Chapter Twelve

Role of Various Agencies in Ensuring Ethics in Corporations

INTRODUCTION

If corporations have to function ethically and serve not only their stockholders, but also cater to
the needs of all stakeholders, there has to be both an internal system and an external framework
kept in place to ensure these ideals. There are several companies that work ethically because
their top brass, starting with the boards to directors and CEOs want them to be so. They know
that running an organization ethically and as per the norms of corporate governance, will cost
them money which cannot be retrieved in a short period. Investments on ethical practices bear
fruit, but slowly, though surely. They have a long gestation period. Ultimately, such investments
result in long-term shareholder value. But, there are other entrepreneurs who are not convinced
that these investments are worth the risk or worth the wait. They may not guide their
organizations to act within the ethical framework on their own. But they have to be made to
understand the importance and imperatives of following ethical practices in the larger interests of
the society if they are not convinced about it. To make them follow the norms of ethical and
corporate governance which are the minimum requirements to ensure corporate democracy, an
external framework has to be evolved and kept in place. Such a framework consisting of various
agencies are discussed in this chapter.

PUBLIC OPINION

In a democracy, public opinion is a strong instrument to bring about ethical practices among
corporations. Several laws have been enacted to regulate business as a result of public pressure
on law-makers. Greater transparency, better disclosure of financial and non-financial information
has been made an absolute necessity ‘among corporations because of hardening public opinion’.
Likewise, corporations have been made environment-conscious because of public demand.
Several companies in the United States and Europe were made to recall their products because of
public pressure. Organizations like Greenpeace, Ralph Nader’s consumer protection movement,
etc. were able to mobilize public opinion and were able to achieve their objectives through public
pressure. In India though public opinion has not been sufficiently mobilized on various issues
due to widespread illiteracy and lack of knowledge on various socio-economic issues, among the
populace, the spectacular growth of media in recent times has made a considerable impact. A
number of scams in which investors lost a large sum of money resulted in public opinion
hardening against the wrongdoing corporations. The Securities and Exchange Board of India
(SEBI) was forced to take corrective measures against banking and non-banking finance
companies when they were unable to pay back depositors’ money.

ROLE OF AUDITORS IN ENSURING BUSINESS ETHICS

Ethics and values get short shrift in business in two ways; first, by the failure of management and
second, by the failure of auditors.
Recent unearthing of corporate frauds both in developed countries and in developing and
transition economies revealed the fact that auditors had failed to do what they were assigned to
do. They involved themselves in unethical practices and failed to whistle-blow when things went
wrong in the organizations where they were engaged as auditors.

Role of Auditors

The allegation that annual reports presented by companies today lack truthfulness and
transparency need not be dealt with in great detail. Window-dressing, manipulation of profit and
loss accounts, hedging and fudging of unexplainable expenditures and resorting to continuous
upward revaluation of assets to conceal poor performance are malpractices companies resort to
with the help of obliging auditing firms. Instances are galore where obliging auditors have
helped companies falsify accounts and in window-dressing for small monetary gains.

Defining Audit

The Institute of Chartered Accountants of India (ICAI) has defined audit as, “… The
independent examination of any entity, whether profit oriented or not and irrespective of its size
or legal form, when such an examination is conducted with a view to expressing an opinion
thereon”.1 Auditing is the process by which a competent independent person objectively obtains
and evaluates evidence regarding assertions about an economic activity or event for the purpose
of forming an opinion about and reporting on the degree to which the assertion conforms to an
identical set of standards.

Objectives of an Audit

“The objective of an audit of financial statements is to enable an auditor to express an opinion on

financial statements which are prepared within a framework of recognised accounting policies
and practices and relevant statutory requirements”.2

Defining Auditor

An auditor is defined as a person appointed by a company to perform an audit. He or she is

required to certify that the accounts produced by his client companies have been prepared in
accordance with normal accounting standards and represent a true and fair view of the company.
Usually, chartered accountants are appointed as auditors.

An auditor is a representative of the shareholders, forming a link between the government

agencies, stockholders, investors and creditors.

Types of Auditors

There are three types of auditors.

Internal Auditors Internal auditors are employed by an organization for which they perform
audits. Their responsibilities vary and may include financial statement audits, compliance audits
and operational audits. They may assist the external auditors in completing the financial
statement audit or perform audits for use by management within the entity.

An organization may have a small or very large internal audit staff. They cannot be independent
as long as the employer-employee relationship exists.

Independent Auditors Independent auditors are usually members of what is referred to as CPA
(certified public accountants) firms. The opinion of an independent auditor about financial
statements makes the statements more credible to investors, bankers, labour unions, government
agencies and the general public.

Government Auditors Government auditors work in various local, state and federal or central
government agencies performing financial, compliance and operational audits. Local and state
governments, for example, employ auditors to verify that businesses collect and remit sales taxes
and excise duties as required by law.

Duties of an Auditor

The duties of an auditor are defined under Section 227 (1A) of the Companies Act 1956.

It says that an auditor can enquire

 whether loans and advances made by the company on the basis of security have been
properly secured;
 whether transactions of the company which are represented merely by book entries are
not prejudicial to the interests of the company;
 where the company is not an investment company within the meaning of Section 372 or a
banking company, whether so much of the assets of the company as consist of shares,
debentures and other securities have been sold at a price less than that at which they were
purchased by the company;
 whether loans and advances made by the company have been shown as deposits; and
 whether personal expenses have been charged to revenue account.

Responsibilities of Auditors

As per the Standard Auditing Practices (2) of the ICAI, an auditor

 is responsible for forming and expressing his or her opinion on the financial statements.
He or she assesses the reliability and sufficiency of the information contained in the
underlying accounting records and other source data by making a study and evaluation of
accounting systems and internal controls.
 determines whether the relevant information is properly disclosed in the financial
statements by comparing the financial statements with the underlying accounting records
and other source data, to see whether they properly summarize the transactions and
events recorded.
  has to ensure that his or her work involves exercise of judgment, as for example, in
deciding the extent of audit procedures and in assessing the reasonableness of the
judgments and estimates made by the management in preparing the financial statements.
 is not expected to perform duties which fall outside the scope of his or her competence.
For example, the professional skill required of an auditor does not include that of a
technical expert for determining the physical condition of certain assets.

Audit Failures Leading to Corporate Scams

In December 2001, in what is termed as the biggest bankruptcy in US history, the Houston-based
transnational trader of natural gas and power, Enron Corporation, filed for bankruptcy under
Chapter 11, and downward restatement of earnings of US$ 500 million.

The mega corporation’s auditor, Arthur Andersen, the fifth largest audit and consultancy firm
worldwide and a member of the Big Five league, also faced investigation by the Securities and
Exchange Commission (SEC) for fudging and shredding official documents and for not being
able to detect accounting jugglery undertaken by Enron. However, Arthur Andersen blamed
Enron for not providing complete information.

 In May 2001, Arthur Andersen connived with its client, Sunbeam Corporation for
financial fraud and fudging of accounts.
 In June 2001, an American Superior Court fined Arthur Andersen towards damages to
shareholders for certifying false statements of accounts of Waste Management Inc. Three
of Arthur Andersen’s partners were fined between US$ 30,000 and 50,000 each and
banned from auditing work for three to five years.
 Deloitte & Touche also landed in trouble in 2002 for applying a valuation model for fast-
food franchisees which misled bankers into extending credit to unworthy clients and
incurring a colossal bad debt of US$ 10 billion.
 In 1999, another reputed US-based accounting firm, Ernst & Young paid US$ 335
million to a client to settle a lawsuit related to accounting problems.
 Another American auditing firm, KPMG attracted censure from SEC for engaging in
improper professional practice. While serving as an audit firm for Short Term Investment
Trust, it also made substantial investments in it. Its money-market account, opened in
May 2000, with an initial deposit of US$ 25 million, constituted 15 of the Trust’s net
assets at one point in time.

The Enron Debacle

The collapse of Enron, indicated by a corresponding collapse in market capitalization, is not

solely due to losses incurred; the real reason is the collapse of public confidence in the process of
examining a company’s health by auditors because audit firms are considered to be watchdogs of
a company’s financial and accounting practices and their signatures certify what is considered to
be the ‘true and fair value’ of financial statements. Enron’s auditor, Arthur Andersen failed in its
duty and falsely certified and authenticated the company’s Strategic Cost Management’s raised-
up financial statements. It was common knowledge that Andersen was paid by Enron US$ 25
million in audit fees and US$ 26 million in non-audit services fees and was therefore one of his
biggest clients.3 The partners of the auditing firm also tried to rescue Enron by shredding its
document even though the Securities and Exchange Commission started investigating the
irregularities committed by the errant firm. Though Andersen paid a heavy price for its deviant
behaviour, investors’ confidence in the securities market was irretrievably lost, and their faith in
the auditing profession was badly shaken.

Establishment of Public Company Accounting Oversight Board (PCAOB)

The Sarbanes-Oxley Act (SOX) was passed by the US Congress in 2002 with a view to
protecting investors from the fraudulent accounting practices of corporations. The SOX Act
created a new board consisting of five members of whom only two will be CPAs. All accounting
firms will have to register themselves with the board and submit inter alia particulars of fees
received from corporations for audit and non-audit services, financial information about the
auditing firm, and a list of its staff who participate in the audit. The PCAOB will establish rules
governing audit, ethics and the firm’s independence.

Audit Committee

The act provides for a new improved Audit Committee. The members of the committee are
drawn from among the directors of the board of the company, but it should be the independent
directors.

Audit Partner Rotation

The act provides for mandatory rotation of the lead audit partner and the partner reviewing audit
every five years.

Conflict of Interest

Public accounting firms should not perform any audit service for a publicly traded company if its
CEO, CFO, controller, CAO or any person serving in an equivalent position was employed by
such firm and participated in any capacity in the audit of that company during the 1-year period
preceding the date of the initiation of the audit.

Prohibition of Non-Audit Services

Auditors are prohibited from providing non-audit services concurrently with audit review
services. Non audit services include book-keeping, financial and information system design,
internal audit, HRD services, investment advice, investment banking services, legal advice,
appraisal, valuation and actuarial services.

Attempts to Prevent Fraudulent Auditing Practices

Till date, four committees played a vital role in framing the responsibilities of the auditors and
the audit committees: The R. D. Joshi Committee, the Kumar Mangalam Birla Committee, the
Naryana Murthy Committee and the Naresh Chandra Committee. All these committees’
recommendations focused mainly on the following aspects of auditing: formation of the audit
committee, their responsibilities, rotation of auditors, prohibition of non-audit services and the
transparency of financial statement.

Audit Committee

An audit committee is a committee consisting of independent directors. It is responsible for

appointment, fixing of fees and oversight of the work of independent auditors. The committee is
also responsible for establishing and reviewing the procedures for the receipt, treatment of
accounts, internal control and audit complaints.

The audit committee, according to the aforementioned four committees which recommended it,
should review the following information:

 financial statements and draft audit reports, including quarterly/half yearly information;
 management discussion and analysis of financial conditions and the results of operations;
 report relating to compliance with laws and risk management;
 management letters/letters of internal control weakness issued by statutory and internal
auditors; and
 records of related pay transactions.

Independence of Auditors

The Naresh Chandra Committee insisted much on auditor’s independence in the following lines:

1. Prohibition of direct financial interest in the audit client by the audit firms, its partners or
members of the engagement team as well as their direct relatives.
2. Prohibition of receiving any loan and or guarantees from or on behalf of the audit client
by the audit firm, its partners or any member of the engagement team and their direct
relatives.
3. Prohibition of business relationship with the audit client by the audit firm and other
associated persons as mentioned above.
4. Prohibition of audit partners and other associated persons from joining an audit client or
key personnel of the audit client wanting to join the audit firm, for a period of two years
from the time they were involved in the preparation of accounts and audits of the client.
5. Prohibition of undue dependence on audit client by ensuring that fees received by a firm
from any one client and its subsidiaries and affiliates should not exceed 25 per cent of the
total revenue of the audit firm, providing certain exceptions in case of small audit firms.
6. Prohibiting audit firms from performing certain non-audit-services.

Disclosures

Full disclosures of accounts and decisions of management involving the funds of the company to
all its stakeholders is a desiderata of good corporate culture. The R. D. Joshi Committee has
suggested the imposition of responsibility on the auditors to check and, report diversion, under
utilization or misappropriation of funds by companies. The Naresh Chandra Committee has
recommended that the auditors should disclose implications of contingent liabilities so that the
investors and shareholders have a clear picture of these.

Penalties

Under section 539 of the Companies Act 1956, if an auditor is found to be involved in unethical
practices, he or she will be punishable with imprisonment for a term which may extend to seven
years and shall also be liable to a fine.

Under Section 21 of the Chartered Accountants Act, it is said that the auditor will be prevented
from exercising his or her duty and his or her license will be cancelled by ICAI.

All these clearly reveal that there are enough regulations in the rule book to ensure that auditing
firms do their job ethically and help in protecting shareholders. But there are many lapses on
their part which hardly attract penalties.

ROLE OF BOARD OF DIRECTORS IN ENSURING ETHICAL BUSINESS

The separation of ownership from active direction and management is an essential feature of the
company form of organization. To manage the affairs of the company, shareholders elect their
representatives called the ‘Directors’ of the company. A number of such directors constitute the
‘Board of Directors’. The board generally has only part-time directors.

Who Is a Director?

Section 2 (13) of the Companies Act defines a director as follows: “A director includes any
person occupying the position of director by whatever name called. The important factor to
determine whether a person is or is not a director is to refer to the nature of the office and its
duties. It does not matter by what name he is called, if he performs the functions of a director”.4

Section 2(6) of the Companies Act states that directors are collectively referred to as the ‘Board
of Directors’ or simply the ‘board’.

Legal Position of a Director They have been described variously as agents, trustees, or
managing partners of the company. The legal position of the directors as agents and trustees
emanate from the fact that a company being an artificial person cannot act in its own person. It
has become a well-settled fact now that directors are not only agents but also act as trustees as a
result of several court decisions in India and England.

Duties and Responsibilities of Directors The directors have certain duties to discharge. These
are (i) fiduciary duties (ii) duties of care, skill and diligence; (iii) duties to attend board meetings;
(iv) and duties not to delegate their functions except to the extent authorized by the act or the
constitution of the company and to disclose his or her interest.
Qualifications and Disqualifications of Directors No body corporate, association or firm can be
appointed directors of a company. A director must (a) be an individual; (b) be competent to enter
into a contract; and (c) hold a share qualification if so required by the Articles of Association.

