Economic Review:

Corporate governance, frauds and control measures

by Sunil KARUNANAYAKE

"The ten commandments or the Dhammapada alone cannot make a human being complete. It is the true practise of the tenets by that individual that would make him succeed.

It is thus the ethical behaviour of companies that can make the difference. At the end of the day, the company, the stakeholders and the society at large should be happy that the company is a clean house and not a dirty one. In a nutshell these are golden rules to be followed by any board, listed or otherwise"

(Duties of company Directors and corporate governance in Sri Lanka- Dr Harsha Cabraal)

Corporate scandals in the developed world and its consequent effects on investors and public have seen the emergence of new laws and tightening of the regulatory regimes and formalising corporate governance.

Insider dealing or the "white collar crime" is one of the commonest crimes committed in the stock market activities. In Sri Lanka prohibition on insider dealing was first introduced by the companies Act No 17 of 1982 but now it is imposed by the Securities Exchange commission(SEC) Act. Insider dealing comprise a process of obtaining price sensitive information by people who have access to such information from the organisations. Those who possess such information will be in an advantageous position in the ultimate situation in trading in securities that is considered an offence.

It was not long ago, that Sri Lankan born Raj Rajaratnam, former head of the multi billion dollar Galleon group hedge fund was sentenced to a prison term of 11 years by the US High Court after having been found guilty of " Insider dealing". Prosecutors has pushed for 25 year sentence after convicting Rajartnam in the biggest insider trading investigation ever conducted by US authorities.

Legal experts said that while prosecutors may have been disappointed with the decision, the sentence was still the highest ever given for insider dealing.

Prosecutors found that Rajaratnam had used a network of insiders to gain illegal tips on some of the world's biggest companies including Goldman Sachs,Google, and Hilton.The scandal also dragged a former Director of Goldman Sachs, a Director and a former head of Mckinsey management consultant group who are now said to be facing criminal investigations.

One of the key signs in the post war scenario was a booming a stock market with many IPO's and new players entering the fray. In Sri Lanka, recently there was much concern on stock market activities that prompted the state agency Securities exchange commission (SEC) to move in for punitive action. Consequently two eminent former- public servants were among those who had to face charges for disclosure lapses and pay hefty fines.

The SEC also had to warn some members of the broker fraternity for misdemeanors.. But to date no prison sentences have been delivered. The SEC was also forced to take action to ensure that just and equitable schemes to ensure are in place and all applicants in public share issues are given a fair deal depriving total dominance by few big players.

Risks

"Under the influence of delusion and greed, greater and greater risks are taken by financial institutions and investors and investors to bring in greater and greater profits in shorter and shorter time spans.

Thus, a financial institution or business which only functions for the benefit of its Directors or shareholders, desiring to grant them ever greater bonuses and dividends, and shirk responsibility to wider society and the environment can turn out to be parasites". (Protest against greed)

Corporate governance has been defined in many ways, it's recognised as a set of mechanisms through which firms operate when ownership is distinct from management.

Corporate governance is also identified as the manner in which companies are directed, controlled and managed. It is the responsibility of the board of directors to ensure that governance principles are observed. It is also being reported that if a country's overall governance systems are weak voluntary governance mechanisms could fail. Corporate governance once confined to board rooms, academics and policy forums has now become a buzz word in the corporate circles.

Forerunner to the priority for corporate governance were the financial crisis in Asia, Russia and Brazil in the late nineties that was threatening the global financial stability equilibrium, then the corporate scandals in USA and Europe in the new millennium further aggravated the situation. This did create awareness for formalizing good governance principles to minimise corporate scandals.

Recent global financial crisis too was attributed to poor governance particularly in the financial sector. With the deregulation, growing free trade, collapse of totalitarian regimes global integration has been strengthened providing for investment and fund flows freely across the barriers. This fact too was another reason for the emergence of corporate governance

While in UK a committee headed by Sir Adrian Cadbury on financial aspects of corporate governance proceeded to set up corporate governance process, in the early nineties, in Sri Lanka Institute of Chartered Accountants of Sri Lanka played the pioneering role in introducing the first ever code in 1997. Later in 2005 together with the Securities Exchange Commission (SEC) ICASL set up a process to revise the code.

Thereafter SEC and ICASL worked together in drafting the corporate governance listing rules applicable to listed companies through the Colombo stock exchange that became mandatory from 2008. ICASL has gone further to give priority to compliance on corporate governance through the Best annual report competition that that is being eagerly awaited by the corporate sector.

It has been proved that companies practising good governance principles benefit from access to financing. Low cost capital, more favourable treatment to all stakeholders and public acceptability. Historical evidence also proves that when a country's overall corporate governance systems are weak voluntary corporate governance mechanisms too deteriorate. It could also be argued that poverty and suffering is less in countries that practise good governance principles Sri Lanka came up with a new company legislation in 2007 that provided for shareholder safeguard by ensuring adequate representation of non- executive directors are appointed thus maintaining a proper board room balance.

The corporate governance code defined the necessity for audit committees and its composition. In addition provision was also made for director's responsibility on duties of directors in insolvency and serious loss of capital. To date, probably only one court case invoking this section has been reported. Perhaps this reflects that directors have not contravened the section 219; 220 of the Companies Act.

Developed countries have been moving swiftly on fraudsters with appropriate legislation and have been able to prosecute them. Investigators tasks are made difficult with the new breed storming in to the IT areas.

Bribery

While white-collar crimes are in the increase organized crimes in terrorism, bribery and corruption have not slowed down providing enormous economic gains to criminals. Legal and prosecution machinery in the third world are still behind times and the cost to the citizens of these could be significant.

Sri Lanka in 2006 formalized legislation on terrorist financing and Money laundering two areas where fraudulently earned money is channeled. It is most common for criminals who engage in fraud to slip out of the home country to escape prosecution.

It was not long ago that a VAT scam involving over RS 3 billion of public funds hit the headlines and some of the suspects are said to have escaped from the country.

Accord to research based information UK frauds cost the country over 14 billion pounds annually with the majority of the losses borne by the public.

The UK government is taking a serious view of the alarming increase in crime and particularly the IT related cases prompting the government to introduce a Fraud Bill in the Parliament. A few years back there was some euphoria when there was some speculation that Sri Lanka Government was going to appoint an anti Corruption commission but this thought never saw the light of the day.

The Permanent Commission for Bribery and Corruption, declaration of Assets by Public officers and Parliamentary select committees for Parliamentarians, Ombudsman are some of the existing checks in the Sri Lankan system, unfortunately these instruments to date have failed to meet the growing civil society demand and confidence for corrupt free society.

In the developed west and the industrialised East Asia, corruption is treated with all seriousness with prosecutions and punishment to the guilty.

Countries in the region such as India (Central Vigilance Commission), Hong Kong (Independent Commission against Corruption), Bangladesh (Bureau of anti Corruption) and Singapore and other countries like Australia (ICAC), UK, USA and even some of the African countries have already enacted legislations to give strength to " Fight against Corruption", a priority need.