud
Section 143(12) of the Companies Act, 2013 imposes a statutory duty on auditors to report
fraud. Where an auditor has reason to believe that a fraud involving a prescribed amount has
occurred, the auditor must report such fraud to the Central Government, usually through the
Serious Fraud Investigation Office (SFIO). Other frauds must be reported to the Audit
Committee or, in its absence, to the Board of Directors. Failure to comply with this reporting
obligation attracts penal consequences.
In this role, the auditor effectively acts as a whistleblower and is protected from retaliation.
Reporting fraud is not considered a breach of confidentiality, thereby encouraging auditors to
report wrongdoing without fear.
MUST WRITE IN EXAM: Section 143(12) mandates reporting of fraud by auditors.

Role of Statutory Auditors

The primary role of statutory auditors is the examination of financial statements, including the
balance sheet, profit and loss account, cash flow statement, and notes to accounts. Through this
examination, auditors provide reasonable assurance, which means a high but not absolute level
of confidence, that the financial statements present a true and fair view and are free from
material misstatements. Although auditors do not guarantee fraud detection, they are required
to maintain professional skepticism (questioning mindset), identify material fraud risks, and
report frauds in accordance with law.
MUST WRITE IN EXAM: Auditors provide reasonable assurance and play a limited but
crucial role in fraud detection.

Audit Committee under Section 177 of the Companies Act, 2013

Section 177 of the Companies Act, 2013 mandates that the Board of Directors of every listed
public company and such other prescribed classes of companies must constitute an Audit
Committee. The Audit Committee must consist of a minimum of three directors, with
independent directors forming a majority. The majority of members, including the Chairperson,
must have the ability to read and understand financial statements, ensuring financial literacy
and competence.
The Audit Committee functions according to written terms of reference specified by the Board.
Its responsibilities include recommending the appointment, remuneration, and terms of
appointment of auditors, reviewing and monitoring auditor independence and performance,
examining financial statements and audit reports, and approving or modifying related party
transactions.
The Audit Committee has the authority to seek comments from auditors on internal control
systems, audit scope, and audit observations, and may discuss these matters with internal
auditors, statutory auditors, and management. It also has investigative powers and may obtain
professional advice from external sources, with full access to company records. Auditors and
key managerial personnel have the right to be heard at Audit Committee meetings, though they
do not have voting rights.
MUST WRITE IN EXAM: Audit Committee is the central pillar of financial oversight and
auditor independence.

Audit Committee and Vigil Mechanism

Section 177(9) requires listed companies and prescribed classes of companies to establish a
vigil mechanism for directors and employees to report genuine concerns. Section 177(10)
mandates that this mechanism must provide safeguards against victimisation and allow direct
access to the Chairperson of the Audit Committee in exceptional cases. Details of the vigil
mechanism must be disclosed on the company’s website and in the Board’s report, reinforcing
transparency and ethical governance.
MUST WRITE IN EXAM: Vigil mechanism protects whistleblowers and strengthens
governance.

Role of Audit Committee under SEBI (LODR) Regulations, 2015

Regulation 18 of the SEBI (LODR) Regulations, 2015 strengthens the role of the Audit
Committee in listed entities. Auditors are required to attend Audit Committee meetings, discuss
audit plans and findings, and highlight financial risks and control weaknesses. Regulation 33
places disclosure responsibilities on the Audit Committee, including limited review of quarterly
financial results and certification of annual financial results, thereby ensuring continuous
financial oversight.
MUST WRITE IN EXAM: LODR, 2015 integrates Audit Committee oversight with
disclosure and financial reporting.
Cases
Satyam Computer Services Case
Satyam Computer Services is one of the most significant corporate fraud cases in Indian
corporate history and is often described as “India’s Enron.” The company falsified its financial
statements over several years by inflating cash balances, profits, and receivables, while
simultaneously hiding liabilities. This created a false picture of strong financial health and
misled investors, regulators, and the market at large.
A major governance failure in the Satyam case was the role played by the statutory auditor, the
PricewaterhouseCoopers (PwC) network. PwC continued to issue clean audit reports year
after year without independently verifying bank balances and relied excessively on
management representations, which means statements made by management without external
confirmation. There was no proper verification of debtors, no questioning of unrealistic
financial figures, and repeated red flags were ignored over several years. This showed a serious
failure of professional skepticism, which is a basic duty of auditors.
Following the exposure of the fraud, Securities and Exchange Board of India found PwC to
be complicit and non-compliant with auditing standards. SEBI banned PwC network firms
from issuing audit certificates for listed companies for two years and ordered disgorgement
(return) of more than ₹13 crore in audit fees. However, this order was later set aside by the
Securities Appellate Tribunal, which held that SEBI did not have the power to ban auditors
under securities law. SEBI challenged this decision before the Supreme Court of India, which
stayed the SAT order, and the appeal is still pending.
MUST WRITE IN EXAM: Satyam case highlights massive audit failure and lack of
independent verification by statutory auditors.