The following persons are disqualified for appointment as directors (i) A person of unsound
mind; (ii) an undischarged insolvent or one whose petition for declaring himself so is pending in
a court; (iii) a person who has been convicted by a court for any offence involving moral
turpitude; (iv) a person whose calls in respect of shares of the company held for more than six
months have been in arrears; and (v) a person who is disqualified for appointment as director by
an order of the court on grounds of fraud or misfeasance in relation to the company. Directors
can be removed from office by (i) the shareholders; (ii) the central (federal) government; and (iii)
the Company Law Board.

Board of Directors The board of directors of a company, which includes all the directors elected
by shareholders to represent their interests, is vested with the powers of management. The board
has extensive powers to manage the company, delegate its power and authority to executives and
carry on all activities to promote the interests of the company and its shareholders, subject to
certain restrictions imposed by public authorities. The board of directors of a company is
authorized to exercise such powers and to perform all such acts and things as the company is
entitled to, subject to two conditions: (1) The board shall not do any act which is to be done by
the company in the general meeting of shareholders; and (2) The board shall exercise its powers
subject to the provisions contained in the articles or the memorandum or in the federal acts
concerned with companies or any regulation made by the company in any general meeting.

Power of the Board Board of directors shall exercise the following powers:

1. make calls on shareholders in respect of money unpaid on their shares;

2. issue debentures;
3. borrow money otherwise (for example, through public deposits);
4. invest the funds of the company; and
5. make loans.

The board of directors also can exercise certain other powers as listed below with the consent of
the company in general meeting, as in the case of an amalgamation scheme:

1. to sell, lease or otherwise dispose of the whole or substantially the whole, of the
undertaking of the company;
2. to remit or give time for repayment of any debt due to the company by a director except
in the case of renewal or continuance of an advance made by the banking company to its
director in the ordinary course of business;
3. to borrow in excess of capital;
4. to contribute to charitable and other funds not relating to the business of the company or
the welfare of its employees beyond a specified amount;
5. to invest compensation amounts received on compulsory acquisition of any of company
properties; and
6. to appoint a sole selling agent.
Nominee Directors A nominee director is generally appointed in a company to ensure that the
affairs of the company are conducted in a manner dictated by the laws governing companies and
to ensure good corporate governance. A nominee director, as an affiliated director, is nominated
to ensure that the interests of the institution which he or she represents are duly or effectively
safeguarded. Kumar Mangalam Birla Committee on Corporate Governance suggested that
financial institutions should not have their nominee directors on the boards of assisted
companies.

Liabilities of Directors Directors of a company may be held liable under the following
situations:

1. Directors of a company may be liable to third parties in connection with the issue of a
prospectus, which does not contain the particulars required under the Companies Act or
which contains material misrepresentations;
2. Directors may also incur personal liability under the Act
1. on their failure to repay application money if minimum subscription has not been
subscribed;
2. on an irregular allotment of shares to an allottee (and likewise to the company) if
loss or damage is sustained;
3. on their failure to repay application money if the application for the securities to
be dealt in on a recognized stock exchange is not made or refused; and
4. on failure by the company to pay a bill of exchange, hundi, promissory note,
cheque or order for money or goods wherein the name of the company is not
mentioned in legible characters.

Directors’ Liability to the Company Apart from director’s liability to third parties, they are
primarily liable to the company in the following cases:

1. Ultra vires acts: Directors are personally liable to the company in matters of illegal acts.
2. Negligence: A director may be held liable for negligence in the exercise of his or her
duties.
3. Breach of trust: They are liable to the company for any material loss on account of the
breach of trust.
4. Misfeasance: Directors are liable to the company for misfeasance, that is, willful
misconduct.

Liability for Breach of Statutory Duties The Companies Act imposes penalty upon the directors
for not complying with or contravening the provisions of the Act, which include sections on
criminal liability for misstatements in prospectus, penalty for fraudulently inducing persons to
invest money, purchase by a company of its own shares, concealment of names of creditors
entitled to object to reduction of capital, penalty for default in filing with the registrar for
registration of the particulars of any charge created by the company.

Disabilities of Directors In order to protect the interest of a company and its shareholders, the
Companies Act has placed the following disabilities on the directors:
 1. Any provision in the articles or an agreement which exempts a director (including any
officer of the company or an auditor) from any liability on account of any negligence,
default, misfeasance, breach of duty or breach of trust by him or her shall be wholly void.
2. An undischarged insolvent shall not be appointed to act as director of any company or in
any way to take part in the management of any company.
3. No person shall hold office at the same time as director in more than 15 companies.
4. A company shall not without obtaining the previous approval of the central government
in that behalf, directly or indirectly make any loan to
1. any director of the lending company or of a company which is its holding
company or any partner or relative of any such director;
2. any firm in which any such director or relative is a partner;
3. any private company of which any such director is a director or member;
4. any body corporate at a general meeting of which not less than 25 per cent of the
total voting power may be exercised or controlled by any such director; or
5. any body corporate, the board of directors, managing director, or manager
whereof is accustomed to act in accordance with the directions or instructions of
the board, or of any director or directors of the lending company.
5. Except with the consent of the board of directors of a company, a director of the company
or his relative, a firm in which such a director or relative is a partner, any other partner, in
such a firm, or a private company of which the director is a member or director, shall not
enter into any contract with the company.
1. for the sale, purchase or supply of any goods, materials or services; or
2. for underwriting the subscription of any shares in, or debentures of, the company.
6. A director shall not assign his or her office. If he or she does, the assignment shall be
void.

Effectiveness of the Board of Directors Though the board is recognized legally as the top layer
of management with the responsibility of governing the enterprise, in actual practice, the board
of directors delegates most of its managerial power to chief executives—say, the managing
director or manager. In many cases, the board appoints many committees and clothes them with
its power.

The realistic functions of the board may, therefore, be enumerated as follows:

1. Confirming management decisions on major changes in objectives, policies, and those

transactions which will have a substantial effect on the success of the company;
2. Providing constructive advice to the executives through discussion on important matters
such as business outlook, new governmental legislation, wage policy, etc., with a view to
guiding the executives when the policies are still in the process of formation;
3. Selecting the chief executives and confirming the selection of the other executives in the
company made by chief executives; and
4. Reviewing the results of current operations.

The effectiveness of the board can be tested in the manner in which it is able to provide strategy,
policy and guidance to the corporation’s top management, which in turn ensures better corporate
governance practices. Undoubtedly, the quality of directors, their competence, commitment,
willingness and ability to assume a high degree of obligation to the company and its shareholders
as members of the board alone drives the value of any board. A strategic board with broad
governing responsibilities rather than one that acts in response to the demands of the CEO has
become the need of an intensely competitive world.

It is generally agreed that a good Board should have the following characteristics:

1. The board should be of small size. This will ensure deep involvement of directors on the
issues concerning the company.
2. If a board has to be both effective and objective, it should have a good number of
independent directors.
3. The directors of the board should have varied expertise and experience, besides having
diverse ethnic and cultural backgrounds.
4. A strategic board is a well-informed board. They should get intelligent, timely and
accurate information on various issues in which they are called upon to decide.
5. Most importantly, the board should have a longer vision and broader responsibility.

Responsibilities of Directors

1. An efficient and independent board should be conscious of protecting the interests of all
stakeholders and not be concerned too much with the current price of the stock.
2. Another important function of the director is to set priorities and to ensure that these are
acted upon.
3. A director is also expected to have the courage of conviction to disagree.
4. Directors have great responsibility in the matter of employment and dismissal of the
CEO.
5. One of the toughest challenges confronted by boards arises while approving acquisitions.
6. An efficient board should be able to anticipate business events that would spell success or
lead to disaster if proper measures are not adopted in time.
7. The directors have a duty to act bona fide for the benefit of the company as a whole.
8. In recent times, those who advocate reform of laws governing corporate practices stress
the importance of reformulation of the concepts behind these laws.

Independent Directors

Who is an independent director?

There have been several discussions and debates in corporate circles and among academicians in
recent times on the need for, role of, and importance of independent directors. An independent
director is defined as a “non-executive director who is free from any business or other
relationship which could materially interfere with the exercise of their independent judgement”.5

The Companies Act provides a negative definition of an independent director, inasmuch as it

renders ineligible 11 categories of persons to be appointed as independent directors in a
company. For instance, a person who has held any post in a company at any point of time is
disqualified to be independent director of the company. Likewise, any vendor, supplier or
customer of goods and services of the company would stand disqualified, notwithstanding the
fact that the amounts of transaction are insignificant.6

Desirability of Having Independent Directors Recent literature on corporate governance is

replete with recommendations of various committees on the desirability of having non-executive,
independent directors on the boards of companies to promote better corporate governance
practices. The Cadbury Report identifies two areas where non-executive directors can make an
important contribution to the governance process as a consequence of their independence from
executive responsibility. First, reviewing the performance of executive management. Second,
taking the lead where potential conflicts of interest arise, as for instance, fixing the CEO’s salary
and perquisites, or dealing with board room succession. Apart from these, independent directors,
being non-executives with no vested interest, can bring in objectivity to the board’s decision
making process. Opinions vary on how many independent non-executive directors are required
to achieve good corporate governance practice. The UK Combined Code recommended that non-
executive directors should make up at least one-third of the board and that a majority of them
should be independent. The IFSA Guidelines and the Toronto Report recommend a higher
standard that a majority of directors should be independent non-executives. IFSA argues that a
majority of directors should be genuinely independent in order to ensure that the board has the
power to implement decisions contrary to the wishes of management or a major shareholder, if
and when the need arises. IFSA contends that this creates “a more desirable board culture” and
imposes a responsibility on the independent majority to be “especially competent and diligent’’
in carrying out their role.

The Indian capital market regulator, SEBI has recently amended Clause 49 of the listing
agreement to ensure that independent directors account for at least 50 per cent of the board of
directors of listed companies, where an executive chairman heads the board. However, if the
chairman is a non-executrive director, at least one-third of the board should consist of
independent directors. Several US sets of guidelines prescribe even more numbers of these
directors. CalPERS Guidelines recommend that a substantial majority of board members should
be independent directors.

Family-Owned Businesses and Business Ethics

The board of directors, including chairmen and managing directors in family-owned businesses,
consisted of family members with a couple of directors from funding financial institutions and
perhaps a couple of outside passive directors. In such cases, the board nods its head for all
decisions of the CEO who may promote his/his family interests and may not be interested in
promoting long-term shareholder value. However, many family-owned corporations are fast
changing their profiles and are introducing professionalism both in their boards and
managements.

Some Pioneering Indian Boards

1. The foray of Infosys Technologies into consultancy and business process outsourcing
(BPO) from its original profile of just a services company was prompted by its proactive
board.
 2. The Industrial Credit and Investment Corporation of India (ICICI), has an active board.
The board initiated and helped actively the merger of the ICICI and its banking arm. The
ICICI Bank also insists that its middle-level managers make presentations to the board
regularly.
3. The board of the fast-growing Chennai-based pharmaceutical company, Orchid
Chemicals and Pharmaceuticals Ltd, directed its managing director to seek the advice of
the international consultant, McKinsey and Co. on his growth strategy for the company.
4. The board of Chennai-based Polaris Software Lab forced its chairman and managing
director not to acquire any new business at the peak of dotcom boom, but instead to
consolidate the company’s business.
5. Godrej Consumer Products consulted the Confederation of Indian Industry (CII) for
forming its board. The CII advised the company to choose independent professionals and
not industrialists.

In the new era, the board of directors has to shoulder larger responsibilities to meet the
increasing demand of the market place.

The board of directors is expected to play a powerful role in such a metamorphosis the world is
waiting to witness.

MEDIA AND BUSINESS ETHICS

The media can play a role in ensuring ethical business by affecting reputation in at least three
ways.

First, media attention can drive politicians to introduce corporate law reforms or enforce
corporate laws in the belief that inaction would hurt their future political careers or shame them
in the eyes of public opinion, both at home and abroad.

Second, media attention could affect reputation through the standard channel that most economic
models emphasize. Managers’ wages in the future depend on shareholders’ and future
employers’ beliefs about whether the managers will attend to their interests in those situations
where they cannot be monitored. This concern about a monetary penalty can lead mangers not to
take advantage of opportunities for self-dealing so as to create a belief that they are good
managers.

Third, media attention affects not only managers’ and board members’ reputations in the eyes of
shareholders and future employers, but also affects their reputation in the eyes of society at large.

Thus, the media does play a role in shaping the public image of corporate managers and
directors, and in so doing they pressure the managers and directors to behave according to
societal norms.

At times, the power of the media is so much that a change takes place even in the absence of any
legal requirement to act or legal liability not to act. For example, the Karunanidhi arrest incident
of June 2001, where the police, in order to maintain a law and order situation, had to release the
police tapes, which otherwise is very confidential and not meant for public viewing.7

Apart from all these, media attention of a good deed performed by a corporate will have great
impact because of public recognition and enhanced reputation would motivate it to continue its
good work. It also will prompt others follow the good example. Likewise, media’s condemnation
of bad deeds too has an impact on the wrong doer. A recent heading in The Hindu “When Trees
Get New Environs” announced that “Many builders now prefer to transplant trees instead of
axing them” has spurred a number of builders to spare the trees at their construction sites and
transplant them elsewhere, instead of axing them, as was done in the past.8

Corporate Advertising

Advertising in India is a big business, though small compared to the United States and Europe.
The main lacuna is that there is no agency or a regulator which has the teeth to control
advertising. Advertising business is constantly bombarded by criticism. It is accused of
encouraging materialism and over consumption, of stereotyping, of causing people to purchase
items for which they have no need, of taking undue advantage of children, of manipulating
people’s behaviour, using sex to sell, and generally contributing to the downfall of our social
system.

Advertising plays a crucial role as a source of information. However, it is seen that this vital tool
of knowledge is often misused by unscrupulous elements for nefarious ends through
misrepresentation and withholding relevant facts.

Harms of Using Advertisement as a Media Tool

Sometimes, the information function of media can be subverted by advertisers’ pressure upon
publications not to treat questions that might prove embarrassing or inconvenient. “More often,
though, advertising is used not simply to inform but to persuade and motivate—to convince
people to act in certain ways: buy certain products or services, patronize certain institutions, and
the like”.9

From a policy perspective, this evidence on the importance of media in ensuring ethical
behaviour among corporations has two important consequences.

