Towards an independent board

Towards an independent board

The Securities and Exchange Board of India has done a commendable job of trying to protect the investor through the provisions on independent directors contained in Clause 49 of the standard listing agreement with the stock exchanges. However, concerns regarding the implementation of the provision as law, and compliance in letter and spirit deserve attention.

Why independent directors

The Board of Directors plays a fiduciary role of protecting shareholders’ interest by providing adequate information on the company’s management, which is, for all practical purposes, the custodian of the money that the shareholders have invested in the company. The board must be adequately populated with qualified and competent independent directors who will have no conflict of interest with either the management or the business per se and will therefore be in a position to safeguard investor interests impartially. /Content/Videos/2007-09-27/02.Ind Board.flv2f1b92a0-6cd8-11dc-aff9-000b5dabf636.flv

Such a director, apart from instilling shareholder confidence, will also be able to bring his expertise to the table and enhance value for the company he represents.

Sebi’s definition

Clause 49 says independent directors must comprise at least 50% of a company’s board if its chairman is an executive director and 33% if the company has a non-executive chairman. In its latest definition, the market regulator says an independent director is one who:

a. Apart from receiving the director’s remuneration, does not have any “material" pecuniary dealings with the company, its promoters, its directors, its senior management or its holding company, its subsidiaries and associates.

b. Is not related to promoters or directors or to persons at one level below the board.

c. Has not been an executive of the company in the preceding three financial years.

d. Is not currently, and wasn’t during the preceding three years, a partner or executive of a statutory or internal audit firm, or legal or consulting organization associated with the company.

e. Is not a vendor, customer, lessor or lessee of the company.

f. Owns less than 2% of the voting shares.

Sebi has defined the term “relative" as per Section 2(41) and Section 6 read with Schedule IA of the Companies Act, 1956.

Why independence was lost

Companies had a great deal of reservation about Sebi’s definition of an independent director, with several saying they would be unable to meet the compliance deadlines, as they’d find it extremely difficult to find people who fit the bill and populate half their boards with them.

This, despite reports in sections of the media about the abundance of eligibles. One report says as many as 10,450 professionals have offered their services for the job on a popular website.

Another area of confusion was the continuing independence of such people once they joined the board, if they already held similar positions in other companies. The corporate view here was that independence risked being substantially diluted in case a director represented two companies in conflict with each other.

What companies did not say, probably intentionally, was that The Companies Act, 1956 does have a provision to deal with such a situation. It bars the director from participating or voting in Board proceedings under Section 300 in case such a situation arises.

Another set of companies exploited loopholes in the definition to adhere to the law in letter, but circumvent it in spirit. Here are some of the ways they did this:

• Companies used the lack of clarity in the definition of the term “relative" to appoint those not related by blood on their boards.

• The original clause didn’t dwell on the qualifications of an independent director, making it easy for companies to appoint people prone to be influenced by the promoter or management.

• The provision permitting a board with a non-executive chairman to have only 33% of its members independent saw several companies appoint their own promoters or “men" as non-executive chairmen.

The market regulator’s provisions relating to independent directors were diluted when the Ministry of Corporate Affairs said that only 33% of the board of any listed company should consist of independent directors instead of 50%.

The panacea

• Sebi should have the power to prosecute non-compliant companies and impose penalties

• A fair degree of co-ordination between the Ministry of Corporate affairs and the market regulator is needed to ensure they speak in the same voice

• The Companies Act allows a person to serve on the board of fifteen companies at the same time. This number should ideally be reduced to five, so he can efficiently execute his responsibilities instead of just attending board meetings. This would also reduce the number of cases in which one person serves on the boards of two companies in conflict with each other

• Independent directors should be vested with the power to change the top management. This was observed in the case of the erstwhile Compaq Corporation, in which the CEOs were sacked twice for non-performance.

• Qualifications of the independent director need to be clearly defined. Even the term “professional" can be deliberately misconstrued to appoint celebrities, whose contribution to the objective of investor protection hasn’t really been proven.

Vikas Verma is the president and CEO of Nirvana Advisory Group Pvt. Ltd, a New Delhi-based consulting organization focused on corporate governance