Whistle Blower Policy and the Indian Corporate Governance

Abstract

In this age of Globalisation, where economic motives precede over all virtues and traditions, protection of larger public interest from great corporate scandals has become matter of great importance. The valiant attempt in this regard was made by the Confederation of Indian Industries by coming up with the voluntary set of guidelines on Corporate Governance, subsequently adopted by SEBI through its Listing Agreement.

The Whistle-blower policy in this regard has been recognized as one of the basic features of Corporate Governance Norms by most of the nations across the world. However due to the lobbying of the Indian Corporations, the Whistle-blower policy, despite being a mandatory recommendation in the Murthy Committee Report, was diluted and made non mandatory provision under the Clause 49. The article deals with the legal implications of this dilution and tries to identify the origin and legislative development of the policy and its need in the present corporate world.

Introduction

“Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?”

– Edward, First Baron Thurlow

(1731-1806)

1. India has the largest number of listed companies in the world, and therefore efficiency and well being of the financial markets is critical for the economy in particular and the society as a whole. According to a report prepared by Pune-based Indiaforensic Consultancy Services (ICS), at least 1,200 companies listed on domestic stock exchanges have forged their financial results. The figure included 20-25 firms on benchmark sensex and Nifty indices. The study called ‘Early Warning Signals of Corporate Frauds’ had alleged that such improper accounting included deferring revenue and inflating expenses.

2. The survey examined 4,867 companies listed on the BSE and 1,288 companies listed on the NSE. Now with the Satyam Fraud unfolding the report does not seem improbable. Infact putting it in Mayur Joshi’s (the founder of Indiaforensic Consultancy Firm) words;

“Satyam is just one component of all those companies which are indulging in such frauds. More than 73% of respondents in our report named Early Warning Signals of Corporate Frauds said companies are indulging into financial statement frauds with the objective to beat the analysts expectation.”

3. The present times are in need of standards of corporate governance more than ever for despite the dominance of organizational actors in contemporary social life, law is desperately short of doctrines, institutions, and regulatory techniques that adequately control corporate entities. It has now become imperative to design and implement a dynamic mechanism of corporate governance, which protects the interests of relevant stakeholders without hindering the growth of enterprises because the corporate veil frequently deflects the penetration of legal values into and, indeed, the imposition of legal sanctions upon the corporate entity. Adversarially-trained lawyers often facilitate avoidance and evasion of corporate liability through ‘creative compliance’ with legal requirements. A commonly proffered solution to the problem of ensuring that legal values permeate the internal workings of the corporation is to require large institutions to regulate themselves in a way that is responsive to social concerns.

4. On the other hand it has been an argument against corporate governance that not all well governed companies do well in the market place nor do the badly governed ones always sink. Counter to that is the fact that modern day corporations raise capital through investment by stakeholders whose interests are to be protected by the company management. Corporate governance is thus ‘concerned with ways of bringing the interests of investors and manager into line and ensuring that firms are run for the benefit of investors’. The Birla Committee on corporate governance sums up the principles in the following manner:

“the fundamental objective of corporate governance is the “enhancement of shareholder value, keeping in view the interests of other stakeholder”. Fundamental to this examination and permeating throughout this exercise is the recognition of the three key aspects of corporate governance, namely; accountability, transparency and equality of treatment for all stakeholders.

5. The Cadbury Committee on Financial Aspects of Corporate Governance further elaborated on the principles of Corporate Governance, by the often and ubiquitously quoted words:

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. The responsibilities of the board include setting the company’s strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board’s actions are subject to laws, regulations and the shareholders in general meeting

The very basic premise of corporate governance is accountability to share holders as the directors always stand in a fiduciary relationship with the company and the shareholders, the welfare of the company is welfare of the shareholders. Various safeguard mechanisms as regards the accountability to shareholders are already a part of our Companies Act as well as various common law doctrines. However the controversy that was aroused by the Caparo’s Case exposed two widely held misconceptions:

i. That the audit report is a guarantee as to the accuracy of the accounts, and perhaps even as to the soundness of the company;

ii. That anyone (including investors and creditors) can rely on the audit, not only in a general sense but also very specifically by being able to sue the auditors if they are negligent.