Yes Bank Case

Yes Bank was founded in 2003 by Rana Kapoor and Ashok Kapoor and witnessed extremely
rapid growth, becoming one of India’s leading private sector banks. However, this rapid
expansion was driven by aggressive lending practices, where large loans were extended to
corporate borrowers without adequate due diligence (proper checking) or sufficient collateral
(security). This led to a sharp rise in non-performing assets (NPAs), which are loans that
borrowers fail to repay.
By 2017, the Reserve Bank of India began identifying serious discrepancies in the bank’s
reported NPAs, indicating misreporting and weak risk management. The situation worsened
over time, and in 2020, the RBI intervened decisively by imposing a moratorium on Yes Bank
for 30 days. This meant restrictions were placed on withdrawals and operations to prevent
systemic collapse. The case reflects governance failures at the board and management level,
poor credit risk assessment, and regulatory intervention as a last resort.
MUST WRITE IN EXAM: Yes Bank case shows failure of risk governance, aggressive
lending, and regulatory intervention by RBI.

Dewan Housing Finance Limited (DHFL) Case

The DHFL case came into public attention during late 2018 and early 2019, when media reports
began exposing serious irregularities in the company’s loan disbursement practices. DHFL was
accused of large-scale fraud involving misappropriation of funds and falsification of accounts
to hide financial losses.
A special audit was commissioned and conducted by KPMG between 2016 and 2019 to
investigate the company’s financial practices and verify the legitimacy of loan disbursements.
The audit findings revealed systematic manipulation of financial records and showed that
DHFL had allegedly disbursed more than ₹29,000 crore to 66 entities that were closely linked
to the company’s founders, the Wadhawan brothers. These transactions indicated serious
related-party abuses and diversion of funds.
This case demonstrates failure of internal controls, misuse of promoter power, and delayed
detection of fraud despite regulatory oversight.
MUST WRITE IN EXAM: DHFL case highlights promoter misuse, related-party
transactions, and failure of internal controls.

Jet Airways Case

In September 2023, the Enforcement Directorate arrested Naresh Goyal, the founder of Jet
Airways, in connection with allegations of misappropriation of public funds obtained through
business loans. The investigation revealed that funds were allegedly siphoned off for personal
use rather than being used for legitimate business purposes.
The methods used for siphoning funds included payment of irrational and inflated commissions
exceeding ₹1,410 crore to general sales agents, which did not meaningfully contribute to the
airline’s revenue. These agents were allegedly controlled by the Goyal family. Further, loans
were granted to subsidiary companies that had no genuine business operations or income,
indicating deliberate diversion of funds.
A forensic audit conducted by Ernst & Young revealed inflated payouts exceeding ₹1,152
crore to professionals and consultants whose businesses did not match the services they claimed
to provide. This pointed to systematic misuse of corporate funds and complete breakdown of
governance and financial discipline.
MUST WRITE IN EXAM: Jet Airways case reflects fund siphoning, misuse of loans, and
forensic audit findings.

Overall Governance Lessons from These Cases

These case studies collectively demonstrate that corporate governance failures often arise due
to weak boards, dominant promoters, ineffective auditors, poor disclosure practices, and
delayed regulatory action. They underline the importance of strong board oversight, auditor
independence, transparent financial reporting, effective audit committees, and proactive
regulatory supervision to protect investors and maintain market integrity.
MUST WRITE IN EXAM: Corporate fraud cases emphasize need for strong governance,
audit independence, and regulatory vigilance.

