Every healthy and financially sound start-up has one basic attribute i.e. sound system of corporate governance. Considering the importance of managing legal compliances for a start-up, there are various rules and regulations prescribed for certain start-up business organizations that should be recognized and timely followed to reduce the risk of occurrences such as fraud, mismanagement, or the potential cost of non-compliance of applicable provisions, which includes conducting a periodical effective audit, namely secretarial audit of start-ups businesses
Since there are hundreds of rules & regulations to be complied with, understanding their requirements and their application poses a major challenge. However, periodical examination and review of the position of the compliances gives exact information on whether, and if so, to what extent the Company has complied with the laws applicable to the Company. Therefore, along with the statutory audits performed by CA/CMAs, there is the requirement of carrying out secretarial audits from time to time in start-up companies/businesses. It comforts the regulators and stakeholders with the fact that the start-up has a disciplined approach toward risk management, control, and governance processes.
The Institute of Company Secretaries of India provides guidance related to the important undertaking of the secretarial audit and issues secretarial standards for carrying out the Audit that was first started under Corporate Governance Voluntary Guidelines, 2009 initially recommending the secretarial audit. This was later included under the Companies Act, 2013 for better implementation as a class of new audits in addition to other audits.
Secretarial Audit- Meaning & Definition
A secretarial audit is an independent examination of all books and records of the business organization including the review of the compliance status of all the applicable rules & regulations under various legislations including the Companies Act 2013, Securities Laws, FEMA transactions related laws, industry-specific laws and general laws applicable to such start-ups.
The purpose of the secretarial audit is to ensure whether there are adequate systems in place within the company depending upon the size and operations of the company for monitoring and ensuring compliance with applicable laws, rules & regulations. Further, it provides information on whether the business organization recognizes, manages, and is taking timely remedial steps through verification of the documents and records of the start-up.
In case of failure to undertake completely the process of audit and submit the audit report timely, there are chances to face non-compliance risks such as severe penalties & prosecution, imprisonment to the key managers & board of directors, and above all loss of goodwill for the start-up. Therefore, it gives an independent and objective assurance to add value to the business and improve the operations of a company.
To explain it further, provided below are the primary aims & objectives behind the requirement of secretarial audit-
i. To warrant strict adherence to various applicable legislation and regulations;
ii. To assist to detect any potential non-compliance and encourages to take timely corrective actions to avoid future risks.
iii. To assure the outsiders and stakeholders regarding the trustworthiness and soundness of the start-up.
iv. To ensure start-ups have an effective compliance management program to have lesser chances of receiving penalties.
Scope of Secretarial Audit
The secretarial auditor so appointed must examine the compliances following the following legislations-
i. The Companies Act, 2013 (under Rules & Regulations)
ii. The Securities Contracts (Regulation) Act, 1956;
iii. The Depositories Act, 1996 Rules & Regulations;
iv. Foreign Exchange Management Act, 1999 and the rules and regulations made under the provisions of Foreign Direct Investment, Overseas Direct Investment, and External Commercial Borrowings;
v. SEBI (Acquisition of Shares and Takeovers) Regulations, 2011;
vi. SEBI (Prohibition to Insider Trading) Regulations 1992 and amended regulations 2015;
vii. SEBI (Issue of Capital & Disclosure) Guidelines 2009;
viii. SEBI (Employee Stock Option Scheme) Guidelines, 1999 and/or SEBI (Share Based Employee Benefits) Regulations, 2014;
ix. SEBI (Issue & Listing of Debt Instruments) Rules 2008;
x. Securities and Exchange Board of India (Registrars to Issue & Share Transfer Agents) Regulations, 1993 in pursuance of the client dealings.
xi. SEBI (Delisting of Shares) Guidelines, 2009;
xii. SEBI (Buyback of Securities) Regulations, 1998; and
xiii. SEBI (Listing Obligations &Disclosure) Regulations, 2015.