First, previous research had mostly focused on the legal and contractual aspects of ethical
corporate governance. Research suggests that this focus should be broadened, and that the policy
debate should undergo a similar shift in focus.

Second, the press pressures managers to act not just in shareholders’ interest, but in a publicly
acceptable way. This finding brings the role of societal norms to the forefront of the corporate
governance debate. The role of these norms has been ignored with a few notable exceptions. This
may present an opportunity for reformers to increase communication about behaviour that
violates norms for effective corporate governance. However, they might also represent a major
obstacle to any attempt to improve a country’s corporate governance system. In countries where
dismissing workers to increase profits is viewed negatively, creating the incentives for managers
to do so will be extremely difficult, especially in highly visible companies. This should be
openly considered in any realistic plan to reform a country’s corporate governance system.

Corporate Ethics and the Press

Shareholder Activists and the Press10 Shareholder activists led by Robert Monks and Neil
Minnow in the United States have partnered with the press to establish legitimate rights of
shareholders. This confirms that the press can and does play an influential role if it wants to
uphold the rights of groups like investors. But, is it possible for activists to get the same rights of
investors established in emerging markets with the help of the press?

It has been found in cases like the Republic of Korea that it is indeed possible. Events that took
place there confirm that the press can and does play an influential role if it wants to promote a
cause. In South Korea where large firms known as chaebol deny investors their legitimate rights
by flaunting their well-entrenched position and strength. National corporate laws convey few
rights to outside investors—they score only 2 out of 5 in La Porta and others’ (1998) index that
measures the strength of protection for minority shareholders—and expectations in relation to
law enforcement are low.

The genesis of attempts to bring about a positive change in Korean corporate culture can be
traced to 1996 with the establishment of the Peoples Solidarity for Participating Democracies
(PSPD), spearheaded by an activist Jang Ha-Sung of Korea University. This investor-activist has
devoted all his attention on changing corporate policies in the largest Korean firms relying on (1)
legal pressures such as proxy battles, criminal suits and derivative suits; and (2) use of the press
to put to shame company executives to goad them to change their policies. Moreover, strong
public opinion created against corporate misdeeds and the resultant pressure on violators to
change ways for the better has contributed to the success achieved in this direction in South
Korea.

The success achieved through the partnership between the press and public opinion and the
pressures thereon stand in sharp contrast to failed legal actions.

Institutional Investors Though institutional investors have many legal remedies to encourage
investor friendly corporate policies, the presence of an active press substantially enhances their
influence by offering them relatively inexpensive means to impose penalties on companies. It
also helps the investors to coordinate the response of other stake holders for availing potential
legal protection.

Private and Government Regulators Public opinion generated by an active press also forces
private sector organizations to use self-regulation to improve corporate governance. Consider the
approach in the United Kingdom to the range of financial scandals of the 1980s, including the
collapse of the Bank of Credit and Commerce International and the Maxwell Group. Instead of
legislation that proscribed certain activities matched by court sanctions and fines, the United
Kingdom pursued self-regulation, enforced through disclosure. The Cadbury Commission,
dominated by the private sector, defined corporate governance standards and developed
mechanisms to compel the disclosure of performance relative to standards, allowing the force of
public pressure generated by disclosure and news stories to change practices. This publicity route
had the advantage that the self-regulatory organization had the power to impose the standards,
and the penalty could be introduced quickly. Alternative sanctions, such as fines and court-
enforced penalties, were either unavailable or could be delayed through court proceedings,
thereby limiting their effectiveness.

The Cadbury Commission, which issued its report in December 1992, was the first effort at
reform by means of disclosure and public pressure. The key element of the report was a code of
best practice with 19 recommendations, including an enhanced role for independent directors, a
minimum number of independent directors, and the separation of the roles of the chair and the
CEO. Since 1993 the London Stock Exchange has made a requirement of listing that a company
include a statement of performance relative to the code and a written explanation for any
variation in its annual reports. It has since become common practice for company statements
issued to the press and for independent press reports to identify performance relative to code
standards, with a lack of compliance described largely as a failure of corporate governance by
the company and its directors. A similar approach regarding company practices towards
executive compensation was adopted in the Greenbury report, issued in July 1995, and in the
Hampel report, released in January 1998. All these best practices have been consolidated into a
‘supercode’ published by the London Stock Exchange in June 1998, again with requirements for
disclosure rather than compliance.

The extent and success of a disclosure and publicity approach is widespread. In Hong Kong
(China) the stock exchange has historically not had the legal authority to impose penalties on
companies that misbehave. Instead, it uses the media as a sanction, taking out advertising space
to notify the public about a firm’s security violations. The threat is usually enough. Shaming is
both a personal penalty for the executives involved and may introduce a financial penalty if
others now update their beliefs about the reliability of the executives and company, and increase
their terms for financing projects suggested by the executives.

The Press Versus Other Mechanisms For Addressing Ethical Problems In some markets the
penalties that can be imposed by the press are at least as important as other mechanisms for
fighting mis-governance that the literature more commonly focuses on. Consistent with this
contention is a recent survey in Malaysia that asked institutional investors and equity analysts to
identify the factors that were most important in assessing corporate governance and deciding to
invest in publicly listed corporations. The analysts thought that the frequency and nature of
public and press comments about the company were more important than a host of other factors
that receive more attention in academic debate, such as the company’s relationship with the
regulatory authorities, the number of independent non-executive directors and their
qualifications, the existence of remuneration and audit committees, and the identity of company
auditors.

Selective Coverage and Media Credibility

It is a well-known fact that media credibility, which is vitally important for enlisting public
support and for extending its reach, would suffer a setback if its credibility is not sustained in
peoples minds. People repose their faith in a newspaper or a journal to the extent that its news
coverage is credible or reliable. In India, for instance, frontline publications such as The Hindu
and The Economic Times have greater credibility than others because of their sustained attempt
to be truthful in their news coverage and reporting. Sometimes, a foreign publication is relied
more than local newspapers because of the former’s unbiased reporting. For instance, even in
countries such as Russia and Korea, reports that appear in The Financial Times have greater
credibility with the local populace than their own newspapers.

The issue of credibility is rather a delicate subject as it opens up the question of a publication’s
interest to follow certain leads in an investigation to establish the validity of information
obtained by it.

Often, the so-called investigative reporting may tend to be biased, because the reporter may try
to impose his or her personal views as part of his or her reporting. Moreover, there are
newspapers that are accused of carrying news items for, or against a particular issue based on
some pecuniary benefits that they are likely to gain. For instance, it is not abnormal in India for
state governments to deny advertisement supports to newspapers that do not toe their line.

It is well known that companies use advertistment support as a bait to influence stories either in
favour of them or against their competitors in the media.

These days in India, several top-notch B-schools such as the IIMs refuse to participate in national
level B-school rankings because the magazines that carry them seek advertisements costing huge
sums of money creating doubts in the minds of readers as to their credibility. Of course, such
practices could hurt the reputation of a newspaper or magazine in the long run.

Similarly, an independent newspaper whose survival rests solely on its own success is less likely
to collude with established business interests. By contrast, a newspaper owned by a business
group is naturally less likely to publish bad news about the group itself.11

ETHICS IN ADVERTISING

Advertising is one of the four major tools corporations use to direct persuasive communications
to target buyers and the public. They advertise to inform potential buyers of the existence of a
product and to establish a positive attitude about it. According to Aristotle, one of the basic
concepts in effective persuasion is to be ethical. Every advertiser needs to be ethical. “Ethical is
what my feelings tell me is right. Ethical means accepted standard norms in terms of your
personal and social welfare: What you believe is right”.12

For decades, broad social and economic issues have been raised concerning the role of
advertising in society. This is an era of the vigilant and well-informed consumer who wants to
know what is in a product, who produced it and under what working conditions. This is an era in
which corporations will have more lasting relationships with consumers than just marketing
products.
Social accusations have been directed at advertising in such pungent and imaginative terms that
they appear to emanate from talents as creative as those within the advertising community.
Advertising is said to destroy the finer things of life. It has been described by some as vulgar,
idiotic, degrading, shrill, noisy, blatant and aggressive. It is said to exalt lower values and glorify
mediocrity.

A number of humanities and social science scholars view advertising as intrusive and
environmental and its effects as inescapable and profound. They see it as reinforcing
materialism, cynicism, irrationality, selfishness, anxiety, social competitiveness, sexual
preoccupation, powerlessness and loss of self-respect. These are strong indictments which imply
that advertising is a powerful force.

Defenders of advertising argue that it has a beneficial effect on several basic areas such as these:

 Information: Advertising aids in the education of the general public; facilitates the
exercise of free choice and free will; and subsidizes mass communication providing
essential services to the public.
 Values and life-styles: Advertising contributes to the improvement in the standard of
living; it contributes to the sharing of opulence (comforts) among the masses; and
represents the essential factor in the economies of abundance.
 Creative experience: Advertising adds new and interesting experience to life.

Discussion on the ethical aspects of advertising can be organized around the various features
such as its social effects, its creation of consumer desires and its effects on consumer beliefs.

Adverse Effects of Advertising

Modern advertising agencies, exposed as they are to intense competition and the dire necessity to
showcase themselves as the best in the industry to corner business, often indulge in certain not so
ethical business practices. Some such practices are listed below.

Deception For example, a soft drink may be described as an orange drink, though it is artificially
flavoured.

Fear Factor The intent of the fear appeal is to create anxiety in the minds of the consumer and
provoke him or her to make use of a particular product to alleviate the fear in him or her. For
instance, an advertisement for a domestic security system shows a visual of a thief with a knife
knocking menacingly at the door, while an old lady with her grandchild stands petrified behind
the door, and then the security system and its uses are shown through visuals.

Advertising to Children Most of the advertisements such as those for chocolates, biscuits are
directed at children. Children between ages of 2 and 11 spend at least 3 hours a day watching
television. Secondly, preschool children cannot differentiate between commercials and
programmes. Most of these advertisements are deceptive as they omit significant information
such as the complexity and safety of operating toys.
Defenders of advertising to children offer the following positive effects:

1. Advertising gives product information to the child that assists him or her in making
decisions.
2. Children are developing skills through advertising and will be more independent and
make better selections among products targeted towards them.
3. Advertising is an influence on the process of socialization—it is a means whereby
children learn the value system and norms of the society they are entering.

Materialism Materialism is defined as a tendency to give undue importance to material interests

and objects. It leads to a sort of Mammon worship and a corresponding lessening of importance
to non-material interests such as love, freedom, and intellectual pursuits.

Promoting Stereotypes Advertising has contributed to stereotyping women. Nearly 90 per cent
of the advertisements show the woman as a housewife. Most of the advertisements portray only
beautiful girls thereby creating inferiority complex in the minds of plain Janes.

Advertising Alcoholic Beverages There is a national concern with the problem of alcoholism.
Children and youngsters are influenced by such advertisements.

Competitive Advertising Competitive advertising is a form of advertising in which two or more

brands of the same product are compared. Comparison is made in terms of one or more specific
attributes leading to consumer confusion and is ethically questionable.

Increasing Costs The ultimate burden of the cost of advertising is passed on to the consumer.

Exploiting Visual Appeals Men succumb to visual appeals, the use of bathing beauties to attract
men’s attention is ubiquitous. The huge success of Marilyn Monroe films for a couple of decades
in the 1950s that showcased her beauty is a clear example of this phenomenon.

“I’m the Best” Nearly all the advertisements contain some measure of exaggeration.

Absence of Full Disclosure For example, most of the advertisements catering to cooking oil do
not disclose the harmful effects such as increasing obesity of an individual by using the product.

Use of Celebrities Most of the advertisements use celebrities from the world of cinema or sports.
These celebrities would not have used the product even once.

Fantasy and Reality Nowadays, most of the advertisements make use of fantasies. For example,
the advertisement of a popular soft-drink shows a boy going in search of the drink in question
and later on lifts a bottle from a moving truck.

Advertising Standards

The code of the Advertising Standards Council of India expects, inter alia, that there will be:
 1. No offence to generally accepted norms of public decency.
2. Truthfulness and honesty in claims and representations.
3. No indiscriminate use of advertising for products which are hazardous to society or to
individuals.
4. References to eminent personalities/political figures and the use of national emblems are
not normally permitted.
5. Comparative advertising should respect the principles of fair competition generally
accepted in business.

Unfair Trade Practices Through Advertisements under the MRTP Act The following trade
practices are considered to be unfair practices.

Misleading Advertisement and False Representation These include

1. falsely representing that the goods are of a particular standard, quality, grade,
composition, style or mode;
2. falsely representing that the services are of a particular standard quality or grade;
3. falsely representing that the re-built, second-hand, renovated, reconditioned or old goods
are new goods;
4. representing that goods or services have sponsorship, approval, performance,
characteristics, accessories, uses or benefits they do not have;
5. representing that the seller or the supplier has a sponsorship, approval or affiliation he
does not have;
6. making false or misleading representation concerning the need for or the usefulness of
any goods or services;
7. making a representation to the public in the form of a warrantee or guarantee of the
performance, efficiency or length of life of a product or of goods that is not based on an
adequate and proper test there of, the proof of which lies upon the person making the
representation;
8. making a representation to the public in a form that purports to be
1. a warranty or guarantee of a product or of goods or services; or
2. a promise to replace, maintain or repair an article or any part thereof or to repeat
or continue a service until it has achieved a specified result, in such form of
purported warranty or guarantee or purpose materially misleading or if there is no
reasonable prospects that it will be carried out;
9. making a materially misleading representation to the public concerning the price at which
a product or like-products or goods have been, or are ordinarily sold; it includes
advertising for supply, at a bargain price, goods or services that are not intended to be
offered for supply at the price, for a period that is, and in quantities that are reasonable;
10. making false or misleading representation of facts disparaging the goods services or trade
of another person.

Recent Trends in Advertising The increase in competitiveness in the marketplace with several
new entrants has resulted in more aggressive advertising, giving rise to more intra-industry
complaints, plagiarism of advertisements published outside India, and advertisements on satellite
television channels in utter disregard of the Advertising Standards Council of India (ASCI) code.
What is more disturbing is the recent increase in vulgarity/obscenity in advertisements in various
media, including outdoor.

To conclude, it could be said that ethics in management should be of concern for all practising
managers, in all organizations, private, public, profit-making, non-profit, manufacturing, service
—in fact, the society as a whole. Ethics in advertising is essential for the betterment of the
business and the society at large.

