I am overwhelmed by the response of the readers to my previous articles on Inspection and Investigation. It motivated me to continue the series. I felt that it would be more appropriate, if I cover the preparatory steps to face inspection or investigation in this article. When I speak of steps, I mean reviewing the compliance of most important provisions of Companies Act, 1956.
Secretary/Compliance officer of every company endeavors his/her best to comply with the applicable provisions of Companies Act, 1956 and other corporate laws. However if the compliance officer understands, the purpose of inspection, the manner in which Inspector conducts inspection and the areas he covers during inspection, it would help immensely in preparing better for facing an inspection and thereby protect the company and its officers from likely imposition of penalties or prosecution by the Director of Inspection.
Set up of Inspection wing
The wing of Directorate of Inspection and investigation at Delhi is headed by Director of Inspection and Investigation. He is assisted by Joint/Dy. directors and inspecting officers. Regional inspection directorates operate from Mumbai, Kolkata and Chennai through the Joint Directors. Each state will have Registrar of companies who functions from each state under the supervision of Regional Directors. Ministry of corporate affairs (MCA) has also set up a Serious Fraud Investigation Office w.e.f 01.07.2003 for investigating serious corporate frauds.
What triggers the inspection/investigation and how it starts?
Regional directors plan for inspection through their team as a routine matter or on instructions from MCA. Some times inspection may be ordered due to complaint from Roc on scrutiny of documents on his records or based on qualification in audit report or on complaint from SEBI/RBI/income tax departments on receiving the complaints either from dissenting or unhappy directors or from shareholders. In the case of inspections u/s 209A, normally a notice is given by the Inspecting officer, indicating the date of inspection of books of account. He seeks preliminary information about company’s incorporation, status, address of registered office, branch offices, main objects of the company, present business, copies of MOA, sales and production details, names of directors, market share, details of selling/sole selling agents, Delegation of powers, income tax assessment orders, names of Internal Auditors and Statutory Auditors etc
What are the objectives of Inspection u/s 209A?
Routine inspection u/s 209A is basically to check whether the companies are complying with the provisions of the Companies Act and also to check whether the affairs of the company are being managed to protect the interest of stakeholders. Most of the small private limited companies do not comply with important compliances such as filing of balance sheet, profit and loss account and annual returns, other returns relating to appointment or cessation of directors. Inspection basically aims to counsel errant companies on the importance of compliance and put them on track of compliances. If it is an investigation, it will be carried out for a specific purpose and no notice /indication will be there to take preparatory steps and it will take its own course.
Inspecting officers empowered
It may please be kept in mind that Section 209-A, gives exhaustive powers to the Registrar of Companies and other inspecting Officers, as they could conduct Inspection to ascertain that all transactions have been validly entered into and recorded in appropriate Books and papers.
How to plan for inspection?
In this article focus is made only on the routine inspection. If a notice is received, to face the inspection, it is suggested that all books of accounts for at least for 5 years may please be kept ready at one place where they can be retrieved quickly and produced for inspection. This preparedness will not only give a good image but also cut short the duration of the inspection. Normally delay in fetching of records and producing and giving explanations would not only annoy the Inspector but also create a suspicion. It is possible that lot of queries will be raised and it is always better to note them at one place and take time to answer rather than answering in a quick go. This line will give enough time to think and give better reply and not caught unaware.
Areas that may be covered by the inspecting officer
1. Books of account:
The first and foremost task of the Inspecting officer is to check whether proper Books of account are maintained at the registered office recording transactions of companies in a fair and transparent manner. He will ask for list of books of account maintained.
Action plan: Prepare list of books of accounts maintained at the Registered office and also at the places other than the registered office. If any places are declared as branches then keep copy of intimation given to RoC for verification along with resolution of Board of Directors. Summarized returns of accounts in respect of branches must be made available for inspection.
2. Wrongly classified and irregular transactions:
The ultimate objective of Inspection is to check whether the books of account maintained reflect the true and fair view of Accounts and applicable Accounting standards are complied with or not. The Inspecting officers look for irregular transactions and wrong classifications whether intentional or unintentional.
Action plan: Before inspection starts, internal audit reports, qualifications in audit reports must be carefully looked into. All observations must be rectified, if not already acted upon. If wrong classifications in current year cannot be justified and do not have significant impact on profit can be rectified. However it must be clarified that there is no malafide intention in such wrong classification. Irregular transactions can be payments without proper resolutions of Board or Shareholders. If it is a board’s sanction, it can be got ratified in subsequent meetings. If it is ultravires the objects clause, then it becomes difficult to get away.