7. It was held in this case;

No duty was owed at all, either to existing shareholders or to future investors by a negligent auditor. The purpose of the statutory requirement for an audit of public companies under the Companies Act 1985 was the making of a report to enable shareholders to exercise their class rights in general meeting. It did not extend to the provision of information to assist shareholders in the making of decisions as to future investment in the company.

8. Lord Denning quoting the the famous phrase given by Cardozo, CJ in the case of Ultramares Corp v. Touche held that there could not be a duty owed in respect of “liability in an indeterminate amount for an indeterminate time to an indeterminate class”.

9. Following the legal implications of this case, where an auditor’s liability for negligence is indeterminate, what was the remedy available to the shareholders? Such a conundrum demanded a proper intra organisational complaint mechanism, whereby any mal practice of the company or any of its organ which may potentially harm the shareholder or any third party, or even be prejudicial to public interest could be duly reported and acted upon. Hence in such a situation an Independent Complaint Mechanism becomes one of the basic tenets of Corporate Governance. However it is indeed a matter of great embarrasment that the Indian Corporate World still argues in sharp contrast.

Whistle Blower

10. The concept of Whistle Blower as it gained much recognition owing to two of the biggest known Corporate Scandals Enron and Worldcom, Sheron Watkins and Cynthia Coopers came to be known as th two most gutsy women of the century to uncover the fraud and misstatements in the accounts of two the very well known Corporations of the United States. As a counterpart to the U.S. corporate fraud, in Inida protection of Whistle Blowers gathered policy attention due the much controversial murder of Satyendra Dubey who tried to expose the corruption in the Golden Quadilateral Highway Construction Project by writing a letter to the Prime Minister.

11. The term whistleblower was first discussed by Doggett, J., in the case of Winters v. Houston Chronicle Pub. Co., The word is derived from the practice of English bobbies, who would blow their whistles when they noticed the commission of a crime. The whistle would alert both law enforcement officers and the general public of danger.

12. Whistle blowing can be defined in a number of ways. In its simplest form, whistle blowing involves the act of reporting wrongdoing within an organization to internal or external parties. Internal whistle blowing entails reporting the information to a source within the organization. External whistle blowing occurs when the whistleblower takes the information outside the organization, such as to the media or regulators.

13. Whistle blowing is an important organizational behavior that can cause quantum change in modern organizations. In the public sector, whistle blowing also can trigger fundamental reforms in the nature and role of government in society.

14. Research has shown that most whistle blowers are not dis- gruntled employees. In sharp contrast, they rank among the most productive, valued, and committed members of their organizations . A number of studies show that most whistle blowers are normal people who have a strong conscience Empirical evidence shows that most whistle blowers are committed to the formal goals of their organization, they identify with the organization, and they have a strong sense of professional responsibility. These employees report feeling an “extended sense of responsibility” when they are confronted with moral or ethical dilemmas. Whistle blowers act on attitudes akin to the public-service ethic in another way, for it is well known that whistle blowing involves self-sacrifice. Since employees who report wrongdoing threaten the authority structure of organizations, whistle blowing can result in swift punishment. Such behavior is difficult to explain in utilitarian terms because self- sacrifice is irrational from a narrow means-ends perspective. Whistle blowers are often ostracized, fired, and humiliated. Even so, most employees expect retaliation to be more frequent and severe than it is. It appears that many whistle blowers willingly put them- selves at risk to preserve the common good.

15. To cite one example, days before the launch of Reliance Infocomm’s overseas service in the US, Akhil Gupta, the then CEO Corporate Development, had warned the management that the idea of disguising overseas calls coming into India as local ones, to avoid paying charges to state-owned BSNL and MTNL, would run foul of regulators. The communication proved to be prescient. Lately the communications ministry began an investigation into Infocom’s call re-routing activities and subsequently penalties worth about Rs. 500 crore were imposed on the Company, preceding a case of criminal conspiracy against the senior officials of the company including Akhil Gupat. In such cases a need for Whistle Blower Policy becomes apparent.