Advertisements must be handled carefully and tastefully if and when they are aimed at a
vulnerable group (e.g., children, elderly people and uneducated people).

ROLE OF GOVERNMENT AGENCIES IN ENSURING ETHICAL PRACTICES

Modern governments even in Laissez-Faire capital societies have cornered enormous powers to
discipline corporations. They have the power to certify the incorporation of business; they can
penalize them for violation of the laws of the land; they can ensure that companies follow ethical
practices in the interests of all stakeholders; and they also have the power to recommend
dissolution of business.

In India, we have the Department of Company Affairs (DCA), the Ministry of Finance, the
Commerce and Industry Ministries that have powers to oversee corporate activities and take
corrective action against corporate misdemeanours. Additionally, there are regulators such as the
Reserve Bank of India (RBI), Telecom Regulatory Authority of India (TRAI) and Insurance
Regulatory and Development Authority (IRDA), which as creatures of public authorities have
the power and responsibility to monitor and supervise companies.

Apart from these public agencies, stock exchanges play a crucial role in ensuring business ethics
in corporations. All those companies that desire to trade stocks and shares through stock
exchanges with a view to ensuring enhanced market capitalization and wider reach, have to enter
into agreement with them. Among various other clauses, there is the famous Clause 49 which
binds corporations to follow ethical practices in their organizations. If they do not observe this
clause, companies will be de-listed.

ROLE OF THE JUDICIARY

The judicial system has an important role to play in ensuring better public governance and
corporate governance. There may be so many regulations, rules and procedures; but ultimately
when disputes arise, they have to be settled in a court of law. There could be, of course,
alternative dispute resolution mechanism such as conciliation or arbitration, but in countries like
India, it is the judiciary that has to step in and ensure that healthy practices prevail.

The basic framework of the Constitution in India depends on three main pillars, namely,
judiciary, executive and legislature. It is axiomatic that the basic structure of the constitution is
not to be tampered with. One of the areas in which the judiciary has been very active is to find
out whether any legislation that is passed or practised are in tune with the basic structure of the
constitution. This is an important characteristic of Indian judiciary and to that extent the judiciary
is found to be effective. It can be a guarantee not only for better public governance but also
better corporate governance.

ROLE OF SEBI IN ENSURING ETHICAL CORPORATE GOVERNANCE

Establishment of SEBI

The Government of India set up the Securities and Exchange Board of India, popularly known as
SEBI, on 12 April 1988. It was given the legal status by the Securities and Exchange Board of
India Ordinance 1992. The overall objective of SEBI, as enshrined in the preamble of the SEBI
Act 1992 is “to protect the interests of investors in securities and to promote development of the
securities market and to regulate it for matters connected therewith or incidental thereto”.13

Since independence, the capital market has grown tremendously in India and the scams of early
1990s (Harshad Mehta scam and Vanishing Companies scam) made the government realize that
the Companies Act of 1956 was not sufficient to bring order to the chaotic scenario at the
securities market. Further, the need for a market regulator was felt strongly to bring a semblance
of corporate discipline in the flourishing Indian corporate world, with more than 25 recognized
stock exchanges and around 10,000 companies listed on them. The securities market, suffers
from enormous issues such as a limited variety of financial instruments, lack of fair financial
disclosure, insider trading, parallel economy fuelled by black money, absence of adequate
control over brokerage entities and numerous instances of unethical practices on the part of
companies. The woes of investors have been doubled by an inefficient and slow judicial system
that takes ages to get legal matters settled.

Basic Objectives of SEBI

The primary task of the regulator is to see to it that the market is operated on the basis of well
laid principles and conventions, essentially to control the activities of the stock exchanges and to
build a framework that will preserve the rights of even the smallest shareholder. The primary
objectives (Fig. 12.1) of SEBI are as follows:

1. protection of investors’ interests in securities;

2. promotion of the development of the securities market; and
3. regulation of the securities market.

Powers of SEBI

In keeping with the above basic objectives, the SEBI is empowered to examine the books of
account and other documents of a corporation, to summon and enforce the attendance of persons
and to issue notices to stock brokers, agents, shareholders, depository participants, sponsors of
any scheme such as venture capital and mutual funds and to any body corporate. It is also
authorized to decide the course of action regarding any stock market scandal and to penalize the
errant traders. SEBI is also conferred a special privilege—it cannot be sued by any of the civil
courts and hence is the final deciding authority with regard to stock market concerns.
SEBI has been clothed with the following powers:

1. to promote fair dealing by the issuers of securities and ensure a marketplace where
companies can raise funds at relatively low cost;

Fig. 12.1 SEBI’s Objectives

2. to provide a degree of protection to investors and safeguard their rights and interests so
that there is a steady flow of capital into the market; and
3. to regulate and develop a code of conduct and fair practices by intermediaries such as
brokers, and merchant bankers with a view to making them competitive and professional.

To carry out these objectives, SEBI would provide

1. Conducive environment: SEBI aims at creating a proper and conducive environment for
money from the capital market. It also aims to restore and safeguard the trust of investors,
especially small investors.
2. Investor education: SEBI aims to make the investors aware of their rights in clear and
specific terms by providing them with information. This way SEBI aims at maintaining
liquidity, safety and profitability of the securities market.
3. Required capital market infrastructure: SEBI aims at developing proper infrastructure for
automatic expansion and growth of business of middlemen such as brokers, jobbers, etc.
4. Efforts to cause necessary legislations and to create a framework: SEBI would also make
efforts to bring about necessary enactments for regulating the business of intermediaries
such as mutual funds, non-banking financial companies (NBFCs), chit funds, etc. SEBI
would work towards creating a framework for more open, orderly and unprejudiced
conduct in relation to takeovers and mergers.
SEBI supervises and controls the operation of stock exchanges, as well as checks the
malpractices of companies tapping capital markets, the basic objective of SEBI being to protect
the retail investors’ rights and to ensure an orderly growth of the primary and secondary markets.

Any company or a listed company making a public issue or a rights issue of value of more than
Rs 5 million is required to file a draft offer document with SEBI for its observations. The
company can proceed further only after getting the regulator’s observations, and has to open its
issue within three months from the date of SEBI’s observation letter.

Through public issues, SEBI has laid down eligibility norms for entities accessing the primary
market. The entry norms are only for companies making a public issue (IPO or FPO) and not for
a listed company making a rights issue.

Companies are required to provide information regarding their governance practices in a separate
Corporate Governance section in the Annual Report to Shareholders, in which non-compliance
with any mandatory requirements, and the extent to which non-mandatory requirements have
been adopted should be highlighted.

SEBI has powers equivalent to that of a civil court with regard to:

 Inspection of books of accounts and other documents of companies, as required.

 Summoning an enforcing attendance of corporate executives and others to examine them
under oath.
 Inspection of books, registers and other documents of stockbrokers, sub-brokers, and
share transfer agents, etc.

The Securities Appellate Tribunal (SAT) functions as appellate authority to hear the appeals
against SEBI’s orders related to issues of capital markets.

SEBI gained greater penal powers through the SEBI (Amendment) Bill, 2002, whereby it was
given powers to search and seize books of accounts, freeze bank accounts, and to slap monetary
penalties.

Some of the Initiatives of SEBI

Pricing of Preferential Share Allotments SEBI has intervened to tackle the dominant
shareholder in the pricing rule that it has imposed on preferential allotments. The prohibition on
making preferential issues at a discount would effectively rule out such private placements
altogether.

Take-overs The acquirer of a controlling block of shares must make an open offer to the public
for at least 20 per cent of the issued share capital of the target company at a price not below what
he paid for the controlling block. However, if more than 20 per cent of the shareholders want to
sell at that price, the acquirer is bound to accept only 20 per cent on a pro-rata basis.
Insider Trading SEBI has framed various regulations to deal with the insidious problem of
insider trading. The fact that there are regulations against such wrong practice does not
necessarily mean that they are followed faithfully. There have been many allegations against
several companies but then allegations have not been easy to prove in most instances as the
promoters can act through numerous friends, relatives and business associates. When SEBI
recently initiated action for insider trading against a large multinational in a somewhat murky
situation, the action proved to be highly controversial and the ultimate resolution of this case has
remained uncertain for too long.

Information Disclosure SEBI has added substantially to the Indian Company Law’s
requirements in an attempt to make documents filed at a time the company goes to the capital
market more meaningful. Information on the performance of other companies in the same group,
particularly those companies which have accessed the capital market in the recent past have to be
disclosed. This information will help investors to make a judgement about the past conduct of the
dominant shareholder.

Promoters’ Contribution and Lock-in Discipline of the capital market is a major concern for
SEBI. Capital market by itself exercises considerable discipline over the dominant shareholder.
A depressed share price makes the company an attractive target take-over. A well-functioning
market for corporate control makes this threat more real.

SEBI also has stipulated that in most public issues, promoters are required to take a minimum
stake of about 20 per cent in the capital of the company and to retain these shares for a minimum
lock-in period of about three years. SEBI exempts from the application of this provision, those
companies which have no dominant shareholder.

Why Is Corporate Governance Needed for a Securities Market? Good corporate governance is
marked by seven characteristics: discipline, transparency, independence, accountability, full
disclosure, fairness and social responsibility, which are expected to be present when one
scrutinizes the prevalent practices in the structures which comprise the governance models of
business enterprises. Corporate governance standards, on the one hand, get reflected in market
conditions and, on the other, help the corporations access the market for raising resources in a
cost-effective manner. As the investor’s protection is a matter of paramount importance for the
regulator charged with the statutory responsibility in this behalf, SEBI has to be concerned with
corporate governance, and to ensure that companies adopt them for their own good and for the
good of the economy. While the Company Law takes care of the basic requirement of the form
of corporate governance structure, SEBI is concerned with the dynamic substance of corporate
governance practices.

India’s equity markets are well developed compared to other emerging market economies. SEBI,
as an independent quasi judicial authority, regulates the exchanges. Corporate governance-
related listing requirements in India are largely based on recommendations of the Cadbury and
Higgs Reports and the Sarbanes-Oxley Act of the United States. SEBI has been proactive in
keeping India’s corporate governance rules and regulations in line with best practices around the
world. In 1999, SEBI appointed the Kumara Mangalam Birla Committee to recommend
improvement to the corporate governance framework. In 2002, SEBI updated its listing
requirements with Clause 49, which has mandatory and non-mandatory corporate governance
provisions. These listing requirements were again changed in 2004 to incorporate some best
practices laid out in the Sarbanes-Oxley Act. All listed companies were required to be in
compliance with Clause 49 by 31 December 2005.

Some of the steps taken by SEBI towards corporate governance are described next.

Appointment of Committees

 SEBI appointed the Kumar Mangalam Birla committee on corporate governance on 7

May 1999, with 18 members with a view to promoting and raising the standards of
corporate governance. This committee discussed issues relating to applicability,
remuneration, board of directors, audit committee, and shareholders.
 The Naresh Chandra Committee was appointed as a high level committee to examine
various corporate governance issues by the DCA on 21 August 2002.
 After this, SEBI set out to form another committee with the twin perspectives: (a) to
evaluate the adequacy of the existing practices, and (b) to further improve them. This
committee on corporate governance was constituted under the chairmanship of N. R.
Narayana Murthy, Chairman and Chief Mentor of Infosys Technologies Ltd. and
comprised representatives from stock exchanges, chambers of commerce, investors
associations and professional bodies.
 Further the Government of India appointed an expert committee on Company Law under
the chairmanship of Dr J. J. Irani on 20 December 2004. The committee submitted its
report on 31 May 2004.

Each committee followed up on each others recommendations and analysis of the prior
committees’ suggestions was incorporated in the new recommendations.

All these recommendations have converged on the following steps to be taken by SEBI:

 Ensuring timely disclosure of relevant information

 Providing an efficient and effective market system
 Demonstrating reliable and effective enforcement
 Abolition of capital issues control and SEBI retaining the sole authority for new capital
issues
 Regulation and reform of the capital market by arming itself (SEBI) with necessary
authority and powers
 Regulating stock exchanges under Securities Contracts Regulation Act
 Bringing all primary and secondary market intermediaries under (SEBI’s) regulatory
framework
 Enforcing companies to disclose all material facts and specific risk factors associated
with projects while going in for public issues
 SEBI encouraged the credit rating agencies—ICRA and CRISIL—to evolve a suitable
corporate governance index as a measure of wealth creation by corporations. Some of the
companies have been rated against this index.
  SEBI’s committee on corporate governance has suggested ‘whistle-blower policy’ where
an official of a company who observes an unethical or improper practice can approach
the audit committee of the company without necessarily informing his or her immediate
supervisors.
 Based on the recommendations of the Narayana Murthy Committee and public comments
received thereof, SEBI issued a circular on 26 August 2003 revising the previously
existing Clause 49 of the Listing Agreement.

In 2004 SEBI issued changes in the Clause 49 as follows:

 Amendments/additions to provisions relating to definition of independent directors

 Strengthening the responsibilities of audit committees
 Improving quality of financial disclosures, such as related party transactions
 Proceeds from public/rights/preferential issues
 Requiring boards and senior management to adopt formal code of conduct
 Requiring CEO/CFO certification of financial statements
 Improving disclosures to shareholders

Non-mandatory clauses:

 Whistle-blower policy
 Restriction of the term of independent directors

Why Should Corporations Improve Their Governance? The motivation to improve voluntarily
the internal governance structure of a company can be attributed to the following reasons:

1. Need to access foreign capital: Companies seek to access capital either through listing on
a foreign stock exchange such as the LSE, NYSE or NASDAQ or by attracting private
equity, foreign institutional investors or joint venture partnerships.
2. Need to become a reputable company to export globally: Many Indian companies,
especially those that wish to export goods or services to companies in developed markets,
realize that buyers in developed markets are more comfortable working with companies
that have transparency and ethics as suppliers.
3. Desire to become multinational companies: In their quest to become multinational
companies and to acquire business or assets in foreign countries, successful Indian
companies such as Tata Steel Ltd, ITC, Larsen & Toubro (L&T), Infosys and Dr Reddy’s
Lab generally have been willing to improve their corporate governance structure. Indian
companies have increasingly realized that the shareholders and boards of directors of
foreign companies consider the corporate governance structure of the bidding company
before approving the sale or merger of an asset. One of the reasons attributed by some
investors for the opposition to Mittal Steel acquiring the French steel company Arcelor
was the questionable corporate governance structure and practices of the former.14

Clause 49 Ensures Corporate Governance

The state of corporate governance in India has improved over the last five years, particularly
among large Indian companies. Ensured standards of corporate governance means increased
transparency with regard to accounting and financial information and, more independent
directors on boards. It is true Clause 49 mandates many of these improvements, but Indian
companies had been voluntarily improving corporate governance even before the requirements
of Clause 49 came into effect for listed companies. One can be certain that corporate governance
would become more efficient and effective as a result of companies following Clause 49.