Inspecting officer would read first the minutes of Shareholders and Board as they form basis for all corporate actions. Inspecting officer will check whether policy decisions, investments, borrowings are as per the intention expressed by the shareholders and Directors.
Action plan: Most of the irregularities are detected from reading of the minutes of shareholders or Board of directors. Most common mistakes are minutes are not signed by the chairman or sometimes not dated. The compliance of Section 193 with regard to maintenance of minutes in a bound book, numbering it serially, initialising pages and sign at the last page within 30 days must be ensured. In the case of board meetings however, the minutes can be signed by the chairman of the succeeding meeting, if such practice is followed.
4. Statutory registers:
After inspections prosecutions are launched mostly for violations of Section 299,301,303,and 307.Check whether the following the statutory registers are updated with all latest entries.
Register of fixed deposits U/s.58A;
Action plan: Check whether deposits are accepted as per 58A Rules, with regard to advertisement and prescribed limits. Ensure that there is no default in payment of interest or principal amount as the default is a cognizable offence under the criminal procedure code (Section 58AAA)
Register of contracts in which directors are interested [Section 301]
Register of particulars of Directors/Secretaries/Managers [section 303]
Register of Directors' shareholdings [sections 307]
Action plan: Most of the companies mechanically keep the register without making/ updating entries in it. A director may have sold or increased his holding but it is not updated. Inspecting officer can catch with reference to its physical folio number and reference to members register or with the disclosure letters.
It would be prudent on the part of the Company Secretary to issue a letter explaining briefly his obligations u/s 299, 301,303, 307 and seek a list of all his relative u/s 6 of the Companies Act. Disclosure u/s 299 can be renewed by a notice before end of the financial year. Many companies do not enter the disclosures received from the directors in Register maintained u/s Section 301. Inspecting officers find from the records of the company that directors do not inform their appointment and cessation of directorship in other companies. If such disclosures are given, the company must make entries accordingly.
a. Check whether Directors general disclosures/renew u/s 299 about their directorships in other companies and also their interest directly or indirectly in any transactions with the company immediately after their appointment have been disclosed.
b. If yes, whether entries have been made in the Section 301 register.
c. Check whether Contracts in which directors are interested is placed before the board and the sheet is signed by all directors present at the meeting.
d. Check whether board resolution noted that interested director has abstained from voting on the resolution in which he is interested.
Register of investments not held in its own name [Section 49(7)]
Action plan: Directors qualification shares are invested by the holding company in its subsidiary and such holding must be entered in the register.
a. Check whether any investments in NSCs or fixed deposits are offered as securities in the name of Government as securities
b. Check whether company invested in shares in the name of directors for meeting the qualification shares.
Compliance of “The Companies (Issue of Share Certificate) Rules, 1960 & Register of renewed and duplicate certificates
Action plan: Many companies fail to issue allotment letters although board allots shares/debentures or fails to issue share/debenture certificates within 3 months from the date of allotment of shares/debentures or within 2months of registration of transfer (Section113).
a. Check whether Board resolution approving the printing of share certificates as to number and distinctive numbers for shares is passed and it is complied with.
b. Check whether board Resolution has been passed approving the names of Authorised signatory, directors for signing of the share certificates either directly or by use of mechanical means of printing of signatures etc and complied with.
c. All share certificates issued on allotment/replacement/consolidation/sub division and duplicate of lost share certificates must find place in this register. Counter foil/stub must contain details of shares issued. Check whether original share certificates are cancelled before issue of share certificates on consolidation/subdivision/replacement.
Register of charges [sections 143 and 136]
Action plan: Check whether all charges created on company’s properties are entered in the register and copies of all instruments creating charge must be available a the registered office.
Register of members u/s 150 and index /BENPOS(Electronic form)
Action plan: With the electronic form of holding shares is in vogue, the rigors of Section 150 are reduced.
a. Check in respect of physical holding whether the entries as per transfer deeds indicating the details of name, father’s, name address, occupation if any, no. of shares and distinctive numbers and the date of entry or cessation as member have been entered and signed by the authorised officer.
b. Check whether transfers are to be approved by the Board or a committee authorised by the board. This is normally not done.
c. Check whether entries in members register are posted as per approved transfer deed as soon as transfer takes place.
d. Some times index is not kept ready. Index is mandatory if number of shareholders exceeds fifty and members register is not arranged in alphabetical order.
