Module III- Corporate Governance

1. Concept Corporate Governance (Pg no 138 to 142)

OECD (Organisation for Economic Co-operation and Development):

Definition: “Corporate governance involves a set of relationships between a company’s

management, its board, its shareholders, and other stakeholders. Corporate governance also
provides the structure through which the objectives of the company are set, and the means of
attaining those objectives and monitoring performance are determined.”

World Bank:

Definition: “Corporate governance is the system by which companies are directed and
controlled. It is concerned with holding the balance between economic and social goals and
between individual and communal goals.”

Cadbury Committee (UK) (1992):

Definition: “Corporate governance is the system by which companies are directed and
controlled. Boards of directors are responsible for the governance of their companies. The
shareholders' role in governance is to appoint the directors and the auditors and to satisfy
themselves that an appropriate governance structure is in place.”

2. History of Corporate Governance in India (Pg no 142 to 144)

International
1. 1929 Wall Street crash in the USA
2. 1970 Watergate scandal in the USA
3. 1997 East Asian Financial crisis
4. 2000 Eron and Worldcom bankruptcies
5. 2008 Financial scandals
India
1. Arthashastra during Chandragupta Maurya
2. 1990’s post liberalization
3. 1991 Fiscal crisis
4. SEBI regulator formed 1992
5. Confederation of Indian Industry (CII)
6. Clause 49
7. Sarbanes-Oxley Act 2002
8. Cadbury committee
9. Companies Act 2013

3. Need for Corporate Governance (Pg no 144 to 146)

1. Satisfy stakeholder’s interest
2. Ensure support of stakeholders
 3. Growing importance of social responsibility
4. Attract and retain employee
5. Ethical conduct of business
6. Reduces risks and face challenges
7. Globalization
8. Ensure long term stability and growth
9. Reduced legal restrictions and government interferences
10. Enhance corporate image
11. Changing ownership structure
12. Ensure transparency and accountability

4. Corporate Governance Framework (Refer to the framework details mentioned

under Corporate Governance in India (Pg 169 to 172))

5. Significance of ethics in Corporate Governance (Pg no 148 to 149)

1. Ethically driven business
2. Increase Wealth generating capacity
3. Increase shareholders value
4. Develop trust between company and stakeholders
5. Transparency
6. Accountability
7. Responsibility
8. Instrument in realising cardinal values of good governance

6. Principles of Corporate Governance (Pg no 149 to 151)

Following principles of Corporate Governance were given by the Organization for Economic
Co-operation and Development (OECD) which was one of the earliest guidelines on
implementing effective corporate governance
1. The rights of shareholders
2. Equitable treatment of shareholders
3. Stakeholders and Corporate Governance
4. Board responsibilities
5. Disclosures and reporting
6. Integrity and ethical behaviour
7. Fundamental principles
i. Equitable treatment to all stakeholders
ii. Independence and integrity of board
iii. Transparency
iv. Accountability
v. Reporting
vi. System of checks and balance
7. Benefits of good Governance (Pg no 151 to 153)
1. Excellent management
2. High level of transparency
3. Stakeholder benefits
4. Reputation and Recognition
5. Reduces wastage
6. Reduce risks, Mismanagement and Corruption
7. Economic Benefits

8. Issues in Corporate Governance (Pg no 153 to 154)

1. Duties of Directors (Issues of Conflict of Interest)
2. Composition and Balance of the Board
3. Remuneration and reward of Directors
4. Reliability of Financial reporting and external auditors
5. Boards responsibility for risk Management and internal control
6. Shareholders rights and responsibilities (Issues of Transparency)
7. Corporate social responsibility and business ethics

9. Theories (Pg no 157 to 164)

1. Agency Theory
2. Shareholder Theory
3. Stakeholder Theory
4. Stewardship Theory

10. Corporate Governance in India (Pg 169 to 172)

Regulatory framework on Corporate Governance
1. The companies Act, 2013
2. Securities and Exchange board of India (SEBI)
3. Standard listing agreement of Stock exchange
4. Accounting standards issued by the institute of chartered accountants of India (ICAI)
5. Secretarial standards issued by the institute of company secretaries of India (ICSI)
Key legal framework for corporate Governance in India
1. The companies Act, 2013
2. Listing Agreement – Clause 49
a. Board of Directors
b. Audit committee
c. Disclosure requirements
d. CEO/CFO certificates
e. Report and compliance
11. Emerging trends in Corporate Governance (Pg no 173 to 174)
1. Increasing expectation round the role of board – scenario planning, succession
planning and investor engagement
2. Attention to Director skill profiles – knowledge, diversity etc.
3. Sustainable value creation
4. Environmental and social governance (ESG)
5. Implementation of corporate governance practices – comply with companies Act,
2013
6. Nomination and remuneration committee to ensure directors skills and CEO
succession planning
7. Gender diversity - Mandatory atleast minimum one female director.
8. Mandatory 2% of net profit on CSR activities
9. Board to actively participate Risk management – cyber security risks
10. Duties and liabilities of directors, strict penalties for breach
11. Companies Act, 2013 and SEBI Clause 49 – Grievance mechanisms for directors and
employees and Whistleblowers protection Act, 2014.