Moreover, corporate governance has acquired importance as a result of the huge foreign
investment inflows into India. “The foreign investors would like to see that the companies they
invest their money in are being managed well, and they expect the law of the land to be open and
transparent.”15

How Would Clause 49 Effect Ethical Practices Among Indian Corporations? As seen earlier,
if the amended Clause 49 of the listing agreement corporations enter with stock exchanges is
compiled with in the letter and spirit, it is an effective instrument to bring about ethical and
corporate governance practices for the long-term benefit of all stakeholders.

On 26 August 2003, SEBI announced an amended Clause 49 of the listing agreement which
every public company listed on an Indian stock exchange was required to sign. The amended
Clause 49 is applicable when companies seek a new listing. Those companies that are already
listed must comply with the provisions of the amended Clause 49 by 31 March 2004. All
companies have been instructed to submit quarterly compliance reports to the relevant stock
exchange in a standardized format. The new Clause 49 has the following changes.

Independent Directors The new Clause 49 stipulates that at least one-third to one-half of a
company’s board of directors must be independent, if the chairman of the board is a non-
executive director. If the chairman is an executive director, at least 50 per cent of the directors
should be independent directors. Clause 49 now provides an objective definition of an
independent director, to mean a non-executive director of the company, who

“(i) does not have any pecuniary relationships or transactions with the company, its promoters,
its senior management or one level below the board, except director’s compensation; (ii) has not,
in the immediately preceding three years, been an executive of the company; (iii) is neither a
partner nor officer of any firm being associated with the company in the capacity of statutory
auditor, internal auditor, legal advisor or consultant; (iv) is not associated with the company as a
supplier, service provider or customer, any of which includes lesser - lessee relationships; and (v)
is not a shareholder of the company having one per cent or more of the corporations voting
shares”.16

Independent directors are required to periodically review legal compliance reports prepared by
the company and the steps taken by the company to remedy any damage. They must also be
completely aware of their responsibilities and are not permitted to take a ‘no awareness’ defense
in the event of any proceedings against them in connection with the affairs of the company.
Non-Executive Directors The total term of office of non-executive directors is now limited to
three terms of three years each. Their compensation now requires shareholders’ approval and
grant of stock options is limited. Companies should publish their compensation policy in their
annual report or on their Web site. Non-executive directors are required to disclose their
shareholding in the company. Performance evaluation should be done by a peer group
comprising the entire board excluding the director being evaluated, and extension of the term of
office of non-executive directors should be primarily based on peer group evaluation.

Board of Directors Every listed company is required to train its board members on its business
model, the risk profile of the business parameters of the company, their responsibilities as
directors and the best ways to discharge them. The board is required to frame a code of conduct
for all board members and senior management and each of them has to affirm compliance
annually with the code. The company is required to affirmatively disclose this compliance in the
company’s annual report.

Audit Committee All members of the audit committee should have the ability to read and
understand basic financial statements and at least one member must have accounting and related
financial management expertise. The audit committee is now required to review:

1. financial statements and the draft audit report;

2. reports of management discussion and analysis of financial condition and result of
operations;
3. reports of compliance with laws and risk management;
4. management letters issued by statutory and internal auditors in the matter of internal
controls;
5. documents of transactions of related parties; and
6. records of matters relating to the chief internal auditor with reference to his or her
appointment, removal and terms of remuneration.17

Whistle-Blower Policy “Every company’s whistle-blower policy should allow any person to
approach the audit committee without necessarily informing his supervisors. This policy has to
be communicated to all employees and the whistle-blowers should be protected from unfair
treatment or termination. Every company must affirm its whistle-blower policies by proper
declaration in its board report on corporate governance”.18

Subsidiary Companies Boards of subsidiary companies should have at least 50 per cent non-
executive directors and one-third to one-half independent directors depending on whether the
chairman is a nonexecutive or executive director.

Disclosures Disclosures have to be made with respect to contingent liabilities, basis of related
party transactions, risk management and remuneration of directors.

Certifications The CEO and CFO of every company are required to certify that the statements
are not misleading and that they comply with existing accounting standards and applicable laws
to the best of their knowledge and belief.
All these important rules and regulations under the Clause 49 of the listing agreements are
intended to make companies follow ethical standards of corporate governance. They are
supposed to bring about discipline, transparency, and accountability, apart from enabling
companies to be fair, independent and committed to ethical business and corporate responsibility.

Role of SEBI in Promoting an Orderly Securities Market

Indian securities market has a large infrastructure to meet the demands of a sub-continental
market. There are 25 stock exchanges, and about 10,000 brokers, 15,000 sub-brokers, 10,000
listed companies, 500 foreign institutional investors, 400 depository participants, 150 merchant
bankers, 40 mutual funds offering over 450 schemes, and 20 million investors.19

All Indian stock exchanges offer fully automated screen-based trading systems.
Dematerialization and depository’s legislation has ensured free, secure, and fast transfer of
securities in electronic form. SEBI also keeps a careful watch on the market to detect anything
undesirable that may affect the value of the market. SEBI also provides timely, quality, price-
sensitive information to all market participants. It also ensures that all market participants are
treated fairly and are provided high-quality services.

According to M. Damodaran, Chairman, SEBI, in the matter of companies that do not meet the
requirements stipulated under Clause 49, the capital market regulator would be forced to take
action, which may include even delisting them from the stock exchanges.

Overall, SEBI can be credited for increasing the awareness and need for corporate governance in
companies in India. A lot is yet to be achieved and this is due to the slow pace of change in
Indian companies thanks to political classes.

Has Clause 49 Achieved Its Objectives?

Though SEBI has been highlighting the importance of corporate governance, there has been very
little visible improvement at the ground level. The number of companies that scores relatively
high on quality corporate governance is still small. And transparency on key corporate matters
remains an ideal. These shortcomings are illustrated in the following examples.

Zee Telefilms’ record on corporate governance has taken a hard knock in the light of evidence
that has surfaced about its group company investments. The company diverted Rs 2200 million
to its promoter group, Essel, on highly concessional terms. If not for the market crisis triggered
by Ketan Parekh, these unethical transactions would never have come to light. The funds were
supposedly ostensibly given to purchase equity in other media companies. But, SEBI’s
investigation showed that these funds found their way into the market. The promoter group
stated that the funds would be returned by 1 June 2001. So far, only around 55 per cent of the
diverted fund has come back.20

A buyback serves its purpose only when surplus cash is not required for financing growth, and
when it benefits long-term shareholders. Yet, quite a few companies pushed through buyback
plans in the last few years that may not have helped the staying shareholders. Bombay Dyeing,
Great Eastern Shipping and Kesoram Industries are some of the examples. In the Grasim-
Reliance deal on Larsen & Toubro, the L&T stock spurted 30 per cent before the deal, with large
blocks of shares traded. Clearly, such action raises the spectre of possible insider trading.21 This
means key information gets out selectively, and regularly, in such cases, placing most
shareholders at a disadvantage. It also is a poor reflection on the systems in place.

A few other instances of SEBI failing in its tasks are, when the Listing Committee of the
Bombay Stock Exchange refused to give listing for Home Trade on charges that the company
was involved in circular trading among its group companies. At that point, SEBI did not take any
interest in enquiring about it. The same was the case at the time of Ketan Parekh-related scam.
Even though the RBI warned SEBI about the unusual price rise in Global Trust Bank, the capital
market regulator chose to ignore it. Lack of coordination among regulators and a delay in taking
cases to their logical conclusion give scope for occurrence of such scams in the financial sector.
It took SEBI over six months to finalize its interim report on the securities scam of 2001.

In the Indian scenario, it is only the ‘form’ that has appeared to have changed over the decades
and not the substance. The culture of the ‘agency system’ is ingrained in the private sector. The
promoters have displayed amazing resilience in adjusting to the changing regulations.
Managements still control the access to information and there are several ways in which
information produced is coloured to suit its purpose. If the board does not accept the prerogative
of management, the latter plays the game of procrastination.

Besides, clauses of listing agreement do not mention whether the independent directors
mentioned therein are executive or non executive. Moreover, it is highly unlikely that the interest
of non-executive or independent directors, even if they are in the majority is going to be
congruent, because there is an unwritten but implicit understanding that they will not raise
inconvenient questions.

The listing agreement of SEBI lacks effectiveness because its penal positions are not hurting
enough, regional stock exchanges lack skills to monitor effective compliance and a vast majority
of unlisted companies remain outside the purview of SEBI’s amendments as pointed by the J. J.
Irani Committee. It should be made simpler and lacunae of all sorts should be redressed.

The other grey area is that there is no explanation of what material pecuniary relationship or
transaction actually means. This loophole could be used against the shareholders. There are
instances where managing directors of companies have continued as the chairman of the board
despite giving up their post of chairman.

The most common complaint relating to ethical behaviour revolves around ‘conflict of interest’.
In India, shareholders with any grievance can seek remedy in a court of law. While the
management can fight indefinitely irrespective of the cost, the common shareholders cannot. The
annual general body meetings are held at places where the registered offices are situated which
are far away from where the majority of shareholders are located. This makes it very
inconvenient for most of the shareholders to attend the annual general meetings.
There is a need for procedures to go beyond corporate to other entities such as financial markets,
intermediaries, financial institutes and academic institutions. Aggregate holdings of the
promoters and their group (and their holdings in other companies) should also be disclosed.

Non-Compliance by Public Sector Enterprises

SEBI has not been particularly successful with regard to the implementation of Clause 49 as
some of the biggest public sector undertakings (PSUs), including the oil majors such as Indian
Oil Corporation (IOC), Oil and Natural Gas Commission (ONGC) and Gas Authority of India
Limited (GAIL) have failed to fall in line while most top private sector companies including
Reliance, Tata Consultancy Services (TCS), Infosys, and Hindustan Lever Limited have become
compliant. The little-known National Mineral Development Corporation has fully complied with
the SEBI directive. Steel Authority of India Limited and Neyveli Lignite Corporation (NLC) are
just one independent director short. The oil majors, except for MRPL, fall woefully short with
ONGC having just three independent directors in a board which is 14 strong. GAIL, with a board
strength of 12, including chairman and managing director has only three and IOC with a 17-
member board has just five. In contrast, all the top 10 private sector companies in terms of
market capitalization have complied. The TCS board consists of five directors, of which three are
independent. Similarly, Infosys has more independent directors (eight) than the number of
company executives (seven) on its board.22

The fundamental objective of corporate governance is not mere fulfillment of the requirements
of law but ensuring commitment of the board in managing the company for maximizing long-
term shareholder value. Consider the sequence of information disclosure in Grasim’s open offer
for 20 per cent stake in L&T. Grasim announced an open offer for L&T on 13 October 2002.
SEBI decided to withhold Grasim’s open offer for L&T on 6 November. SEBI communicated
this to Grasim’s merchant banker, JM Morgan Stanley on 8 November. The media, quoting
unnamed Grasim officials, splashed the news on 18 November. Grasim made a formal
announcement on 20 November in its notice to the stock exchanges, a good 12 days after it
received SEBI’s advice!23

Need to Improve Quality of Investigations

Apart from these problems of non-compliance and non-implementation of clauses by companies,

SEBI’s orders have been reversed or the penalty reduced in most of the cases by the Securities
Appellate Tribunal (SAT). An important issue is the quality of investigation and evidence
gathered by the regulator. Changes perhaps are required on at least two fronts. One is a change in
law itself where explicit and realistic standards of proof are laid down and where required, after a
certain stage, the onus be shifted to explain the evidence. Second, there is a desperate need to
employ qualified and experienced people to go into the allegations. Persons having practical
experience and expertise in the markets would be able to grasp the situation much easier and
decide correctly on the allegation. In most of the cases, SEBI had suspended brokers for several
months for not fully complying with paper requirements. Suspending the broker is clearly a
serious affair. His or her source of livelihood is lost, often permanently. But the impact on his or
her reputation in a market that notoriously relies on integrity of brokers is much worse.
Need for Severe Penalties for Serious Offences

Changes have to be made in the law as well as in the SEBI regulations to ensure that far stronger
penalties be imposed for serious offences such as price manipulation and insider trading. It is
essential that such cases are handled by impartial persons who are experts in securities laws and
markets.24

Need to Look Into Other Issues

The common methods, by which companies hide their malpractices, are to use legal and
accounting jargon, non-disclosure and selective adoption of only those policies that are
mandatory in nature. It is only a handful of qualified persons, primarily the accountants and the
other knowledgeable people, who can get to the picture behind the scenes and unmask the actual
from the portrayed picture. It is in this context that the adoption of the Generally Accepted
Accounting Principles (GAAP), which provides for rigorous accounting standards and
disclosures, assumes relevance.

With regard to insider trading, SEBI tends to catch only the big fish. It has investigated a variety
of cases involving some blue-chip companies and persons associated with them. But its track
record has been poor with regard to penalizing the wrong doers. So far no case of insider trading
has been taken to its logical conclusion either because of lack of sufficient evidence or because
higher authority like the SAT or the finance ministry was not convinced.

It is time SEBI moved on to some high-quality and timely implementation of its key regulations.
Something has been done on this front, but not enough to inspire confidence in, and awe of, the
regulator. If the move to an effective implementation mode requires the improvement of
infrastructure, including personnel, then SEBI should address these aspects expeditiously.

Moreover, as pointed out earlier, SEBI has jurisdiction only in cases of limited and listed
companies and is concerned only with their protection. What about the shareholders and others
of unlisted limited companies? The Serious Fraud Investigation Office (SIFO) in the DCA has
been investigating several ‘Vanishing Companies’. By 2003, SEBI had identified 229 as
‘vanishing companies’. However, thousands of investors have lost their hard-earned money and
no agency has come to their rescue so far.

Another area where SEBI has been a little ineffective is in the manipulation of stock markets
primarily in Penny stocks—by definition low value stocks—having very low levels of liquidity,
which can hence be manipulated by even small operators by doing circular trading. Also, lots of
cases of entities opening multiple accounts to the advantage of the demand supply mismatch in
IPOs and getting a higher entitlement than they should have, have also been unearthed.