Evolution of Audit and Auditor Appointment in Corporate

Governance
Historically, the appointment of auditors was closely linked with the protection of property and
public interest. In the United Kingdom, auditors were initially appointed to manage and
safeguard the King’s property, which later evolved into a statutory system for corporate
auditing. The UK was the pioneer in making the appointment of auditors through legislation.
The Companies Act, 1844 and the Companies Act, 1862 laid the early foundation, and formal
recognition of auditors was provided through the Companies Act, 1900. This Act made the
appointment of auditors by shareholders mandatory, thereby shifting control from management
to owners of the company.
In India, auditors were first statutorily recognised under the Companies Act, 1913. The
Companies Act, 1956 further strengthened the framework by detailing the appointment,
powers, duties, and independence of auditors. The Companies Act, 2013 marked a major shift
by introducing mandatory auditor rotation and imposing strict restrictions on the provision of
non-audit services, with the objective of enhancing auditor independence and strengthening
corporate governance.
MUST WRITE IN EXAM: Auditor appointment evolved from property protection to
shareholder protection through statutory recognition.

Audit Committee: Concept and Origin

The Audit Committee emerged as a central mechanism of corporate governance to ensure
integrity in financial reporting and effective oversight of auditors. One of the earliest formal
recommendations for the constitution of an Audit Committee came from the Cadbury
Committee, which emphasized that non-executive directors, independent of management,
should play a key role in financial oversight. Based on these recommendations, many large
companies constituted Audit Committees, and this practice showed positive governance
outcomes.
The Hampel Committee further examined the functioning of Audit Committees and observed
that only non-executive directors should be members of the Audit Committee. The Committee
also highlighted the role of auditors in reviewing financial and non-financial information in
annual reports, identifying inconsistencies, and reporting internal control weaknesses privately
to directors. However, the Hampel Committee cautioned against excessive public verification
requirements, as such an approach could dilute the sense of responsibility of directors.
MUST WRITE IN EXAM: Audit Committee was recommended to strengthen independent
financial oversight.

Audit Committee in the Indian Context

In India, the first major corporate governance committee to recommend a mandatory Audit
Committee was the Kumar Mangalam Birla Committee. This committee recommended the
compulsory constitution of Audit Committees for listed companies, a minimum number of
independent directors, and financial literacy requirements for committee members. These
recommendations were implemented through Clause 49 of the Listing Agreement in 2000,
thereby giving legal force to Audit Committee requirements for listed entities.
MUST WRITE IN EXAM: Mandatory Audit Committee in India originated from Kumar
Mangalam Birla Committee.

Audit Committee under SEBI (LODR) Regulations, 2015

The SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 provide a
comprehensive framework governing the Audit Committee of listed entities. Under the
principles governing disclosures and obligations, listed entities are required to implement
accounting standards in letter and spirit while ensuring that annual audits are conducted by
independent, competent, and qualified auditors, keeping in mind the interests of all
stakeholders.
Regulation 18 mandates that every listed entity must constitute a qualified and independent
Audit Committee. The Audit Committee must consist of a minimum of three directors, with at
least two-thirds being independent directors. In case of listed entities with outstanding superior
voting right (SR) equity shares, the Audit Committee must comprise only independent
directors. All members must be financially literate, and at least one member must have
accounting or related financial management expertise. The Chairperson of the Audit
Committee must be an independent director and must be present at the Annual General Meeting
to answer shareholder queries. The Company Secretary acts as the secretary to the Audit
Committee, and the committee may invite senior finance officials, internal auditors, and
statutory auditors to attend meetings, although it may also meet without executives when
required.
MUST WRITE IN EXAM: Regulation 18 LODR lays down composition and independence
of Audit Committee.

Role and Powers of the Audit Committee

The Audit Committee plays a crucial role in ensuring the integrity of accounting and financial
reporting systems, including independent audits, internal controls, risk management, and
compliance with law. It reviews financial statements before submission to the board and
monitors the performance and independence of auditors. Under Regulation 24(2), the Audit
Committee of the listed entity is also required to review the financial statements of unlisted
subsidiary companies, particularly focusing on investments made by such subsidiaries.
Regulation 32 requires that statements relating to deviation or variation in the use of funds
raised through public issues be placed before the Audit Committee for review before
submission to stock exchanges. Further, the listed entity must prepare an annual statement of
funds utilized for purposes other than those stated in the offer document, certified by statutory
auditors, and place it before the Audit Committee until full utilization of funds.
MUST WRITE IN EXAM: Audit Committee oversees financial integrity, subsidiaries, and
utilization of funds.