12. Models of Corporate Governance (Pg no 164 to 168)

1. Anglo-American Model

2. German Model
3. Japanese Model

4. Indian Model - Uses a combination of Anglo-American Model and German Model

13. Role of SEBI in Ensuring Corporate Governance (Pg no 133 to 135)

• Audit Committee
• Financial Literacy of members of Audit Committee
• Disclosure of Accounting Treatment
• Unqualified financial statements
• Related party transactions
• Risk Management
• Training of Board Members
• Proceeds from IPO
 • Code of Conduct
• Nominee Directors
• Non-Executive Directors compensation
• Subsidiary Companies
• Evaluation of performance of Non-Executive Directors
• Real time Disclosures

14. Cadbury Committee Report, 1992 (Pg no 135 to 136)

The Cadbury Committee Report, officially known as the Report of the Committee on the
Financial Aspects of Corporate Governance, was published in the United Kingdom in
December 1992. The report is a landmark document in the history of corporate governance,
offering recommendations aimed at improving corporate governance standards and restoring
investor confidence following several corporate scandals in the late 1980s and early 1990s.

Objectives of the Cadbury Committee:

The primary objectives of the Cadbury Committee were:

1. To review the financial aspects of corporate governance.

2. To provide recommendations for improving accountability of boards of directors.
3. To strengthen financial reporting and audit practices.
4. To restore and enhance public and investor confidence in the financial markets.

Key Recommendations:

The report introduced several important principles and recommendations related to corporate
governance, which became the foundation for governance reforms in the UK and
internationally:

1. Separation of Chairman and CEO Roles

 The report recommended that the roles of Chairman and Chief Executive Officer
(CEO) should be separated to avoid too much power being concentrated in one
individual.
 This recommendation aimed to prevent conflicts of interest and ensure that the board
could effectively oversee management.

2. Board of Directors Composition

 The board should have a balanced composition with both executive directors
(responsible for the day-to-day operations) and non-executive directors (independent
from management and capable of providing oversight).
 A significant number of non-executive directors should be independent, meaning they
should not have close ties to the company to ensure objective judgment in decision-
making.
3. Audit Committees

 The establishment of an Audit Committee comprising non-executive directors to

ensure the integrity of the company’s financial statements and audit processes.
 The committee should oversee the relationship with external auditors and review
internal controls to prevent financial manipulation or fraud.

4. Internal Controls

 The report stressed the importance of maintaining robust internal controls to manage
risk and protect shareholders’ investments.
 Directors should regularly review these controls and report on their effectiveness in
the company’s financial statements.

5. Accountability and Financial Reporting

 The board of directors is responsible for ensuring the accuracy and completeness of
the company’s financial reporting.
 Directors should issue a statement of responsibility for maintaining proper accounting
records and a system of internal control.

6. Remuneration

 The report recommended transparency in the disclosure of directors' remuneration. It

called for the remuneration of directors, particularly that of senior executives, to be
set by a Remuneration Committee made up of independent, non-executive directors to
avoid conflicts of interest.

7. Compliance with the Code of Best Practice

 The Cadbury Report introduced the concept of "comply or explain". Companies listed
on the London Stock Exchange were encouraged to either comply with the principles
of the Code of Best Practice or explain why they had not.
 This approach allowed companies flexibility while also requiring them to provide
transparency about their governance practices.

15. Corruption, Causes & Effects, Types

Corruption is the misuse of public power, office, or resources for personal gain. It occurs
when individuals in positions of authority act dishonestly or unethically, often for financial
gain or other advantages. Corruption can exist in various forms, such as bribery,
embezzlement, nepotism, and fraud, and it affects all sectors of society, including
government, business, and civil society.