Despite largely achieving the objectives it was established for, SEBI’s area of improvement
strongly lies in the effective managing of the stock exchanges, insistence on companies’ regular
supply of authentic information, severe penalty for violators of securities’ laws, debarring the
wrong-doers from any activity in the stock market and imposing on them civil penalties and
initiating criminal proceedings, making rules about the manipulative practices, checking insider
trading; and prosecution of a company and its directors suo moto even without receiving
complaints by an aggrieved investor in respect of supplying inadequate, incomplete and incorrect
information. There is a consolation, however, that in recent times SEBI is moving in to the right
direction on all fronts slowly and cautiously.

ROLE OF WHISTLE-BLOWING

Whistle-blowing is a tool that is resorted to by an executive or a worker when convinced that an

unethical practice is being used in the workplace and brings it to the knowledge of the auditors or
CEO as the situation may require, with a view to getting it rectified for the overall good of the
organization. In most ethically run organizations, whistle-blowing is encouraged and a well-laid
system provided to protect the whistle-blower.

Grounds for Whistle-Blowing

1. Internal: to make the product safe or change the process

2. Governmental: faulty design, defects which will affect the public
3. External: individual user who runs the risk

Why is a whistle-blower considered a ‘traitor’ or a wrecker of ‘family’ by ‘others’?

1. Complicity in the misconduct

2. Cowardice
3. False sense of loyalty

Whistle-Blowing Is Not Only Moral but Also Obligatory

The dilemma may be: Is it fair to ‘bite the hand that feeds’?

Loyalty to society or people at large and not to an individual or institution should be the guiding
principle. One’s loyalty should be to the kingdom and not to the king.

When Is Whistle-Blowing Permitted?

1. When listening to the inner voice: the motives are moral.

2. When all existing internal procedures have failed to get the moral error corrected.
3. When the employee has reached the last and sixth stage of Kohlbergh’s six stages of
moral evolution—the stage of universal ethical principles.

Whistle-Blowing

Whistle-blowing is a prelude to corporate reform.25 It is called for to promote moral behaviour

among corporations, because of the following assumptions:

 The concept that corporations are for the sole purpose of profiteering is absurd
  Society gives business all infrastructure and all other facilities expecting fulfilment of its
needs
 Corporations exist so long as there is shared prosperity
 There is justification for corporation only when public and social purposes are served

Why Should a Business Be Moral?

The concept of ‘contractual analysis’ of business implies that a corporation has to be ethical for
the following reasons:

1. In its own interest—prudence and long-term effect.

2. In the interest of the corporate community in general.
3. Because the corporation has (tacitly) agreed to behave morally.
4. Because it is unfair to go back on one’s agreement and expect others to keep theirs.
5. Because it is inconsistent to agree to moral behaviour and then violate it in secret.
6. Because engaging in breaking the rules by the business community if they can get away,
undermines the essential environment for business.

Whistle-blowing is a method that brings to open the unethical practices in corporations.

It is justified because persons who are aware that grave error/injustice is committed in their
workplace, and yet remain mute witnesses to protect their job/personal interest become
accomplices in such acts. This is illustrated by the following quotes:

“The hottest place in Hell is reserved for those who are silent during a moral crisis”, Dante in
Divine Comedy.

“The world is a dangerous place not because of those who do evil, but because of those who look
on and do nothing.” Albert Einstein

“All that is necessary for evil to triumph is for good men to do nothing”. Edmund Burke

SUMMARY

To make corporations follow ethical and corporate governance practices, an external framework
has to be evolved and kept in place through various agencies. In a democracy, public opinion is a
strong instrument to bring about ethical practices among corporations. Recent unearthing of
corporate frauds revealed that auditors had failed to do what they were assigned to do. There are
enough regulations in the statute books to ensure that auditing firms do their job ethically and
help in protecting shareholders. But there are many lapses on their part which hardly attract
penalties. The separation of ownership from active direction and management is an essential
feature of the company form of organization. Recent literature on corporate governance is replete
with recommendations of various committees on the desirability of having non-executive,
independent directors on the boards of companies to promote better corporate governance
practices. The media too can play a role in ensuring ethical business. The media plays a role in
shaping the public image of corporate managers and directors, and in so doing they pressure the
managers and directors to behave according to societal norms. Ethics in advertising is essential
for the betterment of business and the society at large. Modern governments have cornered
enormous powers to discipline corporations. In India, the DCA, the Ministry of Finance, and the
Commerce and Industry ministries have powers to oversee corporate activities and take
corrective action against corporate misdemeanours. There are regulators such as RBI, TRAI,
IRDA, which also have the power and responsibility to monitor and supervise companies. The
judicial system has an important role to play in ensuring better public governance and corporate
governance. The primary task of the regulator is to see to it that the market is operated on the
basis of well laid principles and conventions, essentially to control the activities of the stock
exchanges and to build a framework that will preserve the rights of even the smallest
shareholder. In most ethically run organizations, whistle-blowing is encouraged and a well-laid
system provided to protect the whistle-blower.

Corporations exist not only to serve their shareholders, but to cater to all those who constitute
their stakeholders. This broader objective calls for promoting and maintaining ethical practices in
all corporate activities. Though there are regulatory institutions like SEBI, stock exchanges,
DCA, RBI, TRAI, IRDA and courts of law, corporations circumvent company laws, rules and
regulations, and Clause 49 of the listing agreements with stock exchanges with impunity until
such time nemesis catches up with them. All these go to prove that law-makers and law-
enforcers alone cannot bring in ethical practices among corporations. Ethical behaviour in every
facet of corporate activities has to come from within—from the board of directors, top executives
downwards. There is no doubt that in bringing about this metamorphosis in ethical corporate
behaviour, public opinion and media can play a decisive and statutory role.

KEY WORDS

Environment conscious • Window-dressing • Hedging and fudging • Independent auditors •

Certified Public Accountants • Standard Auditing Practices • Enron debacle • Sarbanes-Oxley
Act • Public Accountants • Audit Partner Rotation • Non-audit services • Fraudulent auditing
practices • Disqualifications of auditors • Undischarged insolvent • Misfeasance • Nominee
directors • Breach of statutory duties • Family-owned business Advertisement as media tool •
Selective coverage • Media credibility • Materialism • Judicial system • Government agencies •
Clause 49 • Independent directors • Whistle-blowing.

DISCUSSION QUESTIONS

1. Discuss in brief about the various agencies that ensure ethical practices among
corporations in India.
2. Discuss the role of (1) public opinion, (2) media, and (3) judiciary in promoting ethical
practices among corporates in India.
3. What is Clause 49? Has it been effective in ensuring better corporate governance/ethical
practices among companies in India?
4. Discuss the objectives of SEBI. To what extent has SEBI been able to realize its
objectives?

FURTHER READINGS
1. S. Balasubramanian, ed., Corporate Boards and Governance (New Delhi: Sterling, 1988).

2. Ethics in Advertising, Pontifical Council for Social Communications (Rome: Libreria Editrice
Vaticana, 1997).

3. ICFAI Journal of Corporate Governance (Vol. 1, No. 1, October 2002).

4. R. H. Paril, “Corporate Governance in India: Some Ground Realities,” Management Review

(Vol. 9, No. 2–3, April–September 1997).

5. R. Rajagopalan, Directors and Corporate Governance (Chennai: Company Law Institute Pvt.
Ltd., 2003).

6. Rajiv Gandhi Institute for Contemporary Studies (RGICS), “Corporate Governance and
Ethics,” Conference Papers and Proceedings (New Delhi: RGICS, 1998).

7. Ian Ramsay and Geof Stapledon, “The Role of Superannuation Trustees,” ICFAI Journal of
Corporate Governance (Vol. 1, No. 1, October 2002).

8. Reed and Mukherjee, eds. Corporate Governance, Economic Reforms and Development—The
Indian Experience (New Delhi: Oxford University Press, 2004).

9. “Reports on Corporate Governance,” ECONOMICAindia INFO-SERVICES (New Delhi:

Academic

Case Study-1
KETAN PAREKH SCAM 2001

(The case is based on reports in the print and electronic media. The case is meant for academic
purpose only. The writer has no intention to sully the reputations of corporations or executives
involved.)

KETAN PLAYED AROUND WITH OTHERS’ MONEY1

Ketan Parekh is a notorious name in the annals of India’s securities market. He used an
ingenious technique to get public funds for his price-rigging operations. Ketan Parekh was
reported to have had approximately Rs 20,000 million to play around with during the month
prior to his arrest in 2001. Securities and Exchange Board of India’s (SEBI’s) preliminary
enquiry unearthed the fact that Ketan got approximately Rs 6700 million from corporations such
as Zee and Himachal Futuristic Communications Limited (HFCL) whose shares he was ramping
up. Zee and HFCL had together raised this huge sum for business purposes, but diverted it to
Ketan illegally. Though Zee reported that it gave funds to Ketan to buy a stake in entertainment
firm ABCL and television channel B4U, both these companies asserted that they never intended
to sell their stakes to Zee. Ketan had also borrowed Rs 2500 million from Global Trust Bank,
against the Reserve Bank of India’s (RBI) norms. He was ramping up GTB’s shares too with a
view to getting a good deal at the time of its expected merger with UTI Bank. Madhavapura
Mercantile Bank gave unauthorizedly to Ketan and his business associates Rs 10,000 million,
though it could lend only a maximum of Rs 150 million to a broker, as per the RBI regulations.

SEBI also found that the Foreign Institutional Investor Credit Suisse First Boston was funding
Ketan Parekh’s operations camouflaging these loans as genuine financial transactions by creating
false records. Continuing its false game, the firm ‘charged’ brokerage to Ketan in its record.
However, it was clear that it was not brokerage, but interest for the loan given to Ketan for the
illegal transaction. Other broker associates of Ketan too chipped in by creating false sell orders to
complete the paperwork as is legally required, to cover up their illegal transaction in the scam.
SEBI also unearthed proofs of a big bear cartel in the market. For instance, one of them by name
Shankar Sharma, who was a major shareholder of the dotcom [Link] resorted to short
selling of its shares anticipating prices to nosedive in future after an impending major political
expose that would shake the then Union Government and make the stock market volatile.

Ketan’s Modus Operandi

Ketan’s modus operandi was to push up shares of firms of his choice in collusion with their
promoters. In the Ketan 2001 scam case, SEBI was able to find prima facie evidence of price
rigging in the shares of Global Trust Bank, Zee Telefilms, HFCL, Lupin Laboratories, Aftek
Infosys and Padmini Polymer. Though UTI denied any link with Ketan, it was found that UTI’s
purchases almost aligned with Ketan’s buying in what are called the K-10 stocks, or those stocks
that Ketan had been buying. UTI also purchased hitherto unknown stocks such as Arvind Johri’s
Cyberspace Infosys—Cyberspace interestingly, was the erstwhile Century Finance, which
changed its name like many others, to sound infotech in order to take advantage of the boom in
infotech stocks. Market rigging was found to be so obvious that the Bombay Stock Exchange
(BSE) was prompted to investigate the sudden steep hike in the stock price of Cyberspace which
peaked to Rs 1450 within a short span of its launching. However, its value fell below par, as the
investigation started.

The Scam’s Impact on the Market

The most alarming feature of the 2001 securities scam was the long period it had been going on
unsuspected and unchecked, and how long it took to discover the fraud. More damaging was the
fact that SEBI’s Regional Chief in Charge of Surveillance went to the extent of telling BSE’s
officials about Johri’s powerful connections and advised them to go slow on the investigations!.
If the shares had not nosedived after the budget, the then Finance Minister Yashwant Sinha
would not have insisted on a thorough probe, and it was very much possible that life would have
continued the way it was!

Nemesis Catches Up With Ketan Parekh2

The following is a list of penalties slapped on Ketan Parekh, the Big Bull of 2001 securities
scam, by SEBI along with investigations that are still to be completed:

Ketan Parekh (KP) and six stock broking entities associated with him have been debarred by
SEBI from under-taking any fresh business as a stock-broker or merchant banker;
  SEBI cancelled the certificate of stock broking registration granted to Triumph
International Finance (India) Ltd (TIFL), in which KP is a director;
 SEBI cancelled the certificate of registration granted to five brokering entities associated
with/controlled by KP;
 SEBI prohibited KP and nine related entities from buying, selling or dealing in securities
directly and also debarred then from associating with the securities for 14 years.

This SEBI penalty imposed on KP by securities is the most damaging price KP had to
pay for his role in the securities scandal of 2001. This blanket ban from dealing in stocks
in India for 14 years has affected his career as a stockholder as nothing has done.

 The Central Bureau of Investigation (CBI) arrested KP and three other co-accused
directors of TIFIL in connection with the securities scam;
 The Enforcement Directorate (ED) of the Income Tax Department has found that KP and
other directors of TIFL violated provisions of the Foreign Exchange Management Act
(FEMA). As a penalty, the ED imposed a penalty of Rs 10 million on TIFIL, Rs 2 million
on KP and another director, and Rs 1 million on two other directors;
 The Serious Fraud Investigation Office (SFIO), under the Department of Company
Affairs, is investigating 16 KP Companies for any violation of the Companies Act 1956,
as per the mandate given by the Joint Parliamentary Committee which probed the 2001
securities scam.
 Subsequently, in August 2006, the CBI has named the former Managing Director of SBI
Mutual Fund (SBIMF), Niamatullah and 32 others in the charge sheet filed before the
Sessions Court in Bombay in the case of Padmini Technologies during the stock market
scam of 2001. It was alleged that this was one of the several stocks that were manipulated
by Ketan Parekh. Further, according to CBI, the 33 SBIMF charge-sheeted top executives
were the ones who decided to invest in these stocks as part of the investment committee
of the fund. SBIMF bought in February 2000 as many as 2.2 million shares at Rs 165
each through off-market deals with Ketan Parekh’s stock broking firms.3

THE LATEST IN THE DEMAT SCAM4

The SEBI in its latest order dated 12 November 2007 has restrained Ketan Parekh (KP) and 17
other entities from accessing the stock market for 14 years. The order will run concurrently with
SEBI’s earlier order of 12 December 2003 which too forbade the group including Parekh from
accessing the equity market for 14 years.

