SECRETARIAL AUDIT – A TOOL FOR GOOD GOVERNANCE

MEANING OF SECRETARIAL AUDIT

1. As per the ICSI, the Secretarial Audit is a process to check compliance with the provisions of all applicable laws and rules/regulations/procedures; adherence to good governance practices with regard to the systems and processes of seeking and obtaining approvals of the Board and/or shareholders, as may be necessary, for the business and activities of the company, carrying out activities in a lawful manner and the maintenance of minutes and records relating to such approvals or decisions and implementation.

SECRETARIAL AUDIT UNDER LEGISLATIVE UMBRELLA

2. Listed below are the legislative provisions relating to Secretarial Audit :

Companies Act, 1956

As per the erstwhile Companies Act 1956 (‘1956 Act’), section 383A provided that, every company having paid-up capital of Rs. 5 crore and above is to have a whole-time secretary. However, where the paid-up capital is between Rs. 2 crore but less than Rs. 5 crore the company may have a whole time secretary or obtain a Secretarial Audit certificate from a practicing company secretary. Every company having paid-up capital Rs. 10 lakh or above to obtain a Secretarial Audit certificate from a practicing company secretary. So as per the 1956 Act, it was merely a secretarial compliance certificate and the scope was also limited.

Corporate Governance Voluntary Guidelines 2009

The Voluntary Guidelines 2009 has suggested for the Secretarial Audit. Para V of the Voluntary Guidelines reads as under :

“Since the Board has the overarching responsibility of ensuring transparent, ethical and responsible governance of the company, it is important that the Board processes and compliance mechanism of the company are robust. To ensure this, companies may get the Secretarial Audit conducted by the competent professional. The Board should give its comments on the Secretarial Audit in its report to the shareholders.”

Although the guidelines were voluntary, but it was expected to set a good governance practice by the public companies as well as the large private companies and were recommendatory in nature. These guidelines were incorporated in the Companies Bill, 2009 and 2012, which later on, shaped in the form of Companies Act, 2013.

Companies Bill, 2009

The Parliamentary Standing Committee on Finance (2009-10) made recommendation to the 15th Lok Sabha in August 2010 for inclusion of Secretarial Audit in the Companies Bill, 2009. The relevant para of the recommendations are as under:

“7.5(iv)/10.52 : Secretarial Audit gives a necessary comfort to the investors that the affairs of the company are being conducted in accordance with the legal requirements and also protects the companies from the consequences of non compliance of the provisions of the Companies Act and other important corporate laws. It is, accordingly, felt and suggested that the Bill may provide for requirement of conduct of secretarial audit by at least bigger companies by a company secretary in practice. The Board of directors shall, in their Report to shareholders, explain in full any qualification or observation or other remarks made by company secretary in practice in his secretarial audit report.

7.8 Further, the suggestion for placing an obligation on the company to provide every assistance to the company secretary in whole time practice to enable him to verify any record or information, etc., in connection with certification of annual return of the company may be considered for inclusion in the clause. Besides, Secretarial Audit may also be mandated for bigger companies, including all listed companies; as it, inter alia, provides necessary assurance to the investors that the affairs of the company are being conducted in accordance with the legal requirements.

10.51 Suggestions have been received regarding inclusion of Secretarial Audit : “Every company having paid-up share capital exceeding ten lakh rupees of having loan outstanding exceeding twenty five lakh rupees from any bank or financial institution or having turnover as per its last financial statement exceeding one crore rupees, or such higher amounts in any of the aforesaid criteria as may prescribed, shall attach with its each financial statement a report called Secretarial Auditor‘s Report addressed to the members of the company”.

10.53 Keeping in view its significance for ensuring procedural compliance by companies, particularly with regard to various statutory disclosures and to ensure adherence to prescribed secretarial standards, the Committee recommend that Secretarial Audit report may be required to be attached with financial statements by companies exceeding certain threshold limit of paid-up share capital.

