Related party transactions:

Monitoring and auditing needed

Harshini PERERA

There should be an appropriate monitoring and auditing system for related party transactions, Securities and Exchange Commission (SEC) Chairperson Indrani Sugathadasa said.

She was speaking at the seminar on related party transactions organized by the Financial Services Academy, the Education and Training arm of the SEC last week.

“Related party transactions are common in the corporate world though it has been treated a corporate risk. It is not always abusive but under certain circumstances it can be abusive”.

“Whether the related party transactions are in the form of material or wealth they should be properly accounted and audited through an effective mechanism that monitors and curves the related party transactions. The listed companies should prevent the abuse of minority share holders being disclosed of related party transactions long after they are done,”she said.

There are three layers identified to monitor related party transactions and to ensure that shareholders’ rights are not compromised.

Under the first layer there should be an additional disclosure to the related party transactions. The second layer is that the SEC is contemplating to recommend that all material related party transactions should be revealed and performed by an audited committee of the listed company.

“The third layer is that any related party transaction exceeds established threshold that transaction or transactions should be approved by independent shareholders of the listed company. This layer is practiced by other regulators in India and Hong Kong,” she said.

Most of the larger companies in Asia are family owned companies which have gone public. It would be the trend of any country’s economy even in the future.

In such a situation related party transactions (RPTs) are critical and the cost can be high. The controlling shareholders should not use RPTs for their benefit. That is the fine line directors should keep in mind all the time, Economic Analyst Sujeewa Mudalige said.

“Even though there is a complicated ownership structure, a listed company could be above board when it comes to RPTs,” he said.

“The shortcoming of listed companies we see as Auditors is that there is an inability to distinguish RPTs with the directors’ interest. Some of the minor transactions does not need disclosure whereas some key transactions need more and explanatory description. Most of the annual reports we review do not reveal them properly,” he said.

There should be a distinguished separation between transactions that need to be mentioned in the annual report.

The Audit committee of the company should therefore ratify RPTs. “One of the things we have considered in going forward is to ensure that all the definitions given for RPTs should be complemented to that of the Companies Act and the Regulator. The companies need to have policies internally about RPTs and the disclosure of RPTs. A shareholder approval or a voting system should be established for the disclosure of major transactions internally.

A related party transaction should disclose the nature of the relationship, types of transaction, volume and value of the transaction, pricing policies and balance at year end.

“A coherent regulatory system can reduce the risk applied with RPTs and we have seen some common issues with RPTs of companies such as non prevalence of database, poor quality of audits and the capacity of Auditors which decide the impact it has on RPTs. These transactions therefore should be highly transparent.”

“It is the responsibility of the board members and key executives to inform the board about any RPTs causing material conflicts of interest and conclude the transactions with the approval of the board through an effective monitoring system including of their performance,” Mudalige said.