SEBI has proposed several changes to the rules relating to corporate governance, mainly to strengthen the status of Independent Directors. The major changes include giving a bigger role to minority shareholders in the appointment / removal of such directors, proposing higher remuneration to them, strengthening the Audit Committee / Nomination and Remuneration Committee (‘NRC’) even further, etc. Views have been sought from the public at large through the release of a Consultation Paper.
The Consultation Paper notes how the requirements relating to corporate governance, introduced formally for the first time in 1999, have, over the years, seen several expert reviews and amendments in law to successively upgrade the requirements. As the paper notes, the Companies Act, 2013 / Rules made thereunder too have corporate governance requirements generally for specified listed and unlisted companies, many of them overlapping with the SEBI requirements. Hence, the fresh proposals are yet another step in that direction, though this time more focused on Independent Directors.
Independent Directors are seen as a pillar that balances the interests of all stakeholders with the primary focus on those of the minority shareholders vis-à-vis promoters. The worry is that promoters with their controlling stake should not be able to usurp the interests of others. This requires that they should not be able to influence the watchdog group – the Independent Directors.
APPOINTMENT AND REMOVAL OF INDEPENDENT DIRECTORS
The first of these important proposals looks at how Independent Directors are appointed and removed. At present, they are usually recommended by the NRC. The next step is appointment by the Board and the validity of their tenure is till the next annual general meeting. At such annual general meeting, the appointment is placed and confirmed by approval of the majority of shareholders who vote. Their removal is also by majority shareholder approval.
It is seen that the promoters who usually have a controlling stake can influence – perhaps decisively – the process at every step. This would mean that at every step they have a direct say and even decision-making ability. Thus, there are fair concerns that their independence may be influenced by the promoters. Hence, adopting the UK model almost wholly, it is proposed that this be corrected and that the appointment at shareholder level should pass two tests; first, approval by a majority of all shareholders including the promoters, and second, approval by the majority of the minority shareholders. Minority shareholders for this purpose would mean shareholders other than the promoters.
Let us understand this better through an example. Say, the promoters of a company hold 60% equity shares. The first test would be achieved when 50.01% of all shareholders approve (the percentage in each case is of shareholders who actually vote). Since promoters hold 60%, they would control this outcome. The second test is majority of the public (40%) shareholding and thus more than half of these – say 20.01% of the total – would also have to approve. If either of these tests fails, the appointment is rejected. There are then two ways out for the management. The first is that it can propose a new person as Independent Director and put him through these tests. Or, it can put the same candidate through a slightly different agni pariksha of sorts after a cooling period of 90 days, but before 120 days. If at least 75% of shareholders (including the promoters) approve, the appointment would be through. A similar process is proposed for the removal of Independent Directors. This ensures a significant role for the public shareholders and the strong influence of the promoters is mitigated to an extent.
SHORTLISTING OF INDEPENDENT DIRECTORS TO BE MORE TRANSPARENT
Even the shortlisting of Independent Directors is given a fillip by requiring more disclosures on how they came to be shortlisted. The process and requirements have to be laid down first and thereafter it is to be seen how each candidate fits these requirements. There have to be extensive disclosures to the shareholders, too.
Higher proportion of Independent Directors in the NRC
Moreover, the NRC that recommends Independent Directors will now have a higher proportion (two-thirds) of Independent Directors instead of just a majority as at present. A higher 67% ratio of Independent Directors would mean even more say to them in the NRC.
Appointment of new Independent Directors only by shareholders
At present the appointment of Independent Directors is made first by the Board and it is only at the later annual general meeting that shareholders get a chance to approve. During this period – which could be as long as a year – the Independent Director functions in office. To avoid this even interim say of the promoters on such appointments, it is now proposed that the appointment of Independent Directors shall only be by shareholders. If an Independent Director resigns / dies, his replacement too has to be made by shareholders, now within three months.
Resignation of Independent Directors to be more transparent and subject to restrictions
Concerns are often expressed that some Independent Directors having issues with the company may prefer to exit quietly without creating a fuss. To tackle this, several proposals have been made. Firstly, the complete resignation letter is required to be published by the company.
