Narayan Murthy Committee

In the year 2002, SEBI analyzed the statistics of compliance with the clause 49 by listed
companies and felt that there was a need to look beyond the mere systems and procedures if
corporate governance was to be made effective in protecting the interest of investors. SEBI
therefore constituted a Committee under the Chairmanship of Shri N.R. Narayana Murthy, for
reviewing implementation of the corporate governance code by listed companies and for issue of
revised clause 49 based on its recommendations. Following are the highlights of
recommendations:
Audit committees of publicly listed companies should be required to review the following
information mandatorily:
_ Financial statements and draft audit report, including quarterly/half yearly financial
information;
_ Management discussion and analysis of financial condition and results of operations;
_ Reports relating to compliance with laws and to risk management;
_ Management letters/letters of internal control weaknesses issued by statutory/internal auditors;
and
_ Records of related party transactions.
• All audit committee members should be “financially literate” and at least one member should
have accounting or related financial management expertise.
Explanation 1: The term “financially literate” means the ability to read and understand basic
financial statements i.e. balance sheet, profit and loss account, and statement of cash flows.
Explanation 2: A member will be considered to have accounting or related financial

management expertise if he or she possesses experience in finance or accounting, or requisite
professional certification in accounting, or any other comparable experience or background
which results in the individual’s financial sophistication, including being or having been a chief
executive officer, chief financial officer, or other senior officer with financial oversight
responsibilities.
• In case a company has followed a treatment different from that prescribed in an accounting
standard, management should justify why they believe such alternative treatment is more
representative of the underlying business transaction. Management should also clearly explain
the alternative accounting treatment in the footnotes to the financial statements.
• Companies should be encouraged to move towards a regime of unqualified financial
statements. This recommendation should be reviewed at an appropriate juncture to determine
whether the financial reporting climate is conducive towards a system of filing only unqualified
financial statements.
• A statement of all transactions with related parties including their bases should be placed
before the independent audit committee for formal approval/ratification. If any transaction is not
on an arm’s length basis, management should provide an explanation to the audit committee
justifying the same.
• Procedures should be in place Companies should be encouraged to train their Board members
in the business model of the company as well as the risk profile of the business parameters of the
company, their responsibilities as directors, and the best ways to discharge them.
• To inform Board members about the risk assessment and minimization procedures. These
procedures should be periodically reviewed to ensure that executive management controls risk
through means of a properly defined framework.
• Management should place a report before the entire Board of Directors every quarter
documenting the business risks faced by the company, measures to address and minimize such
risks, and any limitations to the risk taking capacity of the corporation. This document should be
formally approved by the Board.
• Companies raising money through an Initial Public Offering (“IPO”) should disclose to the
Audit Committee, the uses/applications of funds by major category (capital expenditure, sales
and marketing, working capital, etc.), on a quarterly basis. On an annual basis, the company shall
prepare a statement of funds utilised for purposes other than those stated in the offer document/
prospectus. This statement should be certified by the Independent auditors of the company. The
audit committee should make appropriate recommendations to the Board to take up steps in this
matter.
• It should be obligatory for the Board of a company to lay down the code of conduct for all
Board members and senior management of a company. This code of conduct shall be posted on
the website of the company.
• There shall be no nominee directors. Where an institution wishes to appoint a director on the
Board, such appointment should be made by the shareholders. An institutional director, so
appointed, shall have the same responsibilities and shall be subject to the same liabilities as any
other director. Nominee of the Government on public sector companies shall be similarly elected
and shall be subject to the same responsibilities and liabilities as other directors.
• All compensation paid to non-executive directors may be fixed by the Board of Directors and
should be approved by shareholders in general meeting. Limits should be set for the maximum
number of stock options that can be granted to non-executive directors in any financial year and
in aggregate. The stock options granted to the non-executive directors shall vest after a period of
at least one year from the date such non-executive directors have retired from the Board of the
Company.
• Companies should publish their compensation philosophy and statement of entitled
compensation in respect of non-executive directors in their annual report or put up on the
company’s website and reference drawn thereto in the annual report.
• The term “independent director” is defined as a non-executive director of the company who:
→ apart from receiving director remuneration, does not have any material pecuniary
relationships or transactions with the company, its promoters, its senior management or its
holding company, its subsidiaries and associated companies;
→ is not related to promoters or management at the board level or at one level below the board;
→ has not been an executive of the company in the immediately preceding three financial years;
→ is not a partner or an executive of the statutory audit firm or the internal audit firm that is
associated with the company, and has not been a partner or an executive of any such firm for
the last three years. This will also apply to legal firm(s) and consulting firm(s) that have a
material association with the entity.
→ is not a supplier, service provider or customer of the company. This should include lessor-
lessee type relationships also; and
→ is not a substantial shareholder of the company, i.e. owning two per cent or more of the block
of voting shares.
• The considerations as regards remuneration paid to an independent director shall be the same as
those applied to a non-executive director.
• Personnel who observe an unethical or improper practice (not necessarily a violation of law)
should be able to approach the audit committee without necessarily informing their supervisors.
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.
• Companies shall annually affirm that they have not denied any personnel access to the audit
committee of the company (in respect of matters involving alleged misconduct) and that they
have provided protection to “whistle blowers” from unfair termination and other unfair or
prejudicial employment practices. The appointment, removal and terms of remuneration of the
chief internal auditor must be subject to review by the Audit Committee.
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.
• The provisions relating to the composition of the Board of Directors of the holding company
should be made applicable to the composition of the Board of Directors of subsidiary companies.
At least one independent director on the Board of Directors of the parent company shall be a
director on the Board of Directors of the subsidiary company.
The Audit Committee of the parent company shall also review the financial statements, in
particular the investments made by the subsidiary company.
The minutes of the Board meetings of the subsidiary company shall be placed for review at the
Board meeting of the parent company.
The Board report of the parent company should state that they have reviewed the affairs of the
subsidiary company also.
• The performance evaluation of non-executive directors should be by a peer group
comprising the entire Board of Directors, excluding the director being evaluated; and Peer group
evaluation should be the mechanism to determine whether to extend/continue the terms of
appointment of nonexecutive directors.
• SEBI should make rules for the following:
→ Disclosure in the report issued by a security analyst whether the company that is being written
about is a client of the analyst’s employer or an associate of the analyst’s employer, and the
nature of services rendered to such company, if any; and
→ Disclosure in the report issued by a security analyst whether the analyst or the analyst’s
employer or an associate of the analyst’s employer hold or held (in the 12 months immediately
preceding the date of the report) or intend to hold any debt or equity instrument in the issuer
company that is the subject matter of the report of the analyst.

Narayan Murthy Committee

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Narayan Murthy Committee

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In the year 2002, SEBI analyzed the statistics of compliance with the clause 49 by listed

Explanation 2: A member will be considered to have accounting or related financial

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