13.33 In accordance with the suggestions made by the Committee to include secretarial audit for bigger companies delineation of functions and role of chief financial officer and company secretary, the Ministry have proposed to include following three new sub-clauses 178A, 178B and 178C in clause 178 :

New sub-clause 178A – Provisions to be included in the Bill to mandate Secretarial audit for bigger companies

New clause 178A – (1) Every company having a paid up share capital of rupees five crore or more or such other amount as may be prescribed by Central Government from time to time shall annex with its Board‘s report made in terms of sub-section (3) of section 120 of the Act, a Secretarial Audit Report given by a company secretary in practice in such form as may be prescribed.”

Companies Act 2013 (‘the Act’)

Following are the relevant provisions of the Act

Section 204 (1) – Secretarial audit for bigger companies : Every listed company and a company belonging to other class of companies as may be prescribed shall annex with its Board’s report made in terms of sub-section (3) of section 134, a secretarial audit report given by a company secretary in practice, in such form as may be prescribed.

Rule 9 of Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014 : For the purposes of sub-section (1) of section 204, the other class of companies are :

• every public company having a paid up share capital of Rs. 50 crore or more ; or
• every public company having a turnover of Rs. 250 crore or more.

The format of the Secretarial Audit Report shall be in Form MR-3.

What is ‘paid-up share capital’

In terms of clause (64) of section 2 states that ‘paid-up share capital’ or ‘share capital paid-up’ means such aggregate amount of money credited as paid-up as is equivalent to the amount received as paid-up in respect of shares issued and also includes any amount credited as paid-up in respect of shares issued and also includes any amount credited as paid-up in respect of shares of the company, but does not include any other amount received in respect of such shares, by whatever name called.

What is ‘turnover’

In terms of clause (91) of section 2 ‘turnover’ means as the aggregate value of the realisation of amount made from the sale, supply or distribution of goods or on account of services rendered, or both, by the company during a financial year.

APPLICABILITY OF SECRETARIAL AUDIT

3. Clause (71) of section 2 defines ‘public company’. The proviso to clause (71) states that a company which is a subsidiary of a company, not being a private company, shall be deemed to be public company for the purposes of this Act even where such subsidiary company continues to be a private company in its articles. Hence, by this definition, it can be inferred that Secretarial Audit would be applicable to a private company which is a subsidiary of a public company, and which falls under the prescribed class of companies.

DATE OF COMMENCEMENT OF THE SECRETARIAL AUDIT

4. Rule 9 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014 relating to Secretarial Audit Report has come into effect from 1st April, 2014. Further as per MCA Circular No.08/2014 dated 4th April, 2014, the financial statement (and documents required to be attached thereto), auditor’s report and Board’s Report in respect of financial years that commenced earlier than 1st April, 2014 shall be governed by the relevant provisions/Schedules/Rules and that in respect of financial years commencing on or after 1st April, 2014, the provisions of the new Act shall apply. Hence as per the rules and the circular shows that in case of prescribed companies, the financial year of which closed on 31st March, 2014, Secretarial Audit is not applicable for that year.

APPOINTMENT OF SECRETARIAL AUDITOR

5. Rule 8(4) of Companies (Meetings of Board and its Powers) Rules, 2014 provides the power to be exercised by the Board of directors only by means of resolution passed at the meetings of the Board for the appointment of the secretarial auditor. The Secretarial Auditor should insist letter of engagement from the company and formally accept the same.

Information to earlier Secretarial Auditor

In view of the provisions of clause (8) of Part I of the First Schedule to the Company Secretaries Act, 1980 whenever a practicing company secretary is appointed as secretarial auditor in place of the existing secretarial auditor, he/she should communicate the appointment to the earlier incumbent in writing.

PERIODICITY OF THE SECRETARIAL AUDIT

6. Secretarial Audit is an ongoing process. Continuous basis would help the company in initiating corrective measures and strengthening its compliance mechanism and processes hence it is recommendatory that the Secretarial Audit is carried out periodically (quarterly/half-year/annually) and adverse finding if any, be reported on interim basis to the Board immediately. However, it is to mention that before the preparation of Board’s report, the secretarial audit report should be finalised so as to annexe it with Board’s report.