Register of Debenture holders and index u/s 151 and 152
Action plan: Similar checking as proposed above should be taken.
5. Instruments of transfers u/s 108:
Transfer deeds are to be checked to ensure that all requirements of valid transfer deed are complied with. These are date of presentation, share details, lodgment within 2 months in the case of unlisted company and within 12 months from the date of presentation or book closure which ever is later, date and place of execution, signatures of witness, transferor and transferee, affixation of proper share transfer stamps, etc..
6. Copies Annual returns (Section 163):
Copies of annual returns, members register, Index of members must be available at the registered office unless a special resolution is passed in by shareholders in a General meeting. Annual returns give vital information such as past and present directors, secretaries, members of shares/debentures, transfer of shares/debentures in between the two annual general meetings and indebtedness if it is not a full return..
7. Register of Inter corporate Loans and investments(Sec 372-A):
a. Check whether entries are made giving details of terms of loan, investment or guarantee are entered within 7 days of making of loan or investment or providing guarantee or security.
b. Check the aggregate of loans are investments are within 60% of the aggregate of share capital and free reserves or within the limits approved by shareholders by a special resolution.
c. Check that unanimous consent of all directors present is given to the resolution approving inter corporate loans or investments
8. Cost Accounting records:
If Central government ordered maintenance of cost audit, keep the cost audit reports for inspection by the inspector
9. Income Tax assessment orders and Tax audit reports:
Inspecting officer looks into the past assessment records as they speak of disallowances, irregular payments, any personal amounts of directors being debited to the companies accounts.
10. Scrutiny of share capital:
Inspecting officer will cover the issue of shares, allotment of shares, issue of share certificates, bonus or rights issues compliances, buy back of shares and any mergers/amalgamation orders and resultant changes, reduction of share capital and related compliances. Keep ready all resolutions of shareholders or board of directors, approvals of SEBI/RBI /stock exchanges/High court relating the above for verification of the Inspecting officer.
Debentures may be issued on private placement basis to banks/FIIS or public issue of debentures.
Following information should be made available:
(i) A note may be prepared highlighting the terms and conditions in the debenture-deed,
(ii) Names of debenture-holders.
(iii) Redemption clauses etc.,
(iv) Properties charged,
(v) Modifications to the charge,
(viii) Satisfaction of charges.
All relevant documents may be kept ready for inspection.
12. Bank borrowings:
A statement be prepared showing the working long term and short term borrowing from banks/ FIs. All resolutions of Board /shareholders u/s 293 for limits and creation of charges should be arranged with sanction letters of Banks.
13. Remuneration of Managers/Directors for 5 years.
Resolutions of board of directors, shareholders approving the appointment and terms and conditions of appointment and restrictions if any on payments must be kept ready. Calculation of remuneration with reference to Schedule XIII read with 198,269 and section 349 or 350 and workings will facilitate easy verification.
14. Important agreements/Litigations:
Agreement with sole selling agreements, selling agents or purchase arrangements from major raw materials, etc will be subjected to scrutiny. Plaints and defense papers of the cases will be scrutinized to assess the nature of the litigation. Prosecutions launched against the company for any defaults in compliance any other laws and any stigma to the directors holding their position.
15. Listing agreement clauses: Compliance with listing agreement will be verified, if the company is a listed company. Keep copies agreements and intimation to stock exchanges ready for verification.
16. Statutory auditors qualification in reports. Is there any qualification in auditors report which points out to non compliances as per CARO and how the board responded to such qualifications will be checked. Stand of the company be made clear in respect of such observation as two divergent opinions may exist in interpretation of transactional analysis.
Periodical in house verification will help to eliminate errors of omission or commission. In the case of small companies, it is always better to have a secretarial audit done by a practicing company Secretary. Even big companies can also go through this audit employing a qualified company secretary. Such third party audit will ensure elimination of errors or unintentional non compliance of provisions of companies Act. As Inspecting officer will issue show cause notice for detected violations and prosecution is launched against the Directors or officers for unsatisfactory replies or violations unexplained. Careful planning and verification of records before inspection will give less chance for levy of huge fines or prosecution.
G.S RAO, Chief Manager(Legal), OCL India Limited