Causes of Corruption:

Corruption arises due to a combination of systemic, social, economic, and political factors.
The following are the key causes:
 1. Weak Governance and Institutions:
o Ineffective legal frameworks and lack of proper enforcement mechanisms
create an environment where corrupt activities can thrive.
o A lack of accountability and transparency in government and private
institutions encourages corrupt behavior, as individuals believe they can act
with impunity.
2. Poor Rule of Law:
o When legal systems are inefficient, slow, or corrupt themselves, it
undermines the enforcement of anti-corruption measures.
o Countries with weak judicial systems are less likely to hold officials
accountable, leading to the normalization of corrupt practices.
3. Low Wages and Economic Inequality:
o In countries with low salaries for public officials, employees may seek bribes
to supplement their income.
o Economic inequality can fuel corruption, as individuals or businesses may use
illicit means to gain advantages or overcome obstacles.
4. Lack of Education and Awareness:
o A poorly educated populace may not fully understand their rights or the
mechanisms to hold public officials accountable.
o Cultural acceptance of corruption in some societies, where unethical behavior
is normalized, can perpetuate corruption across generations.
5. Political Instability and Conflict:
o Political instability creates environments where the rule of law is weak, and
individuals in power may take advantage of the chaos to engage in corrupt
activities.
o Corruption flourishes in post-conflict societies or areas with weak state
institutions, where oversight and law enforcement are limited.
6. Concentration of Power:
o In systems where power is concentrated in a few hands, such as in
authoritarian regimes or one-party states, corruption becomes more likely
because of the lack of checks and balances.
o Limited political competition and a lack of independent media reduce the
scrutiny of corrupt practices.
7. Bureaucratic Complexity:
o Excessive regulations and bureaucracy create opportunities for corruption as
people may offer bribes to bypass inefficient or cumbersome procedures.
o Officials in regulatory agencies or government departments may use their
discretionary power to demand payments or favors in exchange for speeding
up processes or approving licenses.

Effects of Corruption:

Corruption has widespread and damaging effects on society, the economy, and governance.
Some of the major consequences include:

1. Economic Consequences:
o Reduced Foreign Investment: Corruption deters foreign investors, as it
increases the cost of doing business and creates uncertainty. This hampers
economic growth and development.
 o Inefficient Resource Allocation: Corruption leads to the misallocation of
public resources. Projects that offer personal benefits to corrupt officials may
be prioritized over those that provide genuine public benefits.
o Increased Costs of Goods and Services: Businesses facing corruption may pass
on the extra costs of bribes and other illegal fees to consumers, leading to
higher prices for goods and services.
2. Impact on Public Services:
o Poor Quality of Public Services: Corruption in sectors such as healthcare,
education, and infrastructure can result in substandard services. For example,
bribes may be required to access basic healthcare or educational opportunities,
and infrastructure projects may be poorly constructed due to embezzlement.
o Undermined Welfare Programs: In countries where social welfare programs
are in place, corruption can siphon off funds meant for the poor and
marginalized, exacerbating poverty and inequality.
3. Weakening of Institutions:
o Erosion of Trust in Government: Corruption damages public trust in
government institutions. Citizens lose faith in their leaders and in the
effectiveness of public services, which can lead to social unrest.
o Undermining of Democracy: Corruption can undermine democratic
institutions by distorting electoral processes, bribing voters, or manipulating
media coverage. This threatens the legitimacy of elected officials and weakens
democratic governance.
4. Social Consequences:
o Increased Inequality: Corruption disproportionately affects the poor and
marginalized, as they often lack the resources to pay bribes for services or
protections that should be freely available. This deepens societal inequalities.
o Social Unrest and Instability: Corruption can lead to public frustration,
protests, and social unrest, especially when it is perceived to be widespread
and systemic. In extreme cases, it can contribute to political instability or
revolution.
5. Impact on the Environment:
o Environmental Degradation: Corruption in regulatory agencies can lead to the
approval of harmful projects or the illegal exploitation of natural resources,
such as deforestation or mining. Bribery may allow companies to bypass
environmental regulations.
o Illegal Activities: Corruption can facilitate activities like illegal logging,
poaching, or pollution, as officials may accept bribes to turn a blind eye to
environmental crimes.
6. Loss of Human Capital:
o Brain Drain: Corruption can drive talented professionals to leave their home
countries in search of opportunities elsewhere. Skilled workers may feel that
merit-based advancement is impossible in corrupt systems, leading to a brain
drain that weakens the economy.
o Demoralization: Honest public servants and citizens may become disillusioned
and disengaged when they see corruption go unchecked, leading to decreased
civic engagement and social cohesion.
Long-Term Effects:

 Slowed Development: In the long term, corruption stifles innovation, economic

growth, and social development. Corrupt practices reduce the effectiveness of
government initiatives, waste public resources, and hamper infrastructure
development.
 Political Instability: Over time, persistent corruption can erode the legitimacy of
political leaders and governments, leading to a breakdown of law and order, and in
severe cases, it can lead to state failure.