The Process of Whistle Blowing

16. The process of Whistle-blowing can be understood by the diagram given hereinabove. It basiclly involves five steps, at first when a concern is raised by an empoloyee, it is communicated to the the Ombudsperson, who could be any person alegal adviser, audit committee or a compliance officer. This would result in initial enquiry , wich could be dismissed when it is found that the complain is frivolous or insignificant and the proceedings can be stopped. On the other hand if the complaint turns out to be a genuine one an enquiry committee can be appointed and which may take up further investigations and based on the results of the investigation appropriate action may be taken agains the wrongdoer as the case may be.

The US Scenario

17. Whistle blowing arose almost a century ago in the False Claims Act of 1863 which was established to offer incentives to individuals who reported companies or individuals defrauding the government. The Act also specifies that the whistleblower can share in up to 30% of the proceeds of the lawsuit. This Act has resulted in more than $17 billion dollars of recoveries for the U.S. government since 1986. Financial rewards to whistleblowers can, however, create an incentive to report bogus false claims. The Act imposes monetary penalties on bogus whistleblowers.

18. Then came the Whistle Blower Protection Act, 1989 amended in 1994, under this act federal employees are protected from workplace retaliation when disclosing waste and fraud. The purpose of the Act and subsequent amendments was to strengthen the protections available to federal employees. In 2007 the House of Representative approved the Whistle Blower Enhanced Protection Act.

19. Subsequent to this was the Sarbanes-Oxley (SOX) Act of 2002, in which Congress introduced a series of corporate governance initiatives into the federal securities laws. The federal regime had until then consisted primarily of disclosure requirements rather than substantive corporate governance mandates, which were traditionally left to state corporate law. Federal courts had, moreover, enforced such a view of the regime’s strictures, by characterizing efforts of the Stock Exchanges to extend its domain into substantive corporate governance as beyond its jurisdiction. SOX altered this division of authority by providing explicit legislative directives for SEC regulation of what was previously perceived as the states’ exclusive jurisdiction.

20. SOX by providing for the substantive corporate governance provisions tried to change the attitude of corporation towards work place crimes. For the first time Whistle Blowing was included as a legislative precept of corporate governance norms. Sections 806, 301, and 1107 of SOX provided additional guidance for whistleblowing.

21. Section 806 states that whistleblowers who provide information or assist in an investigation of violations of any federal law relating to fraud against shareholders or any SEC rule or regulation are protected from any form of retaliation by any officer, employee, contractor, subcontractor, or agent of the company. Employees who are retaliated against will be “entitled to all relief necessary to make the employee whole” (SOX section 806), including compensatory damages of back pay, reinstatement of proper position, and compensation for litigation costs, expert witness fees, and attorney fees. SOX also requires audit committees to take a role in whistleblowing and reducing corporate fraud. Section 301, amending the Securities Exchange Act of 1934, compels audit committees to develop reporting mechanisms for the recording, tracking, and acting on information provided by employees anonymously and confidentially. By mandating policies and protection for reporting wrongdoing, the SOX standards go beyond merely encouraging companies to be more responsive to employee whistleblowers. In SOX Section 1107, the reach of whistleblowing policies extends beyond public corporations. This section extends protection to any person who reports to a law enforcement officer information related to a violation of a federal law. These whistleblowers are protected from any retaliation by the offender. A violator may be fined and imprisoned for up to 10 years.

The Indian Scenario: Institutional and Other Legislative Efforts

22. There is no rigorous theory of how policy proposals come to the forefront of the legislative agenda, but the political science literature identifies shifts in national mood and turnover of elected officials, coupled with focusing events, as key determinants that open “policy windows” for policy entrepreneurs to link their proposed solutions to a problem. The evolution Corporate Governance Policy in India somewhat conforms to this political theory. With globalization, the New Economic Policies became almost unavoidable and hence the decade of 1990s saw the era of privatization and liberalisation. With a need for greater Foreign Direct Investment, the entry of transnational and multinationals to the country, a need for greater accountability and investor protection arose.