Related Party Transactions and Disclosure of Interest

Related Party Transactions (RPTs) pose a high risk of conflict of interest and misuse of
corporate resources. Corporate governance frameworks require that such transactions be
closely scrutinized and approved to protect minority shareholders. The Audit Committee is
empowered to approve or modify related party transactions and to ensure that such transactions
are conducted at arm’s length (fair market terms). Directors are under a statutory duty to
disclose their interest in contracts and arrangements, and failure to disclose such interest can
attract legal consequences.
MUST WRITE IN EXAM: Audit Committee approval is central to governance of RPTs.

Subsidiary Company Disclosures

Corporate governance standards recognize that risks can be transferred to subsidiary companies
to avoid scrutiny. Therefore, SEBI LODR mandates enhanced disclosures and Audit
Committee oversight over subsidiaries, especially unlisted subsidiaries. Financial statements,
investments, and fund utilization of subsidiaries are reviewed by the Audit Committee to ensure
transparency and prevent misuse of corporate structures.
MUST WRITE IN EXAM: Audit Committee oversight extends to unlisted subsidiaries.

Audit Committee and Auditor-Related Disclosures

SEBI LODR also strengthens transparency in auditor appointment and reporting. Regulation
36(5) requires that notices sent to shareholders for Annual General Meetings proposing
appointment or re-appointment of statutory or secretarial auditors must include detailed
disclosures in the explanatory statement. Regulation 52 mandates submission of audited
financial results and annual reports to stock exchanges, ensuring continuous market disclosure
and accountability.
MUST WRITE IN EXAM: Auditor appointment and audit reports are subject to enhanced
disclosure norms under LODR.

Overall Significance of Audit Committee in Corporate Governance

The Audit Committee acts as the most important governance mechanism linking the board,
auditors, management, and shareholders. By ensuring independent financial oversight,
scrutinizing related party transactions, monitoring subsidiaries, and strengthening disclosure
standards, the Audit Committee plays a decisive role in preventing corporate fraud and
enhancing trust in the corporate system.
MUST WRITE IN EXAM: Audit Committee is the cornerstone of financial transparency and
accountability.

Related Party Transaction (RPT): Meaning and Legal Definition

A Related Party Transaction (RPT) refers to any transfer of resources, services, or obligations
between a listed entity and a related party, irrespective of whether a price is charged for such
transaction. This definition is intentionally broad because even transactions without
consideration (price) can be used to confer unfair benefits. Under Regulation 2(1)(zc) of the
SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, the meaning of
RPT is adopted from Section 2(76) of the Companies Act, 2013, read together with applicable
accounting standards. This ensures uniformity in identifying related parties across company
law, securities regulation, and financial reporting.
MUST WRITE IN EXAM: RPT means any transfer of resources, services, or obligations
between a company and a related party, whether or not a price is charged.

Why Related Party Transactions Are Considered Problematic

Related Party Transactions are considered inherently risky from a corporate governance
perspective because they involve parties who are already in a position of influence or control
over the company. The most serious concern is the inherent conflict of interest, where directors
or promoters may prioritise their personal or group interests over the interests of the company
and its shareholders, thereby undermining their fiduciary duty (duty of trust and loyalty).
RPTs have frequently been used as tools for tunnelling and expropriation, meaning diversion
of company resources to promoter-controlled entities through inflated contracts, artificial
expenses, or shifting of profits. Such practices weaken the financial position of the company
while enriching a select group. Unchecked RPTs also erode market confidence because capital
markets function on trust, transparency, and accurate disclosures. When RPTs distort financial
statements, they affect price discovery (fair valuation of shares) and mislead investors who rely
on published accounts to make investment decisions.
MUST WRITE IN EXAM: RPTs pose conflict of interest risks and are often used for
tunnelling and diversion of resources.
RPT and Disclosure Norms under SEBI (LODR), 2015
Regulation 23 of the SEBI (LODR) Regulations, 2015 lays down a strict disclosure and
approval framework for RPTs. All related party transactions must be placed before the Audit
Committee for prior approval, and any director who is interested in the transaction must abstain
from discussion and voting. This ensures independent scrutiny and prevents influence by
conflicted parties.
Listed entities are required to disclose RPTs to stock exchanges on a half-yearly basis in the
format prescribed by SEBI, including transactions involving directors and their relatives. In
case of material RPTs, prior approval of shareholders is mandatory, and importantly, related
parties are not permitted to vote on such resolutions, irrespective of their shareholding. This
rule protects minority shareholders from promoter dominance. Continuous disclosure
obligations also apply, meaning that changes in board composition or relationships that affect
related-party status must be promptly disclosed to stock exchanges.
MUST WRITE IN EXAM: Regulation 23 mandates Audit Committee approval, stock
exchange disclosure, and shareholder approval for material RPTs.