Further, if an Independent Director resigns stating ‘personal reasons’, ‘other commitments’ or ‘preoccupation’, he won’t be able to join any other Board for a year. This obviously makes sense since one cannot claim being busy, resign and then promptly join elsewhere. This may encourage them to be more forthright, if that was the real issue.
There is another concern. The management may have offered full-time employment to an Independent Director. This may be for bona fide reasons such as the management being impressed with his work. But obviously there are also concerns that this would affect his independence. A new proposal now states that if an Independent Director desires to join the company as a Wholetime Director, he will have to wait for one year after his resignation. Interestingly, as we will see later, the cooling period to become an Independent Director after having been an employee or KMP is three years, while in this case only one year’s cooling period is given.
Audit Committee to have no promoter / nominee directors or executive directors
The Audit Committee has an important role in approving related party transactions, accounts, etc. At present it is required that two-thirds of the committee should be Independent Directors and the rest can be any director, including promoter directors. Now, several categories are excluded even for the balance one-third of the committee. These may be non-independent directors but cannot be executive directors, nominee directors or those related to the promoters. The influence of both promoters and management is thus sought to be removed.
Excluding further categories of Key Managerial Persons
Persons who may have, in the immediate past, been employees / Key Managerial Persons (or their relatives) of the company and its holding / associate / subsidiary companies, or having material pecuniary relationships with them, may still have loose ties and may be subject to influence, and hence there may be concerns about their independence. Therefore, cooling periods are prescribed whereby they can join as Independent Directors only after specified periods. Two changes are now proposed. Firstly, now, past employees / KMPs of even promoter group companies will have to be subject to the cooling period. Secondly, the cooling period for all categories would now be uniform at three years.
ENHANCED REMUNERATION OF INDEPENDENT DIRECTORS
Finally, there is the proposal to enhance the remuneration of Independent Directors. The dilemma here is that if you pay too little, the Independent Director does not have the incentive to devote sufficient time to the affairs of the company. And if you pay too much, the concern is about him being influenced by the remuneration which may affect his independence. At present, a maximum Rs. 1 lakh per meeting is permitted as sitting fees. Commission based on profits is allowed but this has issues for loss-making companies. Besides, commission linked to profits has obvious concerns of conflict in approving accounts since there is a link between higher profits and higher commission.
A compromise of sorts is now proposed in two ways. One is by increasing the sitting fees, but this would have to be decided by the Ministry of Corporate Affairs. Hence, this proposal would be forwarded to them for their consideration.
The second is by permitting grant of employees stock options (‘ESOPs’) with at least five years vesting period. Thus, those who stay on for five years can possibly be rewarded through appreciation in the value of shares. However, this solution may not resolve the issue well. ESOPs are generally not very common in companies. Apart from this, a waiting period of five years could be too long and many may not benefit.
CONCLUSION
All in all, the changes are positive. However, much more is needed to be done. The powers and liabilities of Independent Directors have not been touched upon. Individually, Independent Directors have very little power. But the liability, on the other hand, is significant and the enhanced status may raise it even more. The remuneration of Independent Directors is still not resolved satisfactorily on at least two counts. First, the amount would still be decided by the Board and thus the promoters would still have a significant, often decisive, say. Second, the amount and manner may still be found to be insufficient to attract the best of talent. The proposal of dual approval tests giving minority shareholders a bigger role could also be applied for appointment of auditors who represent another pillar of safeguards.
It will also have to be seen how companies are required to transition to the new requirements. Will the provisions be effective immediately? Whether only large companies will be required first to change, with later dates being given for successive categories of smaller companies? Will the existing directors be allowed to complete their terms or will they have to be subject to this test immediately?
It is also seen that two laws – the SEBI LODR Regulations and the Companies Act, 2013 – have simultaneous requirements of corporate governance which overlap and even conflict. Perhaps the first step could be to require that listed companies would be regulated in this regard only by SEBI.
There is also another thought. Many principles of corporate governance are borrowed from the West, including a few significant ones from the UK, even in these proposals. India is different in a very vital way. Promoters typically hold a very significant stake, often more than 50%. Investors traditionally invest on the faith of the reputation and entrepreneurship of the promoters, though there would be cases where this trust is broken. While a check on them is always advisable, it should not happen that adopting a relatively alien concept tilts the balance so much that it actually becomes a hindrance.
