4. Enforcement and Monitoring Division

• 4.1 Overview
• 4.2 Regulatory Actions
• 4.3 Monitoring and Enforcement
• 4.4 Cost Audits

The Enforcement and Monitoring Division (EMD) is responsible for regulation and monitoring of all listed companies, other than insurance companies and specialized companies, which at present number more than 600. The EMD seeks to ensure transparency in financial reporting of listed companies and compliance with relevant laws and lASs with the aim of protecting the interests of minority shareholders, creditors and other stakeholders.

During the year under review, the EMD took appropriate measures to ensure timely holding of AGMs by listed companies and circulation of their annual and interim accounts within the prescribed period. The EMD's regulatory and enforcement actions were also focused towards discouraging unauthorized and unlawful inter-corp orate financing, non-payment of dividends, irregularities and mismanagement, oppression, poor financial performance, non-compliance with statutory requirements and inadequate or misleading disclosures in accounts of companies under its purview. The EMD ordered investigations into the affairs of various listed companies during the year. Based on the findings in inspectors' reports, appropriate penal actions were taken against directors of these companies and their statutory auditors for negligence and professional misconduct.

There has been a visible improvement in the corporate governance structure of listed companies as a result of stricter corporate discipline and higher standards of transparency prescribed by the EMD. Proactive monitoring by the EMD considerably improved compliance with corporate laws and lASs by listed companies that helped to engender confidence among investors and the general public. The auditors of listed companies have also become more vigilant in performing their statutory duties.

The Commission has been proactive in facilitating mergers and amalgamations among companies in order to strengthen their capital base and achieve economies ofscale. Consolidation within the corporate sector will enhance its capacity to deal with systemic risk and to withstand exogenous shocks. During the year under review, the EMD received 20 merger applications, of which seven schemes of arrangement were approved by the concerned High Courts and the SBP, two were rejected while 11 schemes of arrangement were pending at the end of the year.

The Commission carefully examines schemes of arrangement proposed by companies to ensure that they are not prejudicial to the interests of minority shareholders. In

case a scheme of arrangement appears to be detrimental to the interests of minority shareholders, the concerned registrar makes a representation before the Court under Section 288 of the Companies Ordinance, 1984 after obtaining comments of the EMD in this respect. During the year, the proposed merger of Kohinoor Raiwind Mills Limited and Kohinoor Gujar Khan Mills Limited with Kohinoor Textile Mills Limited was rejected by the Honorable Lahore High Court on the representation of the Commission and small shareholders. In another case, the merger of Parke Davis and Company Limited with Pfizer Laboratories Limited was rejected by the Honorable Sindh High Court.

In November 2001, the Commission issued a notification to require listed companies to circulate quarterly accounts to their shareholders, the Commission, registrar and stock exchanges within one month of the close of every quarter in an accounting year. This requirement was in line with international best practice and the Commission's policy to ensure maximum disclosure to shareholders at regular intervals. The EMD ensured early disposal of queries of listed companies with regard to circulation of quarterly accounts and issued necessary clarifications to address practical difficulties. As a result, it was clarified that quarterly accounts would not be required to be circulated for the second quarter of the accounting year, at the end of which half-yearly accounts become due under Section 245 of the Companies Ordinance, 1984. In addition, the requirement for circulation of fourth quarter's accounts was relaxed for companies that undertookto circulate their annual audited accounts within three months from the close of financial year, instead of the stipulated four months. Further, companies were allowed to publish their quarterly accounts in two daily newspapers in lieu of circulation to their shareholders. However, the requirement to furnish quarterly accounts to the Commission, registrar and stock exchanges remained unchanged.

The AGMs provide a forum for shareholders to consider and approve significant matters relating to management and performance of companies, including approval of annual accounts, declaration of dividends, appointment of auditors and election of directors. Under the Companies Ordinance, 1984 listed companies are required to hold AGMs at least once in every calendar year within a period of six months following the close of their financial year.