Protective Role of the Audit Committee in RPTs

Under Regulations 18 and 23 of SEBI LODR, the Audit Committee acts as the first and most
important line of defence against abusive related party transactions. The committee is
responsible for granting prior approval to all RPTs and for closely examining their pricing,
commercial justification, and whether they are conducted on an arm’s length basis (as if
between unrelated parties). Omnibus approvals, which are blanket approvals for repetitive
transactions, are permitted only for routine and recurring transactions and must be carefully
monitored. This mechanism ensures that RPTs are not used as a backdoor to siphon funds.
MUST WRITE IN EXAM: Audit Committee scrutiny is the key safeguard against abusive
RPTs.

Corporate Governance Framework for Subsidiary Companies

Regulation 24 of the SEBI (LODR) Regulations, 2015 extends corporate governance norms to
unlisted subsidiaries of listed companies, particularly when such subsidiaries are material
subsidiaries. A subsidiary is considered material if its income or net worth exceeds twenty
percent of the consolidated income or net worth of the listed entity and its subsidiaries in the
immediately preceding accounting year. This threshold ensures that only economically
significant subsidiaries are subject to enhanced governance requirements.
MUST WRITE IN EXAM: Material subsidiary means income or net worth exceeding 20%
of consolidated figures.

RPTs Involving Unlisted Subsidiaries

Regulation 23 of SEBI LODR applies to related party transactions involving unlisted
subsidiaries even where the listed parent company is not a direct party to the transaction. In
such cases, if prescribed thresholds are crossed, prior approval of the Audit Committee of the
listed entity is required, and in material cases, shareholder approval may also be triggered. This
framework effectively subjects unlisted subsidiaries to governance scrutiny through the listed
parent, preventing promoters from bypassing disclosure norms by routing transactions through
private entities.
MUST WRITE IN EXAM: LODR prevents use of unlisted subsidiaries to escape RPT
scrutiny.

Specific Governance Requirements for Subsidiaries under Regulation 24

SEBI LODR mandates that at least one independent director of the listed entity must be
appointed to the board of an unlisted material subsidiary, whether incorporated in India or
abroad. The Audit Committee of the listed entity must review the financial statements of such
subsidiaries, particularly focusing on investments. The minutes of board meetings of unlisted
subsidiaries must be placed before the board of the listed entity, and the management of the
subsidiary must periodically report all significant transactions and arrangements.
A transaction is considered significant if it exceeds or is likely to exceed ten percent of the total
revenues, expenses, assets, or liabilities of the unlisted subsidiary in the immediately preceding
accounting year. Further, a listed entity cannot dilute its shareholding below fifty percent or
lose control over a material subsidiary without a special resolution of shareholders, except
under approved schemes of arrangement or insolvency proceedings. Similarly, sale, disposal,
or leasing of assets exceeding twenty percent of the subsidiary’s assets requires prior
shareholder approval.
MUST WRITE IN EXAM: Regulation 24 ensures board oversight, disclosure, and
shareholder approval for major subsidiary actions.

Judicial and Regulatory Observations on RPT and Subsidiary Disclosures

In SEBI v. Kanaiyalal Baldevbhai Patel, the Supreme Court held that disclosure is the
cornerstone of securities regulation and clarified that SEBI regulations are preventive, not
merely punitive. The Court observed that disclosure failures directly undermine market
confidence.
In Price Waterhouse & Co. v. SEBI, the Securities Appellate Tribunal emphasized the
importance of true and fair disclosure in consolidated financial statements and held that
auditors must scrutinise RPTs and financials of unlisted subsidiaries. Disclosure failures at the
subsidiary level can attract regulatory action.
In the Eveready Industries India Ltd. matter, SEBI observed that a listed entity cannot escape
disclosure obligations by routing transactions through unlisted subsidiaries, reinforcing the
principle that substance prevails over form.
MUST WRITE IN EXAM: Courts and SEBI treat disclosure as the foundation of securities
regulation.