DESIGNATED COMPANY SECRETARY V. SECRETARIAL AUDITOR

7. Following tabular table shows comparison between designated company secretary and secretarial auditor :

Designated Company Secretary	Secretarial Auditor
Section is 203(1) provides that every company belonging to such class or classes of companies as may be prescribed shall have the whole-time key managerial personnel. Clause (ii) of sub-section (1) includes company secretary as whole-time key managerial personnel.	Section is 204(1) provides for appointment of company secretary for secretarial audit for bigger companies and every listed company and a company belonging to other class of companies as may be prescribed shall annex with its Board’s report made in terms of sub-section (3) of section 134, a secretarial audit report given by a company secretary in practice, in such form as may be prescribed.
Company secretary is in employment.	Company secretary in practice.
Rule 8 of the Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014, provides that every listed company and every public company having a paid-up share capital of 10 crores rupees or more shall have a whole-time key managerial personnel	Rule 9 of Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014 provides that (1) For the purposes of section 204(1), the other class of companies shall be as under : every public company having a paid up share capital of Rs. 50 crore or more; or every public company having a turnover of Rs. 250 crore or more. The format of the Secretarial Audit Report shall be in Form No. MR-3.

BENEFITS OF SECRETARIAL AUDIT

8. The Secretarial Audit is mandatory for all listed companies and other public companies having a paid up share capital of Rs. 50 crore or more; or every public company having a turnover of Rs. 250 crore or more. For rest of the companies, it is not mandatory ; however looking to its advantages, it may be got conducted voluntarily. The benefits of the secretarial audits to the stakeholders are as under:

• Company itself : Benefits are listed below :
  • Inculcation of the compliance culture.
  • Sound adherence of the Corporate Governance.
  • Lesser chances of default in compliance and receiving penalties, both monetary and by way of imprisonment.
  • Companies enjoy employee and customer loyalty and public respect for their brand, which can translate into better market capitalization and shareholder returns.
  • Recognition for the company as a good corporate citizen.
• Promoters : It assures the promoters of a company that those in-charge of its management are conducting its affairs in accordance with the requirements of laws and the owners’ stake is not being exposed to unintended risk.
• Non-executive/Independent directors : Secretarial Audit provides comfort to the Non-executive/Independent directors that appropriate mechanisms and processes are in place to ensure compliance with laws applicable to the company, thus mitigating any risk from a regulatory or governance perspective.
• Government authorities/regulators : It also facilitates reducing the burden of the regulators in ensuring compliances and they can take timely actions against the offenders.
• Investors : It helps the investors in taking informed investment decision, as it evaluates the company in terms of compliance and governance norms being followed by the company.
• Other Stakeholders : It is an effective due diligence exercise for the prospective investors or joint venture partners. Further Financial Institutions, Banks, Creditors and Consumers can measure the law abiding nature of company management.

POWERS AND DUTIES OF SECRETARIAL AUDITOR UNDER THE COMPANIES ACT, 2013

9. Following are the power and duties of secretarial auditor under the Act :

• Section 143(14)(b) provides that the provisions of this section shall mutatis mutandis apply to the company secretary in practice conducting secretarial audit under section 204.
• Section 143(12) casts duty on the part of the auditor to report frauds. It states that ‘Notwithstanding anything contained in this section, if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers of employees, the auditors shall report the matter to the Central Government within such time (not later than 60 days of his knowledge as per rule 13 of the Companies (Audit and Auditors)rule,2014] and in such manner as my be prescribed’. Provided that in case of a fraud involving lesser than the specified amount, the auditor shall report the matter to the audit committee constituted under section 177 or to the Board in other cases within such time and in such manner as may be prescribed.
• Section 204(2) provides that it shall be the duty of the company to give all assistance and facilities to the company secretary in practice, for auditing the secretarial and related records of the company.
• Section 205 (1) provides the functions of the company secretary which shall include, (a) to report to the Board about compliance with the provisions of this Act, the rules made thereunder and other laws applicable to the company; (b) to ensure that the company complies with the applicable secretarial standards; (c) to discharge such other duties as may be prescribed.
• Section 205 (2) provides that the provisions contained in section 204 and section 205 shall not affect the duties and functions of the Board of Directors, chairperson of the company, managing director or whole-time director under this Act, or any other law for the time being in force.
• Hence, in nutshell the powers and duties can be described as under:

Powers

Duties

Right to access to secretarial records. Right of access to the books of account and vouchers. Seek information and explanation from company and its officers. Power to enquire, inter alia, into the following matters : Security for loans and advances and its terms, Transactions represented merely by book entries Sale of assets of the company as consist of shares, debentures and other securities Treatment of loans and advances made by the company / Treatment given to personal expenses. Details of share allotted for cash.

Duty to report fraud Duty to scrutinize and verify the records Duty to examine compliances of all applicable laws. Duty to verify & ensure systems and processes for compliances Duty to report the non-compliances/irregularities/ limitations. Duty to adhere to the highest professional standards and justify the confidence reposed in the profession.

PROFESSIONAL RESPONSIBILITY AND PENAL PROVISIONS

10. Following are the relevant provisions dealing with professional responsibility and prosecution :

• Section 204(4) - Punishment for contravention : If a company or any officer of the company or the company secretary in practice, contravenes the provisions of this section, the company, every officer of the company or the company secretary in practice, who is in default, shall be punishable with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees.
• Section 447 – Punishment for fraud : Without prejudice to any liability including repayment of any debt under this Act or any other law for the time being in force, any person who is found to be guilty of fraud, shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud. PROVIDED that where the fraud in question involves public interest, the term of imprisonment shall not be less than three years.
• Section 448 – Punishment for false statement : Save as otherwise provided in this Act, if in any return, report, certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of any of the provisions of this Act or the rules made thereunder, any person makes a statement, (a) which is false in any material particulars, knowing it to be false or (b) which omits any material fact, knowing it to be material, he shall be liable under section 447.
• Professional misconduct as per the Company Secretaries Act, 1980 : Part I of First and Second Schedule contains the professional misconduct in relation to Company Secretaries in Practice. Section 21C of the Act provides that where the Disciplinary Committee is of the opinion that a member is guilty of a professional or other misconduct mentioned in the Second Schedule or both the First Schedule and the Second Schedule, it shall afford to the member an opportunity of being heard before making any order against him and may thereafter take any one or more of the following actions, namely (a) reprimand the member ; (b) remover the name of the member from the Register permanently or for such period, as it thinks fit ; (c) impose such fine as it may think fit, which may extend to Rs. 5 lakh.

OTHER RELEVANT ISSUES

11. Listed below are other relevant issues which merit mention :

• It is applicable on all the listed companies.
• The secretarial audit is not applicable on private companies irrespective of their size, turnover, paid up capital, net worth, number of employees, etc., whatsoever it may be.
• The applicability is also based on the basis of the paid up share capital or turnover crossing the threshold limit by the public companies even if it is not a listed company.
• The secretarial audit report is to be annexed with the Board report and the Board is to give clarification/explanation if the report has been qualified by the auditor.
• How the secretarial auditor will be appointed and what will be the tenure, has not been prescribed in the Act.
• The Act has specifically earmarked this role exclusively for the company secretary in practice.
• The Act does not prescribe the disqualification for appointment of the secretarial auditor. However the disqualification as prescribed for the statutory auditor in the Act may also be treated as disqualification for the Secretarial Auditor.
• The ceiling of number of audits which a PCS may undertake, has not been prescribed neither under the Act nor by the ICSI.

SCOPE OF THE SECRETARIAL AUDIT

2. The secretarial audit is the process to examine the verification and report of compliance of various laws applicable to that company. Hence, not alone the Companies Act but almost all the Acts and Regulations which are applicable on that particular company or the area/ field in which the company is operating are the subject matter of the Secretarial Audit.