Types of Corruption:

Corruption manifests in various forms, each with its own characteristics and methods of
execution. Here’s an elaboration of the common types of corruption, with examples to
illustrate how they work:

1. Bribery

Definition: Bribery involves offering, giving, receiving, or soliciting something of value

(such as money, gifts, or favors) to influence the actions of a person in a position of authority.

Example:

 A government official is responsible for issuing building permits. A construction

company pays the official a sum of money to expedite the permit approval process or
to overlook regulatory violations.
 Bribery can occur in both public and private sectors. For example, a supplier may
offer gifts to procurement officers to win contracts in a corporation.

Effects:

 Distorts decision-making processes.

 Undermines fair competition in business.
 Reduces public trust in government and institutions.

2. Embezzlement

Definition: Embezzlement is the theft or misappropriation of funds placed in someone’s trust

or belonging to an organization, typically by a person who has access to these funds due to
their position.

Example:

 A government employee responsible for overseeing funds allocated to infrastructure

development siphons off part of the budget for personal use. The public project, such
as a road or school, is left incomplete or poorly constructed.
 Embezzlement also occurs in the private sector, where an accountant might divert
company funds into personal accounts without detection.
Effects:

 Public services suffer due to a lack of resources.

 Destroys public confidence in financial management and government projects.
 Harms the financial health of organizations.

3. Nepotism

Definition: Nepotism occurs when someone in a position of power favors relatives or friends
for jobs, promotions, or other benefits, regardless of their qualifications.

Example:

 A government official appoints a family member or friend to a senior position in a

ministry or state-owned enterprise, even though the individual lacks the necessary
qualifications or experience for the role.
 Nepotism can also happen in businesses, where a CEO hires family members for
executive positions, ignoring other, more qualified candidates.

Effects:

 Reduces organizational efficiency and competence.

 Lowers employee morale when qualified individuals are overlooked for promotions or
jobs.
 Leads to incompetence in key government or organizational roles, affecting overall
performance.

4. Fraud

Definition: Fraud is the intentional act of deception intended to secure an unfair or unlawful
financial or personal gain. This often involves misrepresentation, forgery, or providing false
information.

Example:

 A company submits false claims to the government for reimbursement of expenses

that were never incurred, such as inflated costs for a public construction project.
 In corporate settings, financial statement fraud may involve manipulating accounting
records to misrepresent a company’s financial position, leading to misleading
information for investors or regulators.

Effects:

 Misleads stakeholders and investors, potentially causing financial loss.

 Distorts financial data, making it harder to assess economic performance.
 Can lead to financial crises if fraud is systemic (e.g., corporate accounting scandals
like Enron).
5. Kickbacks

Definition: Kickbacks refer to the practice of offering a percentage of a contract’s value to an

official or intermediary in exchange for securing the contract. It’s a form of bribery that
typically occurs in procurement or project management.

Example:

 A government official awards a construction contract to a particular contractor, who,

in return, pays a portion of the contract’s value back to the official as a kickback.
 In the private sector, a vendor may give a portion of the profits from a deal to the
procurement officer who helped secure the deal.

Effects:

 Leads to inflated contract costs, as the kickback is factored into the price, burdening
taxpayers or the company.
 Reduces competition by favoring those willing to pay bribes over more qualified or
cost-efficient bidders.
 Corrupts procurement processes and leads to poor quality goods or services.

6. Extortion

Definition: Extortion is the act of obtaining money, goods, or favors through coercion,
threats, or force. In a corrupt context, officials may use their power to demand payments in
exchange for not enforcing regulations or laws.

Example:

 Law enforcement officers threaten to arrest business owners unless they pay a
"protection fee." In return, the officers agree not to enforce legal or regulatory
violations, even if the business is breaking the law.
 A public health inspector demands bribes from restaurant owners to overlook
violations of health and safety codes.

Effects:

 Harms businesses by imposing additional, illegal costs.

 Diminishes trust in law enforcement and government institutions.
 Enables illegal activities, as perpetrators can pay to avoid punishment.