The latest order is the result of SEBI investigations of the demat scam that was said to have
occurred during the period between October 1999 and March 2001 in stocks such as those of
Himachal Futuristic Communications, Zee Telefilms, Ranbaxy Laboratories, Padmini
Technologies, Global Tele-Systems, Shri Adhikari Brothers Television Network, Shonkh
Technologies International, Adani Exports, and Aftek Infosys. SEBI has unearthed the fact that
Ketan and 17 others named in its order, who were directly or indirectly related or associated with
him were involved in market manipulation in these stocks. SEBI’s order also said “the modus
operandi adopted by all the entities in manipulating various scrips was, by and large, the same
and Mr Parekh was found to be the mastermind behind all acts of omission and commission by
the entities”.

The Bombay High Court on 1 April 2008 sentenced Ketan Parekh and six others to one year
rigorous imprisonment for the 1992 security scam. Two other accused get six months rigorous
imprisonment. All of the accused are out on bail till 31 July 2008.5

CONCLUSION

In almost all such scams, the public were told that it was a ‘system failure’, that it was not just
individuals who erred. While that sounds like the classic defence, it remains sadly true for every
possible system that could fail or did so in this particular case, either by design or by default.
Moreover, as usual, the cautious investigation and the long legal procedures even when the entire
market was aware of Ketan Parekh’s and his accomplices’ wrongdoings, proved that ‘delayed
justice meant denied justice’ to the hapless investors whose confidence in the securities market
was rudely shaken once again.

KEY WORDS

Ketan Parekh • Securities Scam • Indian Securities market • Securities and Exchange Board of
India • Zee Telefilms and HFCL • Global Trust Bank • Reserve Bank of India • Madhavapura
Mercantile Bank • Foreign institutional investor • Credit Suisse First Boston • Modus operandi •
Ramp up shares • Nemesis catches up.

DISCUSSION QUESTIONS

1. Explain in your own words the Ketan Parekh scam of 2001.

2. What lessons can be learnt from the Ketan Parekh scam?
3. Ketan Parekh scam 2001 reveals certain systemic failures of the Indian capital market.
What are they?

FURTHER READINGS

1. Brian Carvalho and Mahesh Nayak “Is Ketan Parekh Back?,” Business Today, 12 February
2006.

2. A. C. Fernando, Corporate Governance, Principles, Policies and Practices (New Delhi:

Pearson Education, 2006).

3. “The Ketan Parekh Scam,” ICMR Case Studies and Management Resources, available at
[Link]/free%20resources/casestudies/[Link]

4. [Link], “CBI Arrests Stockbroker Ketan Parekh,” available at

[Link]/money/2001/mar/[Link]
5. S. Satyanarayan and Gaurav Chandhury, “Ketan Parekh Blamed for Securities Scam,” The
Tribune, online edition, 20 December 2002, available at
[Link]/2002/20021220/[Link]

Case Study-2
SATYENDRA DUBEY: A PATRIOTIC BUT UNFORTUNATE WHISTLE-BLOWER

(This case study is based on reports in the print and electronic media, and is meant for academic
purpose only. The author has no intention to sully the image either of the corporate or the
executives discussed herein.)

A MURDER MOST FOUL

On 27 November 2003, around 3 a.m., Satyendra Dubey, a civil engineer graduate from the
Indian Institute of Technology (IIT) who was the Project Director of the National Highway
Authority of India (NHAI), the implementing agency for the Golden Quadrilateral project, with
the rank of Deputy General Manager was shot dead by unidentified gunmen in the town of Gaya,
after he returned from Varanasi on a private visit. The US$ 12 billion project was to build a
6,000 km highway network linking India’s four major cities—Delhi, Mumbai, Kolkata and
Chennai. This prestigious project, known as the Golden Quadrilateral, was the then Prime
Minister Atal Bihari Vajpayee’s pet project and was launched by him with great fanfare in 1999.
The first phase of the project was to be completed in the year 2004 and the rest by 2007.

GOLDEN QUADRILATERAL PROJECT: DEN OF CORRUPTION

The Golden Quadrilateral project “was being compromised by numerous criminal acts” in every
conceivable manner “including the fudging of Detail Project reports, the forging of documents
on procurements, the extension of tacit support by NHAI authorities to big contractors and the
like.”1 Knowing this, Dubey could have chosen to keep quiet like the majority of his counterparts
in this country and could have flourished doing his job as a Deputy General Manager of NHAI,
and shut his eyes to the ongoing corruption but he, true to his clear conscience, opted to do the
right thing by alerting the Prime Minister Office (PMO) “to these developments because he
believed the project was of unparalleled importance to the nation”.2 Unfortunately, for his belief
and commitment, Dubey paid with his life.

“The Indian Express newspaper, which broke the story of the murder, reported that the 31-year
old civil engineer had been killed after his name was leaked from the complaint”3 he had sent to
the PMO and the NHAI. “His death sparked off unprecedented condemnation and sympathy in a
country”4 where such allegations of “public money being siphoned off from large government
projects”5 have been too frequent. But the assassination and the poignant story of a youthful
official of integrity stirred the collective conscience of the nation.

The gory incident also made political parties renew demands for laws to protect whistle-blowers
both in government and private organizations. The laws have been pending approval by the
central government since 2002.

DUBEY’S MURDER WAS A SEQUEL TO HIS WHISTLE-BLOWING

Dubey’s tragic death was a sequel to his blowing the whistle on the murky occurrences in the
showpiece Golden Quadrilateral project. In his letter of 11 November 2002, Dubey wrote to the
Prime Minister about rampant corruption and the “loot of public money” in the project, and
“named criminals backed by politicians and police who bagged the biggest contracts for the
60km stretch, resulting in sub-standard quality and a slow pace of construction”.6

When he wrote to the Prime Minister, Dubey took all the precautions he could. His letter read:
“Since such letters from a common man are not taken seriously, I am attaching my full
particulars on a separate sheet of paper. Before moving the file, please remove the attachment
containing the particulars to ensure secrecy”.7

However, contrary to the plea, the PMO forwarded Dubey’s letter with the attachment to the
NHAI for investigation in December 2002. Three months later, Dubey complained to the PMO
in writing that he was receiving death threats because his identity had been leaked, but the letter
was totally ignored. Thus, the onus of responsibility to Dubey’s death lay squarely on those in
the PMO’s office, who covertly or overtly, let out the details of Dubey, the whistle-blower.8

DEADLY CONTENTS OF DUBEY’S LETTER

Dubey, in his letter to the Prime Minister, had questioned the process of procurement of civil
contractors for the Golden Quadrilateral Project stressing that it was “manipulated and hijacked”
by big contractors, who submitted forged documents to justify their technical and financial
capabilities to execute the project. He complained: “The big contractors have been able to get all
sorts of help and secret information and documents from NHAI officials and even note sheets
carrying approval of the chairman have been leaked outside”. He further noted: “The NHAI
officials showed great hurry in giving mobilization advance to selected contractors for financial
consideration”.9

Dubey’s letter read further: “In some cases the contractors have been given mobilisation advance
within 24 hours of signing the contract agreement”. According to Dubey “The entire
mobilisation advance of 10 per cent of contract value, which goes up to Rs 40 crore in certain
cases, are paid to contractors within a few weeks of awards of work”.10 Dubey pointed out “that
there was little follow up to ensure that they were actually mobilized at the site with the same
pace, with the result the advance remained lying with contractors or got diverted to their other
activities”.11

Dubey, in his letter, also highlighted the problems of subcontracting by the primary contractors.
“Though the NHAI is going for international competitive bidding to procure the most competent
civil contractors for execution of its projects, when it comes to actual execution, it is found that
most of the works, sometimes even up to 100 percent are sub-contracted to small contractors
incapable of executing such big projects”.12 Though the phenomenon of sub-contracting was
known to all in the NHAI, everyone remained silent, for obvious reasons.

Dubey’s letter to Mr Vajpayee continued further: “I have written all these in my individual
capacity. However, I will keep on addressing these issues in my official capacity in the limited
domain within the powers delegated to me”.13
Dubey, in another letter to the project director, NHAI, Koderma, Jharkhand, on July 26, two days
before he had taken over as a project manager in Gaya expressed displeasure over his transfer,
felt it was baffling to him and would not serve the interest of the project in Jharkhand. In his
letter, Dubey had drawn the attention of the project director to some alleged ‘irregularities’
committed by contractors and consultants for the project.

THE PMO’S VICARIOUS GUILT IN DUBEY’S DEATH

The irresponsible manner in which the PMO handled Dubey’s letter clearly endangered the life
of the man who had himself foreseen and highlighted the issue in his letter. Moreover, the
unprofessional manner in which the PMO had subsequently responded to it, and the cluelessness
displayed by the Union Minister of Surface Transport, B. C. Khanduri,14 about the consequences,
altogether constituted a damning indictment of a system that has neither the set up for self-
correction, nor the mechanism in place to achieve it.

The right to confidentiality of those in positions of vulnerability, or those who play the role of
whistle-blowers, is taken completely seriously and is considered a sacred duty of the State in
many democracies the world over. Dubey’s sense of duty and commitment to the national cause
was such that he called the PM’s highway showpiece “a dream project of unparalleled
importance to the nation,”15 and wanted to ensure its proper execution. And then he highlighted
several instances of what he called “loot of public money” and “poor implementation.”16 Dubey
requested his name be kept secret but at the same time he was not a coward, he let his identity be
known. Dubey made a request to the PMO to go through his brief particulars (attached to a
separate sheet to ensure secrecy) before proceeding further.

LAW ON PAPER

Dubey’s tragic death must bring back into focus the need for a law specifically designed to
protect such individuals. If the country is serious about launching a frontal attack on wrongdoing
at every level, it will have to seriously think through how it plans to achieve it. Empowering and
protecting individuals in sensitive posts to stand up against the malfeasance that permeates their
working environment is crucial. Dubey’s request for secrecy would have had legal protection had
the government enacted a Whistle-Blower Act recommended by the Constitution Review
Commission in 2002.

This would have ensured that Dubey was “protected against retribution and any discrimination
for reporting what he perceived as wrong-doing”. A designated authority would have probed
without betraying his identity. It would also have been bound to protect Dubey. “Dubey’s letter
is riddled with signatures and scribbles of officials, indicating it was a classic model of a file
going into babudom’s endless orbit. It also showed that the officials were aware of Dubey’s
concerns and it had their tacit approval”.17

In 10 days, the PMO forwarded Dubey’s complaint to his parent Ministry of Road Transport and
Highways (MoRTH). Dubey’s request for anonymity was apparently ignored by the PMO.
Along with the attachment, his letter was sent to the MoRTH.
Eight ministry officials went through the letter, indicating the whole system was porous enough
to let the violators and offenders of the road construction work know who made the complaint
against them.

And on 4 December 2002, Dubey’s letter was sent to the NHAI with a copy to its Chief
Vigilance Officer (CVO) under a covering letter from an official: “I am directed to forward
herewith an unsigned letter on the subject (National Highway’s Development Project complaint)
regarding loot of public money for such action as deemed fit”.18 It was even reported that the
CVO even reprimanded Dubey for approaching the Prime Minister directly with his complaint
without going through the “Proper Channel”.19 The FIR filed at the Rampur police station in
Gaya by Dubey’s brother following Dubey’s murder claimed that the people whose corruption
Dubey exposed were behind his murder. The FIR did not name anyone.

NHAI’S CLAIM OF PROACTIVE ACTION TO IMPROVE THE IMPLEMENTATION OF NHDP

It was not as if NHAI was not aware of the malfeasance of contractors and its own officials. The
NHAI itself was fully alive to the shortcomings of the existing systems and claimed that it had
initiated a series of measures to improve upon the procedures in a gigantic and first-of-its-kind
project like the NHDP, involving up-gradation of over 14,000 km of national highways at the
cost of Rs 580,000 million within a tight timeframe. There was always scope for improvement
and refinement. For instance, the following were the proactive steps claimed to have been taken
by NHAI.

1. The NHAI had been following internationally approved procurement procedures, which
were open and transparent. It claimed that it followed the Federation Internationale des
Ingenieurs Consells (FIDIC)20 conditions in implementing the National Highways
Development Project (NHDP).
2. The MoRTA had already constituted a committee on 24 July 2001, under the
chairmanship of a retired Director General of Roads to streamline the procedure,
documentation and to prepare manuals to facilitate better implementation of NHDP
Another committee headed by Member (Technical), NHAI was constituted on 10
December, 2002 which had reviewed the procedures and finalized model documents and
had suggested further improvements in the prequalification of consultants for preparation
of detailed project reports, evaluation of bids and actual preparation of the reports.
3. A similar exercise had been done for prequalification of contractors. NHAI was also
undertaking quality audit of its projects through Engineers India Ltd. It had also
appointed PriceWaterhouseCoopers as the internal auditors for NHAI headquarters as
well as Project Implementation Units (PIUs).

BLAME GAME BETWEEN DIFFERENT AUTHORITIES

Close on the heels of the orders of Prime Minister Atal Bihari Vajpayee, directing a CBI probe
into the murder of Satyendra Dubey, the Central Government came out with a denial that it ever
revealed the identity of Dubey leading to his murder. On the other hand, it shifted responsibility
for the heinous crime to the Bihar Government blaming lawlessness in the state for Dubey’s
killing. The ministry asserted in a press release that Dubey’s communication to the Prime
Minister was unsigned and undated and the PMO which received about 400–500 letters a day,
forwarded it to the MoRTH (North) for appropriate action.