The EMD undertook strict monitoring to ensure that listed companies held AGMs within the prescribed period and in an orderly manner. As a result of timely actions by the EMD, compliance with this mandatory requirement of the Companies Ordinance, 1984 improved by 5 percent as compared to the preceding year. Of the total 617 companies being monitored by the EMD, 548 companies held their meetings within the specified time period whereas 69 companies failed to hold their meetings in accordance with the statutory requirements.

TABLE Extent of Compliance with the Requirement for Timely Holding of fiE M: A Comparison with Last Year|

The table below shows, for the year under review, the sector-wise status of compliance with the requirement to holdAGM on the basis of the financial year-end.

TABLE 15 Sector-wise Status of Holding of AGM with in the Prescribed Time Period

During the financial year 2002, the EMD initiated proceedings against companies that had defaulted in holding AGMs within the prescribed period. As a consequence of these proceedings, penalties were imposed on 17 companies and their directors while appropriate actions against other defaulter companies are underway.

During the year, the EMD received applications from 36 listed companies to extend the minimum period for holding of AGMs. These applications were examined in light

of the provisions of sub-Section (1) of Section 158 of the Companies Ordinance, 1984 and Rule 14 of the Companies (General Provisions and Forms) Rules, 1985. The Commission allowed extensions of varying periods, up to a maximum of 90 days, to 33 companies. The remaining three applications were rejected as either the grounds for seeking extension in the minimum period were found inadequate or the applications were not in accordance with the requirements of Rule 14 of the aforesaid Rules.

During the preceding year, i.e. 2000-2001, the Commission had received applications from 76 companies for seeking extension in the period for holding ofAGMs, of which 56 applications were approved by the Commission. It is evident that there was a drastic reduction from the preceding year in the number of companies that sought relaxation in the minimum period for holding of AGMs. This declining trend is in line with the Commission's objective to achieve timely holding ofAGMs by companies.

The number of applications received, approved and rejected during the year is given in the following table.

The directors of listed companies are required under the Companies Ordinance, 1984 to present the annual financial statements of their companies to shareholders in their AGMs. A delay in presentation of annual accounts or a failure to present them altogether in AGM is a default that is punishable with imprisonment for a term, which may extend to one year and with a fine of not less than Rs. 10,000.

During the year, the EMD enhanced its surveillance activities to identify companies that failed to prepare, circulate and present their accounts in accordance with the provisions of law. On the basis of vigilant monitoring, the EMD identified 27 companies, which had not prepared and presented their accounts to the shareholders in AGMs within the specified time frame. References were made in the courts of law for prosecution of directors of the companies in default. The list of companies against whose directors prosecutions were in progress as of June 30, 2002 is given in Table 17. The list includes the 27 cases of prosecution initiated during the year as well as two cases that were started in previous years and were pending adjudication by the close of the year 2002.

Table 17 Cases of Prosecution for Default in Presenting Annual Accounts in AGMs

The Companies Ordinance, 1984 requires that notices of AGMs should be sent to shareholders at least 21 days before the date of meetings. Moreover, listed companies are required to publish these notices in two daily morning newspapers in English and Urdu languages. To ensure timely issuance and publication of notices of meetings, the Commission has directed the listed companies to send it copies of notices through facsimile on the same day on which they are issued to shareholders as well as to submit to it clipping of newspapers in which the notices are published.

On the basis of information received pursuant to this directive, the Commission was able to take corrective measures in cases where resolutions were proposed to be passed by companies in violation of the statutory requirements or full disclosure of material facts was not provided to shareholders. During the year, the EMD identified all such instances and issued timely instructions to the concerned companies to either refrain from passing such resolutions or proceed only after removing the deficiencies observed in the notices of meetings.