7. Conflict of Interest

Definition: A conflict of interest arises when a person in a position of authority is involved in

multiple interests (financial, personal, or otherwise), and serving one interest could be at the
expense of another.
Example:

 A legislator owns stock in a company that stands to benefit from a new law. Despite
this personal financial stake, the legislator votes in favor of the law, without
disclosing the conflict.
 A city official awards a lucrative contract to a company owned by their spouse,
undermining the fairness of the bidding process.

Effects:

 Reduces trust in decision-makers and governance systems.

 May result in biased decisions that benefit the individual’s private interests at the
public's or organization’s expense.
 Undermines fair competition in business and government processes.

8. Money Laundering

Definition: Money laundering is the process of concealing the origins of illegally obtained
money by passing it through a complex sequence of banking transfers or commercial
transactions. The goal is to make the illicit money appear legitimate.

Example:

 A corrupt official takes bribe money and funnels it through various shell companies
and offshore bank accounts to hide its origins, eventually reintroducing it as clean
money into the economy.
 Drug cartels or organized crime groups often launder their illicit earnings through
businesses or real estate investments.

Effects:

 Facilitates other forms of criminal activity, such as organized crime and terrorism, by
allowing illegal profits to be reintegrated into the legal economy.
 Distorts financial markets by introducing illicit capital.
 Damages the integrity of financial systems, making it difficult to track legitimate
transactions.

16. Balancing Act and Whistle Blowing Policy (Pg no 119 & Pg no 174 to 176)
Balancing Act
The dilemma faced by many finance managers comes in balancing the need to act ethically
while fulfilling the needs of the employer. The employer's ultimate goal is to maximize
earnings, and the drive to make money may cause an employee to act unethically. If a manager
believes his company may have crossed an ethical line, his first step should be to take it up
with his employer. If he feels the actions warrant legal intervention, he should do so without
fear of repercussion.
Whistle blowing policy
If a discussion with an employer does not resolve the ethical issues facing a finance manager,
he can report the activity to the appropriate government agency for investigation. This is known
as whistle-blowing. Under current laws, an employee has the right to report suspicious activity
without fearing for his job. While the activity may put a strain on his working relationship, he
is protected by law.

17. Case Studies on Good and Bad Corporate Governance

Good Corporate Governance Case Studies

1. Unilever
o What happened: Unilever, a global consumer goods company, is known for its
commitment to sustainability and strong corporate governance. The company
has a well-defined governance structure, with separate roles for the Chairman
and CEO, ensuring a clear division of responsibilities.
o Governance Practices:
 Strong board independence, with a majority of non-executive directors.
 Regular engagement with shareholders on long-term strategy and
environmental, social, and governance (ESG) goals.
 Transparent reporting on sustainability, including annual sustainability
reports.
o Impact: Unilever’s governance practices have enhanced its reputation for
integrity, sustainability, and long-term value creation, earning the trust of
stakeholders and helping the company thrive even in competitive markets.
2. Johnson & Johnson
o What happened: Johnson & Johnson (J&J) has consistently been recognized
for its strong corporate governance, especially in handling crises with
transparency and integrity, such as the 1982 Tylenol crisis.
o Governance Practices:
 A robust code of ethics, known as the "Credo," which emphasizes
responsibility to customers, employees, and shareholders.
 The company’s independent board includes experts from diverse
industries who guide the company's long-term strategy.
 Transparent financial reporting and strong internal control
mechanisms.
o Impact: J&J’s handling of the Tylenol crisis is often cited as a model of good
corporate governance and crisis management, which preserved the brand’s
reputation and trust with consumers.
3. Apple Inc.
o What happened: Apple Inc. is renowned for its corporate governance practices,
especially in terms of executive compensation, transparency, and shareholder
engagement.
o Governance Practices:
 Clear separation of roles between the CEO (Tim Cook) and the
Chairman of the Board.
 Shareholder engagement through regular meetings and transparent
disclosures about executive compensation and corporate strategy.
  A focus on diversity and inclusion in its board composition and
workforce.
o Impact: Apple’s governance practices have contributed to its stable growth,
innovation, and shareholder satisfaction, making it one of the most valuable
companies globally.
4. Nestlé
o What happened: Nestlé has implemented strong governance policies,
particularly in its focus on ESG (Environmental, Social, Governance) and
sustainability initiatives.
o Governance Practices:
 A well-diversified board with independent directors representing
various regions and industries.
 A strong focus on sustainability, with public commitments to reducing
environmental impact and increasing transparency in supply chains.
 Regular, transparent communication with stakeholders about business
performance and ESG efforts.
o Impact: Nestlé’s governance model has strengthened its reputation as a
socially responsible company and has driven its long-term success across
global markets.
5. Toyota
o What happened: Toyota’s corporate governance structure emphasizes quality
control, accountability, and continuous improvement, famously through the
Toyota Production System.
o Governance Practices:
 The company has a well-structured board, with both inside and
independent outside directors who provide diverse perspectives.
 Commitment to total quality management (TQM) and continuous
improvement (kaizen), which applies not only to operations but also to
governance practices.
 A strong internal system of risk management and a focus on corporate
social responsibility.
o Impact: Toyota’s strong governance and operational discipline have helped it
become one of the world’s most successful and respected automobile
manufacturers, known for reliability and innovation.