The MoRTH claimed that Dubey sent several communications to the local officers of the NHAI
and consultants. While his letter to the Prime Minister raised mainly general issues about
perceived procedural shortcomings in the implementation of NHDP, his local communications
were very specific. These communications were not marked secret. The ministry also blamed the
murder of the official on the ‘lawlessness’ in Bihar. The government criticized the role of the
media too. It rued that “media reports have not taken into account the serious law and order
problem existing in Bihar, where Dubey was working,” and listed several instances of
government personnel being attacked. It also cited several instances where the Department’s
Minister, B. C. Khanduri, had written to the Bihar Chief Minister, Rabri Devi, complaining how
‘lawlessness’ was affecting the prestigious project.21

“Between March 2002 and November 2003, the Minister of Road Transport and Highways had
written as many as five letters to the Chief Minister of Bihar expressing concern over the law and
order problems in the State and urging her urgent attention to the severity of the situation”,22 the
ministry said, adding that Mr. Khanduri also spoke to Rabri Devi on many occasions on the
issue. The Phase-I of the NHDP, with four/six lane highways, was progressing satisfactorily in
most States but “the progress in Bihar has been delayed mainly because of the law and order
problem”.23

It went on to emphasize that the MoRTH took Dubey’s letter with all seriousness. NHAI officials
at the headquarters fully shared Dubey’s concerns and views regarding the need to improve
various activities in NHDP such as preparation of detailed project reports and award of civil
works. “He was called to NHAI headquarters with a view to obtaining specific details in the
matter. Also, suitable corrective action was taken on several points contained in his
communication,” it said.24

The ministry clarified that Dubey was not penalized for writing directly to the Prime Minister.
“On the contrary, on October 31, 2003, he was promoted to the post of Deputy General Manager
in the NHAI in recognition of his professional competence and his courageous, conscientious
and persistent efforts to improve implementation of the work on NHDP at his level”, it said.25

RESPONSE OF THE BIHAR GOVERNMENT

The Bihar Government pointed out to the irregularities in the quadrilateral project and wanted
the Central Bureau of Investigation (CBI) to probe Dubey’s murder. The ruling party, The
Rashtriya Janata Dal (RJD) Chief, Laloo Prasad Yadav said at a press conference in Patna, that a
special investigating team headed by a Deputy Superintendent of Police (DSP) would conduct a
parallel inquiry into Dubey’s assassination. He also requested the Centre to provide adequate
compensation to the family of the deceased. He continued that the RJD also would request Rabri
Devi, the Chief Minister to make an exgratia payment to the slain engineer’s family.26

FOLLOW-UP ACTIONS AFTER DUBEY’S MURDER

In the wake of Dubey’s murder, the CBI had registered in September 2004 a case against a
project director of NHAI about whom Satyendra Dubey had levelled allegations of bunglings,
and a retired army brigadier, who was running a consultancy service for the highway authority.

Nearly two years after Dubey’s murder in September 2005, his organization NHAI admitted to
substance in his charges. Apart from constituting several in-house enquiries, the NHAI claimed
that it had carried out radical reforms in the selection and contract procedures for highway
projects.

In a lengthy report submitted to the CBI, NHAI said its reforms included introduction of a peer
review of Detailed Project Reports by independent experts, modification of the system of
sanctioning mobilization and equipment advances which was to be henceforth sanctioned in a
phased manner linked to the progress of the project. The NHAI’s listing of the actions, and the
corrective measures taken vindicated Dubey’s allegations on several counts. Apart from the CBI,
the case is also being monitored by the Supreme Court.

Further, of the cases of variations listed by Dubey in the three Golden Quadrilateral packages,
NHAI issued show-cause notice to one consultant and warnings to three more for ‘noticed
flaws’.27

NHAI took punitive action under criminal law and law of contract, apart from making recoveries
and blacklisting firms, wherever allegation of forgery was established.

Of the three Golden Quadrilateral contractors against whom Dubey made specific allegations,
NHAI cancelled contract of one (China Coal Construction) for ‘tardy progress’ and listed the
progress of the other two as 42 per cent (Centrodorstroy) and 61 per cent (Progressive
Construction), respectively.28

NHAI now insists on end-use certificates, issued judiciously, for consultants getting excise duty
and customs duty exemptions.

NHAI has taken ‘stern action’ against the Golden Quadrilateral consultants in instances of fake
curriculum vitae. Key personnel who left projects midway have been banned.

TARDY INVESTIGATION

The CBI investigation of the murder of Dubey took the usual tardy and clueless pace. The CBI
found that Dubey’s stolen mobile phone that was switched off for 15 days after the murder was
being used by Pradeep Kumar, a rickshaw puller, and resident of a Gaya slum. Kumar, a history-
sheeter in some petty robbery cases, was let off after the investigation. It was reported that he
could not be traced a month thereafter. The CBI sleuths also questioned on 31 January 2004 two
other suspects, Sheonath Sah and Mukendra Paswan. Both of them were found dead from
poisoning within 25 hours of the CBI questioning. However, the CBI Director termed their
unnatural and unusual deaths as ‘suicides’.
After their investigations, the CBI charge-sheeted four persons on 3 September 2004 based on
the testimony of Pradeep Kumar. The person accused of actually shooting Dubey with a country-
pistol was Mantu Kumar of Katari village, in Gaya district. His accomplices in the crime were
Uday Kumar, Pinku Ravidass and Shravan Kumar. An incident that created the suspicion that
higher-ups were involved in it was that when the case was being heard in Patna on 19 September
2005. Mantu Kumar escaped from the court premises, leading to the widespread allegation of
complicity of police and persons who engineered the murder. After one month, Mantu Kumar
was arrested in Gaya.

DUBEY CASE IN SUPREME COURT

On 12 December 2003 the Supreme Court bench comprising Justice S. Rajendra Babu and
Justice G. P. Mathur fixed 5 January 2004 for hearing a public interest litigation (PIL) petition
seeking a probe into the alleged leakage of the name of Satyendra Dubey. The petitioner
advocate, Rakesh U. Upadhyay, sought an early listing of the case in courts and a direction to the
Centre to evolve a system, as recommended by the Constitution Review Committee in 2002, to
ensure protection to a citizen/person complaining about a corrupt system and keep the
complainant’s name a secret. He also wanted a CBI probe into the death of Dubey.

Another Court Bench comprising Justice Ruma Pal and Justice P. Venkatarama Reddi issued
notice on 5 January to the Centre, the PMO, the Bihar Government and the NHAI in a probe into
the alleged leakage of the name of Satyendra Dubey.29 The petitioner submitted that despite the
request of the deceased not to divulge his name, his identity was disclosed, leading to his murder.
This case was a pointer to the fact that no one from the public would come forward and complain
to the authorities about involvement of powerful corrupt persons. Even in the absence of the
Whistle-blower Act, the State had a fundamental duty to keep the name of such person secret for
protection of his fundamental right to life, he said.30

WHO ORDERED DUBEY’S MURDER?

The CBI, which investigated the murder, alleged in the case filed in the court that Dubey might
have been the victim of a simple robbery attempted by Mantu Kumar. But, if we consider the
death and disappearance of several key witnesses, and the startling escape of Mantu Kumar, the
prime accused, in the court premises, it cannot be construed to be a simple case of robbery. We
cannot totally discount the widespread speculation that powerful vested interests might have
engaged the criminals who did away with Dubey. There is a very strong circumstantial evidence
to suggest that Dubey’s death was caused by big money bags associated with the NHAI project,
who felt threatened by his actions.

WHISTLE-BLOWERS NEED PROTECTION

Satyendra Dubey was a whistle-blower par excellence. The PMO’s Office to whom Dubey blew
the whistle should have considered it its sacred duty to protect him at all costs instead of
exposing him to the very same evil and corrupt men who conspired to kill him.

What is whistle-blowing, and why should it be protected? Whistle-blowing involves a conflict

between two competing duties, to protect the public and be loyal to the organization. But then
given the fact often there exists no mechanism to deal effectively with ethical concerns, someone
who is in the horn of an ethical dilemma has a “3-way choice; shut up (and take a hard knock on
your conscience); get out (on the grounds of conflicting values) or blow the whistle (and pay for
the heavy consequences)”.31 A whistle blower may be generally a worker either in a public sector
organization or a private sector company who goes to the designated authority with complaints
of corruption or mismanagement in the organization with a view to mitigating the evil.

The term ‘whistle-blower’ is derived from the practice of British policemen who used to blow
their whistle when they saw a crime being committed with a view to alerting both law
enforcement officers and the general public of danger. Presently, whistle-blowing has
increasingly become part of the Western standard vocabulary.32

In this case, Dubey was a government employee, who unable to tolerate the high level of
corruption in NHAI blew the whistle, in spite of him being aware of the serious repercussions it
could cause.

Penalizing the whistle-blower has become a serious ethical issue in many parts of the world.
Although whistle-blowers are often protected under the law from employer retaliation in the
United States, the United Kingdom, Ireland, South Africa, Belgium, the Netherlands, Canada,
Australia, New Zealand and Japan, there does exist a ‘widespread shoot the messenger’
mentality by corporations or government agencies accused of misconduct, and in some cases
whistle-blowers have been subjected to criminal prosecution in reprisal for reporting
wrongdoing”.33

In India, the Veerappa Moily Commission on Administrative Reforms II has advocated the
system of whistle-blowers. According to the commission “an honest and conscientious public
servant, privy to information relating to gross corruption, abuse of authority or grave injustice,
should be encouraged to disclose it in public interest without fear of retribution. Along with the
Right to Information Act, a Whistle-blower’s Protection Act can indeed be a potent tool for
promoting good and transparent governance in the country”.34 This recommendation of the
Administrative Reforms Commission was endorsed by the erstwhile Chief Justice of India, Y. K.
Sabharwal. Subsequently in 2001, the Law Commission also favoured a whistle-blower’s law, to
be christened the Public Interest Disclosure (Protection) Act. However, nothing concrete has
emerged out of all these pious recommendations and endorsements, except the notification
issued by the Central Government at the instance of the Supreme Court following the Dubey
case. This notification has designated the Central Vigilance Commissioner (CVC) as the
authority to receive and process complaints about corruption and mismanagement in the
government. Had the law been enacted in time, and the legal protection guaranteed to the
whistle-blower put in place, the PMO’s office would have been more careful in leaking the letter
of Dubey, as they would have been held responsible for the offence and the concerned person
would have been penalized.

However, though the untimely and unfortunate death of Dubey stirred the sense of guilt of the
nation which fell penitent at the tragedy, nothing much was expected or achieved. On 19
November 2005, a full two years after the Dubey assassination, another bright and equally
promising youth, S. Manjunath, a manager of Indian Oil Corporation (IOC) was shot dead at the
instance of petrol adulterators, because of his relentless crusade against such corrupt practice.

POSTHUMOUS HONOURS CONFERRED ON DUBEY

The untimely death of 31-year-old IIT engineer stirred the nation’s conscience as nothing else
did before. Satyendra Dubey has been posthumously honoured with a prestigious Whistle-
Blower Award. He was named the “Whistle-blower of the Year” by the UK-based Index on
Censorship, a human rights publication. Indian Express, the newspaper which first broke the
story, has instituted a fellowship in Dubey’s name. Transparency International has announced an
Annual Integrity Award, while the All India Management Association (AIMA) has instituted the
Service Excellence Award in Dubey’s honour.

In his tribute to Dubey, the then Prime Minister Vajpayee called him “an upright and dedicated
officer” and assured the nation that “those responsible for his death, wherever they may be, will
not be spared”.35

In another rare and glowing tribute ever paid to a government official, the press release of the
Ministry of Road Transport and Highways said: “Dubey will be remembered for his honesty,
dedication and professional commitment to the NHDP”.36

Further, a group of grateful compatriots in the United States mainly led by student and alumni
bodies of IITs had launched the “S. K. Dubey Foundation for Fight Against Corruption in India”
in memory of Satyendra Dubey as a not-for-profit foundation organized under the laws of the
state of Florida, USA.37 IIT Kanpur instituted an annual award in his sacred memory known as
Satyendra K. Dubey Memorial Award to be given to an IIT alumnus for exhibiting a high degree
of professional integrity in promoting and upholding human values.

The name of Satyendra Dubey will ever be remembered and honoured by people who believe in
the principle Satyameva Jayate, or ‘Truth Alone Triumphs’.

CONCLUSION

The tragic death of Satyendra Dubey brings to light the all-pervading and rampant corruption and
malfeasance that sap the country’s development process. It also reveals the sordid state of affairs
in the government machinery that fails to protect honest and committed persons like Dubey who
wanted to be sincere to the job that was entrusted to him. He knew what fate would befall him if
his act of whistle-blowing was leaked to the criminals “who committed irregularities worth Rs
100 million”38 in the NHAI project.39 Probably, it was only the tip of the iceberg in a project that
was worth US$ 12 billion. Though he knew that he was targeted and that his blowing the whistle
would invite immediate retribution, Dubey did not backtrack in his resolve to do what was best
for the project he was involved in and for the country. His assassination revealed the enormous
loopholes that exist in our system of governance even at the level of the PMO’s office. It also
exposes the lethargy, utter carelessness and callousness of our bureaucrats in protecting the
whistle-blowers and the information they provide for the good of the society. The only silver line
in the whole episode of Dubey’s murder was the exemplary manner in which the common man
responded and how it stirred the collective conscience of the entire nation. It also resulted in
several improvements in the system of execution of the prestigious Golden Quadrilateral project.
Dubey’s martyrdom was certainly one more attempt, albeit painful, to cleanse India of corruption
and mismanagement in public life. His supreme sacrifice defies description. What sacrifice can
be greater than when a man lays down his precious life for the cause he espouses?

KEY WORDS

Whistle blower • Golden Quadrilateral project • Detailed Project Reports • National Highway
Authority of India • Undesirable pressures • Prime Minister’s Office • Central Bureau of
Investigation • Collective conscience • Retribution • Alleged bunglings • Corrupt practices •
Supreme Court Bench • CBI sleuths • Indian Institute of Technology • Martyrdom •
Malfeasance.

DISCUSSION QUESTIONS

1. What is whistle-blowing? Why and how should the whistle-blowers be protected?

2. Discuss in brief the tragic episode of Stayendra Dubey’s death. What, in your perception,
is an alternative course that Dubey could have used to achieve his objective without
sacrificing his life?
3. Did Dubey’s martyrdom bring any tangible benefits to the Golden Quadrilateral project
and the nation as a whole?
4. What are your suggestions for India to get rid of corruption and bribery?

FURTHER READINGS

1. BBC News, “India Whistle Blower Honoured,” available at

[Link]/uk/go/fr/-/2/hi/south_asia/3559809.stnPublished2004/03/237.

2. BBC News, “Suicides in India Murder Case,” 2 February 2004, available at

[Link]/uk/go/fr/-/2/hi/south_asia/[Link] 02 Feb.

3. Raghu Dayal, “Whistle Blowers Need to Be Protected,” Economic Times, Chennai edition, 26
December 2006.

4. S. K. Dubey Foundation for Fight Against Corruption in India, available at

[Link]/[Link]

5. The Indian Express, “Truth Is Dangerous,” 2 December 2003, available at

[Link]/[Link]?contentid=36391

6. Tribune News Service, “Public Servants Among 190 in CBI Net: Nationwide Raid Yields
Jewellery, Cash Worth 9 cr,” The Tribune, 30 September 2004, available at
[Link]/2004/20040930/[Link]

7. Whistleblower, Wikipedia, the free encyclopedia, available at

[Link]