Why Corporate Governance Norms Apply to Unlisted Subsidiaries

Corporate governance requirements are extended to unlisted subsidiaries primarily to protect
public shareholders of the listed entity. Historically, unlisted subsidiaries were used as vehicles
for tunnelling, asset stripping, shifting liabilities, and executing abusive RPTs away from public
scrutiny. By extending disclosure and approval requirements, SEBI neutralises the so-called
“unlisted shield” and prevents promoter opportunism.
Modern corporate governance is based on the principle of substance over form, meaning that
economic reality matters more than legal structure. Since financial statements are consolidated
at the group level, risks also flow across entities, and therefore disclosure obligations must
operate at the group level. At the same time, over-regulation is avoided because only material
subsidiaries are subjected to these enhanced governance norms.
MUST WRITE IN EXAM: CG applies to unlisted subsidiaries to prevent tunnelling and
protect public shareholders.

Insider Trading: Concept and Importance in Corporate

Governance
Insider trading is treated seriously across jurisdictions because it is not merely a case of unfair
profit-making but is considered a serious offence affecting the integrity of the capital market.
It is classified as a market integrity offence because it undermines the fairness and transparency
on which securities markets function. Insider trading violates the principle of informational
equality, which means that all investors should have equal access to material information at the
same time. When some participants trade on unpublished price sensitive information, it
threatens investor confidence and distorts price discovery, which is the process by which the
market arrives at a fair price of securities.
MUST WRITE IN EXAM: Insider trading is a market integrity offence that violates
informational equality and undermines investor confidence.

Background: Asymmetric Information and Market Abuse

Capital markets often suffer from the problem of asymmetric information, which means a
situation where some participants possess information that others do not. This informational
imbalance creates a form of market power that can be exploited by those who have access to
information with greater depth, accuracy, and commercial value. Such information asymmetry
leads to unequal treatment of investors and allows insiders to manipulate or exploit the market
for personal gain. Insider trading arises precisely from this unequal access to information,
where insiders trade securities by leveraging insights gained while discharging their official or
professional duties.
Insider trading, therefore, involves trading in securities by insiders or connected persons who
have access to unpublished price sensitive information, commonly referred to as UPSI.
MUST WRITE IN EXAM: Insider trading exploits asymmetric information available only to
insiders.

Insider Trading under the SEBI Act, 1992

The statutory foundation for prohibition of insider trading in India is contained in Chapter VA
of the SEBI Act, 1992, titled “Prohibition of manipulative and deceptive devices, insider
trading and substantial acquisition of securities or control.” This chapter was inserted by the
SEBI (Amendment) Act, 2002 with effect from 29 October 2002.
Section 12A of the SEBI Act expressly prohibits any person from engaging in insider trading,
dealing in securities while in possession of material or non-public information, or
communicating such information to any other person in contravention of the Act or regulations.
This provision forms the statutory backbone of insider trading regulation in India.
MUST WRITE IN EXAM: Section 12A SEBI Act prohibits insider trading and dealing while
in possession of non-public information.

Penalties for Insider Trading under Section 15G

Section 15G of the SEBI Act prescribes stringent monetary penalties for insider trading. If an
insider deals in securities on the basis of unpublished price sensitive information,
communicates such information to another person, or counsels or procures another person to
trade on the basis of UPSI, such insider is liable to a penalty which shall not be less than ten
lakh rupees and may extend to twenty-five crore rupees or three times the amount of profits
made, whichever is higher. This provision reflects the deterrent approach adopted by SEBI to
curb insider trading.
MUST WRITE IN EXAM: Section 15G prescribes severe monetary penalties for insider
trading.

