China; The Rough Guide

The Securities and Exchange Commission adopted rules under the Securities Exchange Act, 1934 and the Investment Company Act, 1940 that require an issuer’s principal executive officer and principal financial officer to certify the contents of the issuer’s quarterly and annual reports.

The rules implement Section 302 of the Sarbanes-Oxley Act of 2002, which was enacted as law on July 30, ‘02. Section 302 directed the SEC to adopt, by August 29,’02, rules requiring issuers’ principal executive and financial officers to certify their quarterly and annual reports.

On June 27, ‘02, the SEC issued an order under Section 21(a)(1) of the Securities Exchange Act, 1934 making it compulsory for certain publicly traded companies (with revenues during their last fiscal year of greater than $1.2bn) to file a statement under oath, regarding the accuracy of their companies’ financial statements and their consultation with the companies’ audit committees.

Further, the statement is to be given separately by both, that is, by the principal executive officer and principal financial officer. This order requires that the principal financial officer and the principal executive officer of the company to file a written statement in a prescribed format.

The text of the prescribed format of the statement is as follows: “To the best of my knowledge, based upon a review of the covered reports of (company name) and, except as corrected or supplemented in a subsequent covered report: No covered report contained an untrue statement of a material fact as of the end of the period covered by such report (or in the case of a report on Form 8-K or definitive proxy materials, as of the date on which it was filed); and no covered report omitted to state a material fact necessary to make the statements in the covered report, in light of the circumstances under which they were made, not misleading as of the end of the period covered by such report (or in the case of a report on Form 8-K or definitive proxy materials, as of the date on which it was filed). I [have/have not] reviewed the contents of this statement with [the company’s audit committee, in the absence of an audit committee, the independent members of the company’s board of directors]”.

The covered reports refer to the most recent annual report of the company filed with the SEC and the reports on Form 10Q, Form 8-K, 10K and all proxy material filed with the SEC.

As of today, six Indian companies are listed on the NYSE and three companies on the Nasdaq. SEC has also indicated the applicability of these requirements to the foreign companies whose shares are listed on the US stock exchanges, for example, on the Nasdaq or the NYSE.

Though the CEOs and CFOs are strongly protesting the requirement of them certifying the financial statements, the provisions of the Sarbanes-Oxley Act and the SEC order do not leave them with much choice.

Though, the giving of the above statements by CEO/CFO of companies look very stringent and somewhat draconian, under the Indian Securities and Company law, specifically the Companies Act, 1956 (the Act) and Indian Stock Exchange Listing norms, directors of companies are required to certify the accounts and financial affairs of the company.

Section 209 of the Act, prescribes for every company to keep such books as are necessary to give a true and fair view of the state of affairs of the company or branch office and to explain its transaction.

Section 211 of the Act, provides for preparation of annual accounts and balance sheet in such manner so as to give a true and fair view of the state of affairs of the company as at the end of the financial year.

Section 215 of the Act provides for signing of balance sheet and profit and loss accounts (accounts). It provides for signing by at least two directors, out of which, one must be the managing director.

It also provides that a company secretary should also sign the accounts. Further, in most Indian companies, all whole time directors, who are involved in day-to-day management of the company, sign too.

The other important provision is Section 217 of the Act, which makes it compulsory for every company to attach a report called the Directors’ Report along with the audited accounts and circulate the same to all the shareholders of the company.

Further, it provides a list of various information and material changes, which a directors’ report should contain. Pursuant to the Companies Amendment Act 2001, to Section 217 it is compulsory for the board of a company to make a statement called a directors’ responsibility statement in the their report which forms part of the Annual Report.

The statement is as follows: “Your Directors hereby confirm: That in the preparation of the annual accounts, the applicable accounting standards had been followed alongwith proper explanation relating to material departures. That the directors had selected such accounting policies and applied them consistently and made judgments and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company at the end of the financial year and of the profit or loss of the company for that period. That the directors had taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of this Act for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities. The directors had prepared the annual accounts on a going concern basis”.

If one looks at overall language of the above statement, provisions related to certifying the correctness, fairness and disclosure of material facts and events, the provisions under Indian law relating to disclosure statements are equivalent to the recent requirement prescribed by the SEC.

Paragraph 49 of the Listing Agreement of stock exchanges on corporate governance, it is compulsory for all listed companies to form various committees including an audit committee consisting of an independent director. It also provides for review of accounts by such audit committee before the finalisation of the accounts.

One may raise a question as to penalties and whether strict penalties are imposed on the defaulters. In case of all the above provisions and regulation, Indian companies prescribe stringent penalties including imprisonment in certain cases.

Further, Section 628 of the Act, which is very general but very stringent, provides that if any return, report, certificate, balance sheet, prospectus, statement or other document required under this Act, and if any person made false statements or otherwise will be punishable with imprisonment of two years. What India may require is not other rules but a more effective mechanism to enforce the existing requirements under the various laws.