Listed companies are required to hold their AGMs in the city where their registered offices are situated, except where the Commission allows a company to hold its AGM at any other place. During the year under review, the EMD received applications from five companies to allow holding of their AGMs at places other than their registered offices. After careful examination of explanations provided by such companies, the Commission accorded its approval to allow holding the respective AGMs at places other than the registered offices.

The EMD identified two cases where companies had held their AGMs at places other than their registered offices without seeking the approval of the Commission. Necessary proceedings were initiated during the year against those companies for violation of mandatory provisions of the Companies Ordinance, 1984.

The Companies Ordinance, 1984 requires that where any special business (a business other than approval of annual audited accounts, declaration of dividends, appointment and fixation of remuneration of auditors and election of directors) is to be transacted at a general meeting, a statement setting out material facts concerning the business should be circulated to the shareholders along with the notice of the meeting. The intention is to apprise shareholders sufficiently in advance about relevant details of significant matters to be decided in general meetings. The Companies Ordinance further requires that the nature of interest of a director, whether directly or indirectly in such special business should be disclosed.

During the financial year 2002, the EMD focused its monitoring efforts on requiring listed companies to provide all material information to shareholders in respect of any special business to be transacted at a general meeting. The EMD examined the statements of material facts pertaining to special businesses transacted by 130 listed companies during the year under review. Strict monitoring by the EMD resulted in an enhanced disclosure of information by companies. However, certain deficiencies were noted in a few cases and nine companies were directed to circulate additional information to their shareholders. Broadly, these actions were taken in respect of deficiencies in the following matters:

(i) remuneration of directors;

(ii) investment in associated companies;

(iii) sale of assets by companies;

(iv) merger of companies;

(v) alteration in memorandum and articles of association; and (vi) increase in authorized share capital.

During the year under review, the Commission also sent its representatives as observers to attend AGMs of selected companies. The presence of these observers resulted not only in orderly holding of meetings but also helped to enhance shareholder confidence. A large number of shareholders were motivated to attend AGMs and to discuss the affairs of their companies openly with the management.

Listed companies are required to circulate their half-yearly accounts to shareholders within two months from the close of first half of their accounting years, in terms of Section 245 of the Companies Ordinance, 1984. In addition, half-yearly accounts have to be furnished to the Commission and the stock exchanges on which shares of the companies are listed. During the year under review, 361 companies circulated

their half-yearly accounts within the prescribed period whereas 170 companies circulated them late. Another 86 companies failed altogether to prepare and circulate half-yearly accounts to the shareholders, stock exchanges and the Commission. In view of these defaults, show cause notices were issued to directors of 38 companies while EMD is scrutinizing the remaining 48 cases for initiating appropriate proceedings. Of the 38 companies that were issued show caused notices during the year, penalties were imposed on directors of 24 companies while the remaining cases were pending at the year end.

The status of compliance with the statutory requirement to prepare and circulate half-yearly accounts within the prescribed time period is given in the following table.

During financial year 2002, listed companies were directed to circulate quarterly accounts to their shareholders, stock exchanges, registrar and the Commission. A total of 712 quarterly accounts of listed companies were due to be filed during the year. Although it was the first year of its application, this requirement was substantially complied with. As many as 605 accounts were circulated by listed companies at a compliance rate of 85 percent. Since circulation of quarterly accounts was a new requirement, only warnings were issued for defaults pertaining to the quarter ended December 31, 2001. However, for the quarter ended March 31, 2002 - the second quarter after introduction of this requirement - show cause notices were issued to the companies in default. The status of compliance forthe year under review is tabulated below.

During the year under review, the EMD undertook careful examination of published accounts of listed companies to identify deficiencies in disclosures and other irregularities. As a result of strict monitoring by the EMD, the quality of financial reporting by companies improved significantly, which was apparent from more comprehensive and transparent presentation of financial statements.