Some Additional areas that needed to be checked
Further, Secretarial Auditor needs to scrutinize and report on compliances in pursuance of the compliances with the relevant clauses of the following:
i. Secretarial Standards are issued by the ICSI institute from time to time.
ii. The Listing Agreements entered into by the Company with any public stock Exchange(s)(NSE/BSE), if applicable;
Applicability of Secretarial Audit
Section 204 of the Companies Act, 2013 read with Rule 9 of Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014 specifies the applicability and manner of undertaking a Secretarial Audit. Therefore, it shall be mandatory for the following companies to conduct a secretarial audit –
i. Every company listed on the public stock exchange i.e. Listed company; or
ii. Every public Company having paid-up share capital of either Rs. 50 crores or above; or
iii. Every public Company has an annual turnover of Rs. 250 crores or above;
iv. Every company has outstanding loans and borrowings from banks or financial institutions equal to Rs. 100 crores or more.
v. It is also mandatory for a private company that is a subsidiary of any public company that falls under the above-mentioned class of companies.
vi. Those companies not included under section 204 of the Companies Act may undertake secretarial audits voluntarily to provide independent assurance of the compliances in the company.
Who is authorized to conduct a Secretarial audit of companies?
Since the rules & regulations to be complied with by a business organization could be varied and complex, therefore, the section 205(1) of the Companies Act 2013 provides that only a Company Secretary who holds a certificate of practice and membership of the Institute of Company Secretaries of India (ICSI) can only conduct Secretarial Audit and prepare the Secretarial Audit Report of the Company. Such a practicing company secretary will ensure that all proper compliance mechanisms and systems are in order.
According to Rule 8 of the Companies (Meetings of Board and its Powers) Rules, 2014, the Board of directors of the prescribed class of companies should appoint a secretarial auditor at the beginning of the financial year by passing a board resolution and communicating his appointment through a letter of engagement. Additionally, such an appointment must be intimated to the registrar in e-Form MGT-14 within 30 days of passing the resolution.
After completion of the process of the audit, the secretarial auditor will prepare his reports providing his findings from the examination along with his remarks and submit a copy of the same to the Board of Directors continuously as it would help the company in initiating corrective measures and strengthening its compliance mechanism and processes.
The Secretarial Audit is carried out periodically i.e. quarterly, half-yearly, or annually along with any adverse findings which could be reported to the Board on an interim basis. However, the secretarial Audit Report must be submitted and annexed to the Board report before the preparation of the Board’s Report.
Preparation & Submission of Secretarial Audit Report-
Rule 9 of the Companies (Appointment & Remuneration of Managerial Personnel) Rules 2014 provides for the format of the secretarial audit report to submit in form MR-3 on the successful completion of the process of audit. Upon receipt of the audit report, it shall also be the responsibility of the Board of Directors to fully explain any qualification or observation or any other remarks made by the secretarial auditor in his/her Audit Report.
Particulars to be specified in the Secretarial Audit.
Typically, a secretarial audit report contains the following particulars –
- Complete Verification of records and documents.
- Key areas of focus under the Companies Act 2013.
- Key areas of focus under SEBI Rules and Regulations.
- Relevant Period of the Secretarial Audit (applicable quarter)
- Any disqualification for the appointment of the Secretarial Auditors.
- The company must assist in the process of completion of the audit process.
Further, a Secretarial Audit report also provides whether-
i. There is the proper constitution of the board of directors with a proper balance of executive, non-executive directors, independent and women directors on the board
ii. Any changes that took place in the composition of the Board of Directors that took place during the period under which the audit was carried out in compliance with the provisions of the Act.
iii. An Adequate notice was given to all the directors before the scheduled Board Meetings, along with the agenda and detailed notes on agenda were sent at least seven days in advance.
iv. There is a strong system in place for seeking and obtaining further information and clarifications on the agenda items before the meeting and for meaningful participation at the meeting.
v. Most of the decisions are carried through while the dissenting members’ views are captured and recorded as part of the minutes.
vi. There are adequate systems and processes in the company to monitor and ensure compliance with all applicable laws comprising of general rules like labor laws, competition laws & consumer laws, environmental laws, and other regulations and guidelines.
vii. And, finally secretarial auditor shall be required to report details of any major event that occurred during the applicable period which has a major impact on the affairs of the company in pursuance of the above rules & regulations.
What is the process of carrying out the Secretarial Audit?