Bad Corporate Governance Case Studies

1. Enron Corporation
o What happened: Enron, an American energy company, collapsed in 2001 due
to fraudulent accounting practices and gross mismanagement.
o Governance Failures:
 Lack of board oversight, with close ties between the board and senior
executives.
 Fraudulent financial reporting, hiding debts and inflating profits.
 Conflict of interest: The company's executives were involved in off-
the-books partnerships that benefited them personally.
o Impact: The collapse of Enron resulted in billions of dollars in losses for
investors and employees and led to one of the largest bankruptcies in U.S.
history. It triggered major reforms, including the Sarbanes-Oxley Act, aimed at
improving corporate governance and accountability.
2. Lehman Brothers
o What happened: Lehman Brothers, a global financial services firm, collapsed
in 2008 during the financial crisis due to risky investments in mortgage-
backed securities.
o Governance Failures:
 Excessive risk-taking without sufficient oversight by the board of
directors.
 Lack of transparency in financial reporting, which obscured the true
financial health of the company.
 Poor risk management practices that ignored warning signs from the
housing market.
o Impact: The collapse of Lehman Brothers contributed to the global financial
crisis of 2008 and raised awareness about the need for stronger governance,
risk management, and regulatory oversight in the financial industry.
3. Volkswagen (Dieselgate)
o What happened: Volkswagen (VW) was involved in a massive scandal in
2015, where it was discovered that the company had installed software to
cheat emissions tests on diesel engines.
o Governance Failures:
 A toxic corporate culture that prioritized profit over compliance with
environmental regulations.
 Lack of transparency and ethical oversight, as the company misled
regulators and the public about the emissions levels of its vehicles.
 Inadequate board oversight and internal controls that allowed
fraudulent behavior to continue unchecked.
o Impact: VW faced billions of dollars in fines, legal settlements, and
reputational damage. The scandal highlighted the importance of ethical
corporate governance and accountability.
4. Wells Fargo
o What happened: In 2016, it was revealed that Wells Fargo employees had
opened millions of unauthorized customer accounts to meet aggressive sales
targets.
o Governance Failures:
 A toxic sales culture driven by unreasonable performance expectations,
without adequate oversight from senior management or the board.
 Failure of risk management and internal controls, allowing unethical
practices to persist for years.
 Weak board governance, with directors failing to hold management
accountable for the bank's culture and behavior.
o Impact: Wells Fargo paid billions in fines and faced widespread criticism from
regulators, shareholders, and the public, damaging its reputation as a trusted
financial institution.
5. Theranos
o What happened: Theranos, a health technology company, was exposed for
fraudulent practices in 2018 after it falsely claimed to have developed
revolutionary blood-testing technology.
o Governance Failures:
 A lack of independent oversight, as the board of directors consisted
mainly of high-profile figures without relevant expertise in health
technology.
  Secrecy and lack of transparency, with the company’s CEO, Elizabeth
Holmes, preventing board members and investors from scrutinizing the
company’s technology and financial practices.
 Manipulation of financial and clinical data to deceive investors,
regulators, and patients.
o Impact: Theranos collapsed, and its founders faced criminal charges for fraud.
The case highlighted the importance of having an independent and informed
board, strong internal controls, and transparency in corporate governance.

18. Role of Securities exchange commission (SEC)

The Securities and Exchange Commission (SEC) plays a crucial role in overseeing and
regulating the securities markets in the United States, helping to ensure fair, efficient, and
transparent markets. Its functions touch on various aspects of corporate governance, investor
protection, and market regulation. Here's an elaboration on the key roles the SEC plays in
corporate governance:

1. Regulation and Oversight

 The SEC regulates securities markets and enforces securities laws in the United
States. Its oversight ensures that companies, investors, and financial professionals
adhere to legal standards, preventing fraud and market manipulation.
 It oversees the activities of public companies, stock exchanges, brokers, investment
advisers, and mutual funds, making sure that market participants comply with
established rules and that markets function smoothly.
 The SEC also regulates initial public offerings (IPOs) and monitors corporate
activities such as mergers, acquisitions, and other significant corporate events that
could affect market integrity.