The Fourth Schedule to the Companies Ordinance, 1984 together with lASs forms the framework for preparation and presentation of financial statements of listed companies. The directors of every company are responsible for complying with the requirements set out in the Fourth Schedule and lASs to give adequate and meaningful disclosures in financial statements that are essential for a true and fair view. During the year, the financial statements of companies were thoroughly examined and directors of several listed companies were asked to furnish explanations with regard to deficiencies noted in the financial statements of their companies. Accordingly, warnings were issued to nine companies to ensure due compliance in future while show cause notices were issued to eight companies where serious violations were noted.

The Companies Ordinance, 1984 lays down the minimum parameters for information to be provided in the directors' report, annexed with the financial statements of listed companies in terms of Section 236. The EMD noted that vital information was missing from directors' reports in several cases with the result that shareholders were deprived of meaningful information about the affairs of these companies. During the year, directors of32 companies were asked to furnish reasons for deficiencies in their respective directors' reports. While most of the companies were issued warnings to comply with the disclosure requirements in future, proceedings were initiated against directors of six companies for grossly inadequate disclosures in directors' reports.

The directors of listed companies are required to maintain proper books of account that give a true and fair view of the state of affairs of companies. Failure to maintain proper books of account is an offence in terms of the Companies Ordinance, 1984, which is punishable with imprisonment and fine. During the year, it was observed that the auditors of two listed companies had qualified their audit reports on account of inadequate books of account maintained by the management. The case ofAdil Polypropylene Products Limited was referred to the Court of Session for prosecution of directors while the other case was pending adjudication as of June 30, 2002.

During the year under review, the EMD noted seven cases where statutory auditors had qualified their audit reports on financial statements of the companies for non-maintenance of Fixed Assets Register. The Commission has directed the management of the respective companies to undertake necessary steps for preparation of Fixed Assets Register within a period of one year, failing which appropriate penal proceedings would be initiated.

Section 235 of the Companies Ordinance, 1984 deals with the treatment of surplus arising out of revaluation of fixed assets of a company During the year, there were three cases where depreciation had been charged to revaluation surplus, in contravention of the requirements of the aforesaid provisions of law. Show cause notices were issued to the directors of these companies and after providing reasonable opportunity of hearing, fine was imposed in one case while the other two cases were pending finalization at the end of June 2002.

Under Section 237 of the Companies Ordinance, 1984, every holding company should attach with its financial statements the financial statements of its subsidiaries. However, the Commission, on application of a company or with the consent of its directors, is empowered to grant exemption from this requirement. During the year under review, the Commission received three applications for seeking this exemption. The EMD expeditiously disposed of all the three applications during the year. Further, it initiated action against a company that had failed to comply with the requirements of Section 237 without obtaining approval of the Commission in this regard. Consequently the violation was rectified by circulation of accounts of the subsidiary to the shareholders of the holding company.

While inter-corporate financing constitutes a major source of funding for productive investment and capital formation, this avenue has been greatly abused by managements and sponsors for transfer of funds to their own companies. In order to curb this misuse of funds, the Companies Ordinance, 1984 has placed certain restrictions on investments in associated companies. During the year under review, efforts were made by the EMD to deter unlawful inter-corporate financing. As a result of its proactive monitoring, the EMD was able to detect material deficiencies in the information provided by certain companies in the proposed resolutions and statements of material facts annexed to notices of general meetings. Timely interference by the EMD caused four companies to withdraw the proposed resolutions for making investments aggregating Rs. 120 million in their associated companies. In another case, a company was prevented from selling its investment in a subsidiary at a "throw away" price. Another

company was restricted to pass a resolution for making advances to associated undertakings without any return thereon.

A number of cases were also identified where investments were either made in associated companies without approval of shareholders or in excess of the prescribed limit or free of any return. Proceedings were initiated against 15 companies for violation of the mandatory provisions of the Companies Ordinance. Of these, five cases were disposed of during the year while others were pending adjudication as of June 30, 2002. As a result of actions taken by the EMD, more than Rs. 1.1 million, along with return thereon at not less than the borrowing cost of the investing companies, would be returned to these companies. The details of cases disposed of during the year are given in the table below.