Rule 9 of the Companies (Appointment and Remuneration Personnel) Rules 2014

Rule 9 prescribes that the Secretarial Audit Report should be given in Form MR-3. The report shall cover the adherence of compliance of the provisions, inter alia of the followings :

• The Companies Act, 2013 and the rules made thereunder,
• The Securities Contracts (Regulations) Act 1956 and the rules made thereunder,
• The Depositories Act, 1996 and the Regulations and Bye-laws framed thereunder,
• Foreign Exchange Management Act, 1999 and the rules made thereunder,
• Regulations and Guidelines prescribed under the Securities and Exchange Board of India Act, 1992 (‘SEBI Act’) :
  • The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
  • The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992.;
  • The Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009.
  • The Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999.
  • The Securities and Exchange Board of India (Issue and Listing of Debt Securities) Regulations, 2008.
  • The Securities and Exchange Board of India (Registrars to an Issue and Share Transfer Agents) Regulations, 1993 regarding the Companies Act and dealing with client.
  • The Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009.
  • The Securities and Exchange Board of India (Buyback of Securities) Regulations, 1998.
• Any other law specifically applicable to such company:

Coverage of any other laws

The ICSI has made the following suggestions vide its 226th meeting held on 21st November, 2014 :

• Reporting on compliance of ‘other laws as may be applicable specifically to the company’ which shall include all the laws which are applicable to specific industry. For example
• All laws applicable to banking industry ; all laws applicable to insurance industry ; all laws applicable to petroleum industry ; all laws applicable to pharmaceutical industry
• Examining and reporting whether the adequate systems and processes are in place to monitor and ensure compliance with general laws like labour laws, competition law, environmental laws, etc.

Format of Secretarial Audit report

Report is required to deal with the following points :

• The Board of directors of the company is duly constituted with proper balance of executive directors, non-executive directors and Independent directors. The changes in the composition of the Board of directors that took place during the period under review were carried out in compliance with the provisions of the Act.
• Adequate notice is given to all directors to schedule the Board meetings, agenda and detailed notes on agenda were sent at least seven days in advance, and a system exists for seeking and obtaining further information and clarifications on the agenda items before the meeting and for meaningful participation at the meeting.
• Majority decision is carried through while the dissenting members’ views are captured and recorded as part of the minutes.
• Report on adequacy of systems and processes in the company commensurate with the size and operations of the company to monitor and ensure compliance with applicable laws, rules, regulations and guidelines.
• Report on specific observations / qualification, reservation or adverse remarks in respect of the Board structures/system and processes relating to the audit period.
• Details of specific events / actions having a major bearing on the company’s affairs in pursuance of the above referred laws, rules, regulations, guidelines, standards, etc. referred to above). For example: (i) public/right/preferential issue of shares / debentures/sweat equity, etc. (ii) Redemption / buy-back of securities. (iii) major decisions taken by the members in pursuance to section 180 of the Act. (iv) Merger / amalgamation / reconstruction, etc. (v) Foreign technical collaborations.

CORPORATE GOVERNANCE AND SECRETARIAL AUDIT:

13. The introduction of Secretarial Audit and to make it compulsory for all the listed companies and for certain class of public companies in the Companies Act 2013, is a welcome step and it is the way towards the adherence of the Corporate Governance. The ‘Corporate Governance’, as defined by the ICSI, is the application of the best management practices, compliance of laws in true letter and spirit and adherence to ethical standards for effective management and distribution of wealth and discharge of social responsibility for sustainable development of all stake holders. The definition narrates the words “compliance of laws in true letter and spirit and adherence to ethical standards”, is very much important. The laws though discussed and drafted by the eminent personalities and passed by the respective governments, often leaves some lacunas / loop holes which may be the areas of practice for the professionals and advocates. However, in order to enhance the values of the best corporate governance practices, the compliance of the laws should in true letter and spirit to enhance the value to all the stakeholders. It has been well said that the business cannot go a long way on the false representations, unethical standards of profit making and ballooning the size of the balance sheet.

SUMMING UP

14. The Secretarial Audit should not be treated merely as the compliance audit, rather it is an audit of the examination and verification of the ethical standards, observance of the transparency and disclosure, observance of integrity and honesty of the key managerial persons, efforts for environmental protection for sustainable growth and corporate social reasonability for the benefit of the society at large.