2. Disclosure and Transparency

 The SEC enforces laws requiring public companies to provide regular and accurate
disclosures of financial information, risks, and material developments through forms
such as 10-K (annual report), 10-Q (quarterly report), and 8-K (significant events).
 It ensures that investors have access to accurate, timely, and comprehensive
information about companies, enabling them to make informed decisions.
 Transparency in corporate governance practices, executive compensation, and board
activities is a key area of focus for the SEC, which helps maintain investor confidence
in the markets.

3. Investor Protection

 The SEC is tasked with protecting investors from fraud, market manipulation, and
misconduct by companies or market participants.
 It aims to prevent practices that may harm investors, such as insider trading,
accounting fraud, or the misrepresentation of financial statements.
 The SEC runs programs like EDGAR, which provides investors with free access to
company filings, enabling them to better evaluate their investments and avoid
potential risks.
4. Corporate Governance Standards

 The SEC plays a role in ensuring that companies adopt good corporate governance
practices that promote accountability, fairness, and transparency.
 Through its regulations, it helps enforce standards such as the separation of the roles
of CEO and Chairperson, disclosure of conflicts of interest, and the structure of board
committees (e.g., audit, compensation, and nomination committees).
 The SEC may set or influence standards for executive compensation, risk
management practices, and board responsibilities.

5. Facilitating Shareholder Engagement

 The SEC supports shareholder rights by ensuring that shareholders can participate in
corporate governance through activities like voting on important corporate matters,
such as the election of directors or significant transactions.
 It regulates the proxy process, ensuring that shareholders can vote on issues like board
appointments and executive compensation through proxy voting. The SEC's rules
ensure that shareholders receive proxy materials in a timely manner and have a voice
in corporate decisions.
 Through regulations, the SEC also makes sure that shareholder proposals are
considered and allows institutional investors to communicate and collaborate on
governance reforms.

6. Rule-Making

 The SEC has the authority to issue rules and regulations that impact the functioning of
securities markets and corporate governance.
 Its rule-making activities may relate to financial reporting, risk disclosures, conflict
minerals, climate-related disclosures, and insider trading, among other issues.
 The SEC also updates rules as needed to reflect evolving market conditions or to
address new risks. For instance, it develops rules that help protect retail investors and
keep up with advances in financial technology (e.g., high-frequency trading,
blockchain).

7. Enforcement of Corporate Governance Laws

 The SEC has a key role in the enforcement of corporate governance laws and
regulations, taking action against companies or individuals that violate securities laws.
 It can bring civil enforcement actions against companies or individuals engaged in
securities fraud, insider trading, misrepresentation, or breach of fiduciary duty.
 The SEC’s Division of Enforcement investigates and prosecutes securities law
violations, often imposing fines, suspensions, or barring individuals from serving as
company officers or directors.
 Through enforcement, the SEC holds corporations accountable for misconduct,
enhancing market integrity and protecting investors.

8. Advisory Role
  The SEC acts as an advisor to Congress on issues related to securities regulation and
corporate governance. It may provide recommendations on new laws or amendments
to existing legislation that impact the financial markets or investor protection.
 It collaborates with other regulatory agencies (e.g., the Federal Reserve, Commodity
Futures Trading Commission) and international bodies on global regulatory issues.
 The SEC also advises public companies and financial professionals on compliance
with new or evolving regulatory requirements, including guidance on specific rules,
governance issues, or reporting standards.

In summary, the SEC plays a central role in ensuring fair and efficient markets, protecting
investors, promoting corporate governance standards, and maintaining the transparency and
integrity of the securities market. By enforcing laws, facilitating shareholder rights, and
offering advisory support, the SEC is integral to promoting responsible corporate behavior
and protecting the financial ecosystem.

19. Sarbanes-Oxley Compliances (SOC)

The Sarbanes-Oxley Act (SOX), passed by the U.S. Congress in 2002, is a landmark law
designed to protect investors from fraudulent financial reporting by corporations. It was
enacted in response to major accounting scandals like Enron, WorldCom, and Tyco, which
shook investor confidence in the financial markets. SOX aims to improve the accuracy and
reliability of corporate disclosures and strengthen corporate governance.

Sarbanes-Oxley Compliances (SOC) refer to the specific requirements and internal controls
that companies must follow under the Sarbanes-Oxley Act. These compliances are
particularly important for publicly traded companies in the U.S. and companies that are listed
on U.S. stock exchanges. SOX compliance is monitored by the Securities and Exchange
Commission (SEC).

