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Tightening governance: SEBI proposals for independent directors

SEBI’s suggestions were provoked by worries about the efficiency of the directors and the need to strengthen their autonomy and effectiveness to safeguard minority investors. But more needs to be done.

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By Shivanand Pandit

With the intention of reinforcing the role of independent directors, the regulator of securities market has recommended a few changes in the rules dealing with their selection, removal and remuneration and their part in the audit committees of a listed company.

A consultation paper of SEBI, uploaded on its website, also suggests that independent directors’ resignation letters be fully revealed to stock exchanges. SEBI said these suggestions were provoked by worries around the efficiency of independent directors and the need to fortify their autonomy and effectiveness to safeguard minority investors. The regulator has invited remarks from the public until April 1, 2021.

According to the Companies Act, at least one-third of the board of directors in a listed corporate entity who do not possess significant financial interest in it must be neutral or non-executive directors. They are appointed for five years. With their impartiality, knowledge and expertise, independent directors are expected to look into the welfare of minority stakeholders. They should also act as bridges between the minor, unvoiced shareholder and the management to contribute to healthier corporate governance.

SEBI’s first proposal is linked to the definition of an independent director. Presently, there are restrictions on those who have been key managerial persons (KMP) in an organisation or those who have had substantial financial affiliation with a company, its subsidiaries or promoters. The cooling-off term for the each was three and two years, respectively. In order to synchronise this, SEBI has suggested a single cooling-off period of three years. Therefore, as per the new rule, a KMP or his relative can be appointed as an independent director in a listed entity only for three years from the date when he stops having a financial or employment association with the listed entity.

The second proposal relates to disclosures pertaining to the resignation of independent directors. SEBI has recommended that the complete resignation letter of an independent director must be unveiled to shareholders, accompanied by a list of his membership in committees of the Board of Directors. An independent director who resigns from a board quoting pre-occupation, private obligations, etc., will be subject to a cooling period of one year before joining any other Board of Directors.

The third proposal relates to dual approval process for appointment, reappointment and removal of independent directors. As per the present law and SEBI regulations, independent directors are selected and appointed by the company’s board subject to later consent by shareholders through an ordinary resolution, ie., simple majority must vote in favour of the agenda. Reappointment should be approved through a special resolution, ie., not less than 75 percent of those voting must be in favour of the agenda.

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A similar method of ordinary and special resolutions applies in case of removal of a director. In the case of promoter-led entities, the shareholder vote upshot would be influenced by the majority. To provide a resilient voice to non-promoter or public shareholders, SEBI has recommended a dual approval process for appointment, reappointment or removal of independent directors from the board of a listed company.

According to the new rule, appointment, reappointment or removal of independent directors would require approval of both shareholders and a majority of minority shareholders. The shareholder vote would be through ordinary or special resolution as in the case of the existing system for appointments and reappointments. Most of the minority votes would be through simple majority. Both votes would be done through a single method and meeting.

If any candidate fails to get twin approval, he can be proposed again for independent directorship through a second vote after 90 days. The vote in such a circumstance would be through a special resolution. In addition, SEBI has suggested comprehensive disclosures by the Nomination and Remuneration Committee pertaining to the appointment of candidates for the post of independent director. The new candidate’s appointment by the board, in case of vacancy in an independent director’s post, must be subject to shareholder approval within three months.

The fourth proposal relates to the audit committee. As per regulation, two-thirds of a board’s audit committee must include independent directors. Considering the significance of the decisions made by audit committees, from finalisation of accounts to related party transactions, SEBI has suggested that two-thirds of their total strength must include independent directors, while the rest must be non-executive directors who are not related to the promoter.

The fifth proposal links to the issue of remuneration for independent directors. To bring their interests in line with shareholders, SEBI proposes the grant of long-vesting Employee Stock Options (ESoPs). The regulator has mentioned that skin-in-the-game is important, but profit-linked commissions may motivate short-termism.

Since 2014 when the amended Companies Act came into effect, SEBI has been stressing for a greater role for independent directors. But more needs to be done. More stringent rules should be pronounced for protecting them because in bigger listed establishments, especially family controlled firms, they are largely controlled by those close to the management. They are also influenced by huge sitting fees.

The battle between Ratan Tata and Cyrus Mistry has shown that the position of independent directors is in danger because those with a difference of opinion with the management were removed. The boardroom war in this case uncovered the vulnerabilities of independent directors if they stand on the wrong side of the fence. Therefore, SEBI should safeguard the voice of the minority, which is needed for corporate democracy.

Although SEBI’s suggestions are good, intense examination of the proposal discloses some snags. In spite of getting extra powers, typically, retail stakeholders are lethargic to corporate voting practices. Institutions also show their unwillingness to vote against current directors. Too many executive directors with a significant stake in the shares of the company they manage can also confine promoters. Therefore, there is a need for independent directors. 

It is prejudicial to expect that independent directors should have a say in every affair of the company, from related party deals to amalgamations and acquisitions. Besides, even for admirably managed organisations supported by friendly promoters, the recommended procedure for appointment and removal of independent directors will increase the compliance load.

Surprisingly, SEBI’s suggestions are silent on independent directors’ liabilities. The amount of accountability on them increases considerably due to which many reputable professionals hesitate to walk into circumstances where the assessment of liability is subject to many issues.

Additionally, questions on how entities are required to change to the new obligations remain unanswered. Will the provisions be effective instantly? Will only big firms be obliged to change first, with dates being given to other entities later? Will the present directors be permitted to complete their tenures or will they be subject to the new norms immediately?

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SEBI should address these problems immediately. It should trim the accountabilities of independent directors and embolden meticulous candidates who desire to be in these posts. Depending on their proficiency and aptitude, their statutory responsibilities must be limited to scrutiny of governance violations and involvement in tactical decisions. Moreover, the compensation package should be attractive and match their responsibilities. Instead of ESOPs, which can sometimes just be window-dressing, SEBI can think about a slab wise remuneration, depending on the size of the company. It should also formulate ways to enlarge the restricted group of managers who are eager to apply for the position of independent director.

—The writer is a financial and tax specialist, author and public speaker based in Margao, Goa

What SEBI proposes

  • Greater say to minority shareholders in appointment/re-appointment/ removal of independent directors through a dual approval process. First, there should be approval of shareholders, followed by approval of “majority of minority” shareholders.
  • Bring more transparency in the process followed by the Nomination and Remuneration Committee (NRC) of the Board in selection of independent director candidates.
  • Replace profit-linked commission paid to independent directors with ESOPs, with a long-term vesting period of five years, along with a cap on remuneration.
  • Mandatory cooling-off period of three years for employees of promoter group of companies who are to be appointed as independent directors.
  • Two-third members of the NRC should be independent directors, instead of just majority.
  • Appoint independent directors on the board only after shareholder approval.

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