Provided below is the step-by-step process of undertaking a secretarial audit of any company-
i. Appointment of Company Secretary
The process of conducting a secretarial audit starts with the appointment of a practicing company secretary (PCS) by taking his consent to act as a secretarial auditor for the company and passing a board resolution to this effect in a manner as provided under Rule 8 of the Companies (Meetings of the Board) Rules 2014.
ii. Acknowledging and Acceptance of Letter of Engagement
Once the auditor is appointed, a formal letter of engagement shall be communicated to the person and the letter would be further signed to ensure that the duties and responsibilities so entrusted to him are carried out diligently.
iii. Undertaking Audit & submission of Audit Report
Next, the auditor so appointed shall start the audit process for which the company including the board of directors should provide full assistance and cooperation in the process. The auditor will carry out a thorough examination of books & records, and prepare an audit report along with his remarks & reservations in the process. The auditor should also mention any event/situation in which he was not able to perform his functions due to limitations imposed by the company. In the last step, the report shall be submitted to the board of directors following the requirements of the Companies Act, 2013.
iv. Remarks & Explanation by the BOD
As the audit is carried out by an independent third person, it must be transparent and unbiased and the report should be in the form of an opinion. The secretarial auditor must clear out his opinions based on examination in the report on which the Board of Directors should explain finally filling a copy of the report to the MCA portal and in the annual report of the company.
What is the Manner of Reporting Qualification in the Secretarial Audit Report?
i. While Reporting a Secretarial Audit report, the Secretarial Auditor shall be required to mark any qualifications, and remarks and highlight any adverse remarks based on findings.
ii. Since the audit report is in the form of an opinion, if the auditor is unable to form an opinion on any matter, he/she should specify the fact of his inability to express an opinion on such matter stating the reasons for the same.
iii. If the requisite work necessary to be performed is hampered due to any restrictions imposed by the company or on account of any circumstantial limitations, the auditor must highlight such limitations.
What are the Benefits of a Secretarial Audit?
Provided below are the benefits of a Secretarial Audit of a start-up company-
i. It can be an effective proof of due diligence for the prospective acquirer of a company or to acquiring interest or entering into strategic Joint venture partnerships.
ii. It ensures that the affairs of the company are being conducted as per requirements of law and avoids the risk of penalties & prosecution of the company & its management.
iii. It increases the value of the business organization for better growth prospects.
iv. It increases the trustworthiness of the business organization among its shareholders and external parties like potential investors and banks/financial institutions
.
What are the penalties prescribed for Non-Compliance with secretarial Audit?
i. Punishment for Default – Under section 204(4) of the Companies Act, 2013, provides that if a company or any officer of the company or the company secretary in practice commits a breach of the provisions of section 204 of the Act, the company including its officers and the
Company secretary in practice in default will be punished with fine, not lesser than one lakh rupees but which may extend to five lakh rupees.
ii. Professional Responsibility And Penalty For Incorrect Audit Report-Under section 448 of Companies Act 2013, if any return, certificate or any document of similar nature contains/or contains any statement made by such person-
i. Which is false in any material particulars with the understanding of it being false;
ii. Which omits any substantial fact with the knowledge of its importance
Shall be liable of punishment for fraud under section 447 of the Companies Act 2013 and the person guilty of such shall be punished with-
- Sentence for a term which is anywhere between six months in minimum to up to ten years;
- Fine which shall be anywhere between the amounts involved in the fraud to up to three times the amount involved in the fraud.
- Where the concerned default involves public interest, the term of sentence shall not be lesser than three years.
Punishment/Penalty for Professional Misconduct
A Company Secretary in practice who has been found guilty under section 448 of the Companies Act for any deliberate misstatement in the secretarial audit report or omits any material fact, shall be liable for professional or other misconduct under First or Second Schedule or in both the Schedules to the Company Secretaries Act, 1980 and could have to face following consequences-
(i) Where found guilty of professional or other misconduct mentioned in the First Schedule of Company Secretaries Act, 1980-
(a) Reprimand;
(b) Removal of name from the register of members up to three months;
(c)Payment of fine which may extend up to Rs. one lakh rupees.
(ii) Where found guilty of professional or other misconduct as provided under the Second Schedule of the Company Secretaries Act, 1980-
(a) Reprimand;
(b) Removal of name from the register of members permanently or for such period as decided by the Disciplinary Committee;
(c) Payment of fine which may extend to five lakh rupees.
Therefore, a secretarial audit is an effective process of checking the compliance of a start-up company that ensures that all the legal & procedural requirements are meted out for effective business management and avoiding risks of any potential mismanagement which could have disastrous consequences. At times, when India is witnessing massive growth in the start-up valuations and more and more start-ups are in line with their public issue, start-ups should have appropriate mechanisms in place to fulfill compliances related to secretarial audit to save themselves from any legal implications and above all ensure the financial health of their business.
