Vigil mechanism under the Companies Act, 2013

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Vigil mechanism under the Companies Act, 2013

11 July 2016

Introduction

Vigil mechanism – an important and new concept under the new Companies Act, 2013 (Companies Act) – appears to have gone unnoticed by corporates. However, vigil mechanism, akin to the popular concept of “whistle blowing,” has been introduced in a bare bones manner.

While the concept has been introduced under the provisions relating to audit committees, its applicability, in fact, extends to certain classes of companies that are not required to establish audit committees. Initially, the obligation to establish a whistle-blowing mechanism was only applicable on listed companies emanating from the listing agreement and corporate governance norms of the Securities and Exchange Board of India (SEBI); however, the provisions under the Companies Act extend its applicability to other companies, too.

Background

Whistle-blowing is a popular concept in the US, the UK and other European countries. It refers to calling the attention of the top management to any wrongful conduct within the establishment.

The Sarbanes-Oxley Act, 2002 of the US (US Act) requires all companies listed in the US to have a whistle-blowing system in place. It was enacted by the US Congress to protect investors by improving the accuracy and reliability of any information/representation made pursuant to securities laws and other related purposes. All companies (including Indian companies) that are listed on US stock exchanges fall within the purview of the US Act. Clause 49 of the Listing Agreement applicable to Indian listed companies under SEBI’s corporate governance rules also emanates from the US Act. The Dodd-Frank Act of 2010 of the US further deals with the protection and rewarding of whistle-blowers.

The UK has enacted the Public Interest Disclosure Act, 1998 to prevent employers from discriminating against whistle-blowing employees. In the UK, it is suggested that genuine concerns about any malpractices be raised internally in the first instance. Therefore, a whistle-blower mechanism is necessary to facilitate this and ensure that such matters are treated confidentially.

The Companies Act has also introduced this concept – termed as vigil mechanism – extending its applicability to certain classes of unlisted (public or private) companies.

Provisions under the Companies Act

All (i) listed companies, (ii) companies that accept deposits from the public and (iii) companies that have borrowed money from banks and public financial institutions in excess of INR50 crores (Covered Companies) are required to establish a vigil mechanism for their directors and employees to report their genuine concerns or grievances.

The Companies Act, while dealing with the provisions relating to the constitution of an audit committee and its roles and

responsibilities, extends certain powers to the audit committee to investigate into the financial matters of a company either suo motu or on being referred by the board of directors of a company.

It further provides that Covered Companies are required to establish a vigil mechanism where they are required to make provisions for direct access of employees and directors to the chairperson of the audit committee in appropriate or exceptional cases. Covered Companies that are not required to have audit committees under the Companies Act are required to nominate a director who shall act as the reportee of complaints.

The Companies Act further imposes an obligation on Covered Companies to provide for adequate safeguards against victimization of people who use such a mechanism. The Companies Act (read with rules) prescribes certain basic compliances and procedures to be undertaken by such Covered Companies in this regard.

Additionally, the Companies Act also imposes certain duties on the independent directors of a company to (a) ascertain and ensure that (i) the company has an adequate and functional vigil mechanism and (ii) the interests of the people using this mechanism are not prejudiced by the mechanism, and (b) report concerns about unethical behavior, actual or suspected fraud and violation of the company’s code of conduct or ethics policy.

Procedures and compliances for Covered Companies

  • To draft a policy and establish a vigil mechanism
  • To disclose the details of the vigil mechanism on its website, if any, and in the board’s report
  • To protect and adequately safeguard the people using the whistle-blowing mechanism against victimization
  • To empower the audit committee or the nominated director (as applicable) to take suitable action in case of repeated frivolous complaints

Implications

The purpose of a whistle-blower policy is to encourage employees to bring ethical and legal violations they are aware of, to the notice of an internal authority so that appropriate action can be taken immediately. This is essential to minimize organizations’ vulnerability to the injury that can occur as a result of the side-stepping of internal mechanisms by employees and also to ensure transparency to the shareholders and prospective buyers. The provisions relating to vigil mechanism under the Companies Act have somewhat resolved the need for a whistle-blower mechanism for companies to report concerns. However, effective implementation of such a mechanism is still to be tested as it may be affected by to following factors:

Employees are hesitant to “tell on“ the company for fear of retaliation and alienation.

The expression “adequate safeguards“ used in the Companies Act is ironically inadequate as it lacks a system of anonymity for the whistle-blower, which is the considered to be an essence of a whistle-blower protection policy.

The obligation of companies under the Companies Act to provide for “adequate safeguards“ against victimization is vague and susceptible to failure without any guidelines for the protection of whistle-blowers.