Further to the orders made by the Executive Director, EMD, appeals were filed before the Appellate Bench of the Commission in the matter of Spencer and Company (Pakistan) Limited and Gharibwal Cement Limited. While the decision of the Executive Director was upheld by the Appellate Bench in the case of Spencer and Company (Pakistan) Limited, the penalty, in the case of Gharibwal Cement Limited, was reduced from Rs. 1.5 million to Rs. 600,000. The case of Spencer and Company (Pakistan) Limited is now pending before the Honorable Sindh High Court. In another case, the Honorable Sindh High Court has stayed the show cause proceedings initiated by the

EMD against a listed company for making unlawful investments in its associated companies.

During the year under review, the EMD also took note of situations where sale proceeds of assets of companies were used to settle their outstanding debts, including the amounts borrowed from sponsors. Effectively, this practice results in a loss in the value of investment of minority shareholders. The EMD took a number of remedial measures to discourage this practice. Based on a review of notices published in newspapers regarding sale of assets by companies, appropriate directions were issued to concerned companies to ensure that minority shareholders were adequately compensated. This policy was adopted in the case of companies in which eitherthere was no chance of revival of operations or the future returns to shareholders were considered negligible. During the year, two companies were directed not to sell a sizable part of their assets without the approval of the Commission. Accordingly these companies were unable to undertake business that was prejudicial to the interest of minority shareholders.

Provisions of the Companies Ordinance, 1984 place certain restrictions on exercise of powers by directors. During the year under review, two cases were identified where directors had exceeded their powers in violation of statutory provisions and had, in each case, disposed of a sizeable part of the undertaking without seeking the consent of shareholders in general meetings. Taking cognizance of these violations, the EMD issued show cause notices to the directors of these companies. While one of the cases was pending adjudication at the end of financial year 2002, the directors of the other company have obtained the stay order of the Court in respect of proceedings initiated by the EMD.

Section 195 of the Companies Ordinance, 1984 prohibits public companies and private companies, which are subsidiaries of public companies, to provide loans, or give guarantees in connection with loans, to their directors. These restrictions equally apply to loans or guarantees to relatives of directors and private companies or firms in which such directors have substantial interest. During the year under review, the EMD issued directives to the following companies whose funds had been transferred in contravention of the statutory requirements.

Quality Food Products (Private) Limited. This amount was unlawfully advanced to the associated company and no interest was being charged under the pretext of non-trading transactions. The company, on the directions of the Commission, recovered an amount of Rs. 46.1 million on account of principal and mark-up.

(iii) The directors of Brothers Textile Mills Limited were directed to cancel the

guarantee provided to a bank in connection with a loan given by the said bank to one of its associated undertakings. The company has complied with the direction of the Commission and consequential proceedings have been dropped accordingly

Section 195 allows that a company, subject to the approval of the Commission, can extend a loan to a whole time working director for the purpose of construction or acquisition of a house or other purposes enumerated in the said Section. During the year, only one application was received from a company to seek approval for giving a house-building loan to its director. The application was suitably processed and disposed of.

In case of 22 listed companies, the EMD took cognizance of lack of disclosure in notices of general meetings regarding proposed resolutions for election of directors. Explanations were called and remedial actions were taken by the EMD. However, on a complaint by NIT that election of directors in a company was held through show of hands and not in compliance with the procedure prescribed in Section 178 of the Companies Ordinance, 1984, necessary proceedings were initiated against the company. As a result, the CEO of the company was fined for violating mandatory provisions of the Companies Ordinance, 1984.

During the year under review, 255 listed companies paid dividends to their shareholder. In addition, five listed companies came out of the Defaulters Counter of KSE dueto resumption of dividend payments. The pattern of dividend payment by listed companies during the last four years is presented below.

TABLE 21 Sector-wise Pattern of Dividend Declared During Financial Years 1999-2002