23. The first step taken in this regard was in 1996, when the Confederation of Indian Industries took a special initiative on Corporate Governance – the first institutional initiative in Indian industry. The objective was to develop and promote a code for Corporate Governance to be adopted and followed by Indian companies, be these in the Private Sector, the Public Sector, Banks or Financial Institutions, all of which are corporate entities. The code however focused on listed companies for the simple reason that these are financed largely by public money (be it equity or debt) and, hence, need to follow codes and policies that make them more accountable and value oriented to their investing public. The preference was given to the shareholders and the creditors for instead of the employees, local communities, suppliers or ancillary units for the simple reason that;

• • Firstly corpus of Indian labour laws is strong enough to protect the interest of workers in the organised sector, and employees as well as trade unions are well aware of their legal rights. In contrast, there is very little in terms of the implementation of law and of corporate practices that protects the rights of creditors and shareholders.
  • Secondly there is much to recommend in law, procedures and practices to make companies more attuned to the needs of properly servicing debt and equity.

24. There was no material provision as regards the policy of Whistle blowers in the Code, however the code in substance talked about the reporting of internal audit reports, including cases of theft and dishonesty of a material nature to the Board and an Independent Audit committee consisting of non-executive directors.

A major break through was achieved by the amendment to clause 49 of the SEBI’s Listing Agreement to include the recommendations of the Narayan Murthy Committee Report on Corporate Governance, 2003. Owing to the controversy raised by the murder of Satyendra Dubey, the policy of Whistle Blower was given as a mandatory recommendation.

The Recomemdation involved the following dimensions:

a. Personnel who observe an unethical or improper practice (not necessarily a violation of law) shall be able to approach the audit committee without necessarily informing their supervisors.

b. Companies shall take measures to ensure that this right of access is communicated to all employees through means of internal circulars, etc. The employment and other personnel policies of the company shall contain provisions protecting “whistle blowers” from unfair termination and other unfair prejudicial employment practices.

c. Company shall annually affirm that it has not denied any personnel access to the audit committee of the company (in respect of matters involving alleged misconduct) and that it has provided protection to “whistle blowers” from unfair termination and other unfair or prejudicial employment practices.

d. Such affirmation shall form a part of the Board report on Corporate Governance that is required to be prepared and submitted together with the annual report.

26. However, owing to the lobbying by the corporate world many of the mandatory recommendations were made non mandatory in the amendment to the Clause 49 of the Listing Agreement, which was to be enforced by April, 2005.

27. At present clause 49 recommends the company to “establish a mechanism for employees to report to the management concerns about unethical behavior, actual or suspected fraud or violation of the company’s code of conduct or ethics policy. This mechanism could also provide for adequate safeguards against victimization of employees who avail of the mechanism and also provide for direct access to the Chairman of the Audit committee in exceptional cases. Once established, the existence of the mechanism may be appropriately communicated within the organization.” This is a mere recommendation and not a mandatory provision which is to be complied with.

28. Corruption as it has permeated to every nerve and vein of the country, the central government following the gruesome murder of Satyendra Dubey, on recommendation of the Law Commission Report, which came up with a draft bill on Whistle Blower Protection, designated the Vigilance Commissioner with an authority to take up complains about corruption and mismanagement in government, which subsequently adopted the Whistle-Blowers Resolution. In 2006 finally the draft bill Whistle blowers (Protection in Public Interest Disclosures) Bill recommended by the Law Commission was presented in Rajya Sabha and till date it is pending.

29. There is certain lacuna quite apparent in the bill. Firstly the term ‘whistle blower’ has been given an ambiguous definition. According to the Bill, ‘whistle blower’ means “any individual making a public interest disclosure”. However, as discussed before in this article, a whistle blower is an employee, former employee or member of an organization who reports misconduct. Thus, a whistle blower is essentially a ‘worker’. A more specific definition with reference to various labour legislations needs to be incorporated in the Bill.

30. The second question is with regard to the jurisdiction. The question as to offences committed outside the territory of India by the companies, could that be brought under preview of this act? To solve this, Clause 43B(2) of the UK Public Interest Disclosure Act, which gives sweeping jurisdiction: ”… it is immaterial whether the relevant failure occurred, occurs or would occur in the United Kingdom or elsewhere, and whether the law applying to it is that of the United Kingdom or of any other country or territory” can be adopted.