SEBI (Prohibition of Insider Trading) Regulations, 2015

In exercise of its rule-making powers, SEBI notified the SEBI (Prohibition of Insider
Trading) Regulations, 2015. These regulations define key concepts such as “connected
person,” “insider,” “trading,” and “unpublished price sensitive information,” though they
deliberately do not define insider trading itself.
The concept of insider trading was explained in the report of a high-level committee chaired
by former Chief Justice N.K. Sodhi, which described insider trading as trading in securities
with the advantage of having asymmetrical access to UPSI. Regulation 3 of the PIT Regulations
prohibits insiders from communicating, providing, or allowing access to UPSI to any person,
including other insiders, except where such communication is for legitimate purposes,
performance of duties, or discharge of legal obligations.
MUST WRITE IN EXAM: PIT Regulations, 2015 prohibit communication and use of UPSI
except for legitimate purposes.

Meaning of UPSI and Insider

Unpublished Price Sensitive Information (UPSI) refers to information that is not generally
available and which, upon becoming public, is likely to materially affect the price of securities.
An insider includes any connected person or any person in possession of or having access to
UPSI. The definition is intentionally broad to cover not only formal insiders like directors and
employees but also those who gain access through proximity or professional relationships.
MUST WRITE IN EXAM: UPSI is non-public information that can materially affect share
prices.

Shift from “Use” to “Possession” Standard

A significant shift occurred between the 1992 Regulations and the 2015 Regulations regarding
the standard of liability. The 1992 regime prohibited trading “on the basis of UPSI,” which
required proof that the information was actually used in making the trade. The 2015
Regulations moved to a possession-based standard, prohibiting trading “while in possession of
UPSI.”
This shift introduced a deeming fiction, meaning that possession of UPSI itself raises a
presumption of misuse. SEBI adopted this approach because proving actual use of information
is extremely difficult. While debates continue on whether possession-based liability is fair, the
shift reflects a preventive and market-protective approach.
MUST WRITE IN EXAM: 2015 Regulations adopt possession-based liability to strengthen
enforcement.

Defences and Safe Harbours against Insider Trading

The PIT Regulations recognize certain defences against insider trading allegations. These
include absence of UPSI at the time of trading, proof that the decision to trade was independent
and had no causal link with UPSI, trading pursuant to a pre-disclosed trading plan, and the
information barrier defence (Chinese Wall), which refers to internal controls preventing
information flow between departments. Confidentiality safeguards and the argument that no
profit or unfair advantage was gained are also relevant considerations under Section 15(j) of
the SEBI Act.
MUST WRITE IN EXAM: Trading plans and Chinese Walls act as defences against insider
trading.

Nature of Liability under PIT Regulations

The PIT Regulations, 2015 do not prescribe criminal liability and are largely civil and
regulatory in nature. This aligns with the modern trend towards decriminalisation of corporate
law. Notably, the SEBI Act does not itself define insider or insider trading, which appears to be
a deliberate legislative choice. Parliament left the task of defining and regulating insider trading
to SEBI, recognising it as an expert regulatory body in securities markets.
MUST WRITE IN EXAM: Insider trading liability under PIT Regulations is regulatory, not
criminal.

Shadow Trading and Emerging Developments

Traditionally, insider trading focused on trading in the securities of one’s own company, known
as the classical theory. Shadow trading represents an extension of the misappropriation theory,
where insiders misuse confidential information of one company to trade in the securities of
economically linked companies.
In SEC v. Matt Panuwat, US regulators argued that confidential information of one company
could be material to similarly situated companies in highly concentrated markets. This case
reflects a global trend towards expanding the scope of insider trading regulation.
MUST WRITE IN EXAM: Shadow trading extends insider trading to economically linked
companies.

Insider Trading Case Study: Rajat Gupta and Rajaratnam

The case involving Rajat Gupta and Rajaratnam is a classic illustration of insider trading. Rajat
Gupta, a former managing director of McKinsey & Company, held board positions at major
corporations such as Goldman Sachs and Procter & Gamble. Through these roles, he had access
to material UPSI relating to mergers, acquisitions, and quarterly earnings.
Gupta leaked this information to Rajaratnam, the founder of the Galleon Group hedge fund,
who used it to make substantial profits by trading in securities before the information became
public. This case demonstrated how board-level access to UPSI can be misused and highlighted
the importance of strict fiduciary duties and confidentiality obligations.
MUST WRITE IN EXAM: Rajat Gupta case illustrates misuse of UPSI by a board-level
insider.