Key Provisions of Sarbanes-Oxley Act Compliances (SOC)

1. Section 302: Corporate Responsibility for Financial Reports

o Requirement: Senior executives, such as the CEO and CFO, must personally
certify the accuracy and completeness of the company's financial statements.
o Objective: Ensures that top management takes responsibility for the company's
financial disclosures and internal controls.
o Consequences: CEOs and CFOs are held personally accountable for any
misrepresentations or errors in financial reporting, with penalties including
fines and imprisonment.
2. Section 404: Management Assessment of Internal Controls
o Requirement: Companies must establish and maintain an adequate internal
control structure for financial reporting. They must also assess and document
the effectiveness of these controls annually.
o External Audit: An external auditor must independently evaluate and attest to
the effectiveness of the company’s internal controls.
o Impact: This is one of the most expensive and resource-intensive requirements
for companies, as it requires the implementation of detailed internal control
mechanisms.
 o Objective: To prevent financial fraud and errors by ensuring robust internal
controls and accountability at all levels of financial reporting.
3. Section 409: Real-Time Issuer Disclosures
o Requirement: Companies must disclose material changes in their financial
condition or operations in real-time, as they occur.
o Objective: Provides transparency to investors by ensuring that any significant
event that could impact the company's financial health is promptly reported to
the public.
4. Section 802: Criminal Penalties for Altering Documents
o Requirement: It is a federal crime to alter, destroy, mutilate, or conceal any
records or documents with the intent to impede, obstruct, or influence an
investigation or the administration of any matter within the jurisdiction of a
federal agency or in bankruptcy.
o Objective: To deter corporate fraud by making document manipulation a
serious criminal offense.
o Penalties: Severe penalties, including fines and up to 20 years in prison.
5. Section 906: Criminal Penalties for CEO/CFO Misrepresentation
o Requirement: CEOs and CFOs must certify that financial statements are
accurate and complete to the best of their knowledge.
o Objective: To hold corporate leaders accountable for intentional fraud or
misrepresentation in financial disclosures.
o Penalties: Fines of up to $5 million and imprisonment for up to 20 years for
false certifications.
6. Section 301: Audit Committee Independence
o Requirement: Public companies must have an independent Audit Committee,
consisting entirely of independent board members. The committee is
responsible for hiring, overseeing, and compensating the company’s external
auditors.
o Objective: Ensures that external audits are truly independent and that the audit
committee can effectively monitor the company’s financial reporting and
internal controls without undue influence from management.
7. Section 802: Retention of Records
o Requirement: Companies are required to retain all audit or review papers for at
least five years.
o Objective: Prevents the destruction of documents and records that could be
relevant to financial audits or investigations.
8. Section 806: Whistleblower Protection
o Requirement: Companies are prohibited from retaliating against employees
who report fraudulent activities within the organization (whistleblowers).
o Objective: Encourages employees to report fraudulent practices without fear
of reprisal, thus promoting transparency and accountability.
9. Section 402: Enhanced Conflict of Interest Provisions
o Requirement: It is illegal for public companies to extend loans to executives
and directors.
o Objective: Prevents conflicts of interest and personal enrichment at the
expense of shareholders.
Impact of Sarbanes-Oxley Compliances (SOC)

 Improved Financial Reporting: SOX ensures that financial statements and other
corporate reports are accurate and truthful, which has improved the integrity of
corporate financial disclosures.
 Greater Accountability: Corporate executives are held personally responsible for the
accuracy of financial reports, leading to more cautious and honest reporting practices.
 Stronger Internal Controls: The emphasis on internal control assessments (Section
404) has led to more robust financial systems and processes, reducing the risk of fraud
and errors.
 Higher Compliance Costs: While SOX has improved corporate governance, it has also
led to increased compliance costs, especially for smaller companies. This is
particularly true for the Section 404 requirement, which necessitates substantial time
and resources to implement and audit internal controls.
 Investor Confidence: By addressing the causes of major corporate scandals, SOX has
restored investor confidence in the financial markets and ensured that investors have
access to reliable and accurate information about public companies.

Criticisms of SOX

 Cost of Compliance: The most common criticism is that SOX compliance,

particularly Section 404, is very costly and resource-intensive, especially for smaller
public companies.
 Overregulation: Some argue that SOX imposes too many regulations on businesses,
which could stifle innovation and entrepreneurship due to the fear of non-compliance
and associated penalties.