31. Also Section 6(1) of the Bill, which supplies emphasis to the source of the complaint as anonymous complaints are not admissible, can act as potential deterrents to Whistle-blowers for there is a great degree of difference in legislative purpose and legislative compliance in our nation.

32. Even the Limited Liability Partnership Act, 2008 has brought in corporate governance by including the concept of ‘whistle blowing’. Any applicable penalties against the partner or an employee who provides useful information may be reduced or waived. The whistle blower may not be penalised by the LLP for providing such information.

Legal Implications of the Dilution of the Whistle-blower Policy

33. One of the reason for dilution of the Whistleblower Clause was that if such a mechanism comes into force audit committee would be flooded with frivolous complaints and that the clause was silent on “aspects of evidence” and other procedural technicalities. This contention can easily be disregarded because legally and economically speaking shareholder/creditor’s interest is certainly more important than not burdening the audit committee with complaints. In any case the encumbrance of frivolous complaints can be taken care of adopting adequately procedures like imposing penalty on any malicious or insignificant complaint. In absence of such a policy the legitimate concerns of the employees would never be brought to the notice of the appropriate authorities and hence preventive actions could not be taken.

34. The arguments of “frivolous complaints” can be summarily dismissed if one draws an analogy with the mechanism of public interest litigation where though frivolous and malicious petitions have been made before the Apex court, yet certain petitions have genuinely addressed issues pertaining to malpractices in the government etc.

35. Secondly, the doctrine of ‘indoor management’ assumes ‘that if a Director or other officers are entering into transactions, they would have obtained necessary permission. Further in a Madras High Court case, the learned judge opined that lenders to a company cannot be expected to embark upon an investigation as to the ‘legality, propriety and regularity of acts of director.” In view of the above, the doctrine of indoor management would aid corporate directors and other personnel in indulging in economic offences and crippling investor interest. Thus in order that the doctrine remains true in letter and spirit the Whistleblower Policy should be made an indispensable tenet of clause 49.

36. Thirdly, a non mandatory Whistle-blower clause recognizes the principle enshrined in the case of Garcetti v. Ceballos that whistleblowers who make statements while performing their jobs may not be constitutionally protected. This judgment is however is invalidated by the the Whistle-blower Protection Enhancement Act, 2007, in the United States, which has been approved by the Congress. India on the other hand lacks such a legislation and hence the ration of the above quoted judgement can be used in pari materia for defending the discriminatory actions of the Companies towards their Whistle-blowers.

37. The other argument that whistle blower protection would only empower disgruntled employees to harass the management also stands invalidated as statistics tell us that most whistle blowers rank among the most productive, highly valued and committed members of the organization.

Conclusion and Suggestions

38. It took almost a century for legal scholars to combat the evil created by the Separate Legal Entity Theory for Corporations and Companies. The separation of power between the shareholder and directors, the fiduciary relationship of the directors with company and the shareholders, gave the directors a little too much of space to commit fraud with an ever available defense of “Indoor Management”. Corporate Governance Norms came as a saviour for protecting the share holder/creditor and also the larger public interest. Today with scandals like Satyam, a need for more ethical governance has arisen.

39. Whistle-blower has already been described as one of the basic tenets of Corporate Governance. Though this policy forms the non mandatory provision of the Listing Agreement, if one follows the legal and economic implications of not having such a protection for its employees, ultimately is disadvantageous to the company for a director’s fraud directly affects the company’s market value, of which Satyam Fraud is a clear example.

40. Secondly in the absence of a mandatory provision for Whistle-Blower, such a policy by a company should be so formed so as to consider all the dimensions necessary not only to protect the Whistle-blowers but also to inculcate among the employees a commitment to their work and fearlessness in conduct when exposing employees at higher pedestal. As it is always said, Norms of Corporate Governance are not merely to be complied with but have to be adopted as day-to-day practice of the Company. For this purpose, clear definition of Whistle-blowers, non-retaliation clauses, confidentiality and due process should be ensured. Many of the Companies in India have voluntarily formed such policies.

41. Whistle-Blower Policy would result in reporting of the frauds which earlier used to go unreported thereby ensure greater protection to the investors. Also the contention of frivolous complaints can be take care of by imposing heavy penalty on malicious or insignificant complains.