By Jayant M. Thakur, Chartered Accountant
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Securities LawsThis series of articles
introducing securities laws for listed companies to the lay reader continues . .
.
Developments in securities laws are churned out through many sources — decisions of SEBI through decisions of its Adjudicating Officers/Whole-time Members, of the Securities Appellate Tribunal, through Informal Guidance, through Circulars, amendments of Regulations and so on and on, not to speak of relatively rarer amendments in the parent enactments themselves. It is then worth reviewing, from time to time, some of these important amendments to update our knowledge. Let us consider here one very recent development (as per SEBI’s Circular of 8th April 2008) that has far reaching implications. This Circular amends the corporate governance requirements as contained in Clause 49 of the Listing Agreement.
Let us first consider a quick background of the scheme of
corporate governance through the Listing Agreement.
Clause 49 of the Listing Agreement :
As readers would be aware, provisions relating to Corporate
Governance for Listed Companies are mainly contained in Clause 49 of the Listing
Agreement. Wisely or otherwise, in India, for Listed Companies, the principal
provisions relating to Corporate Governance are contained neither in an
enactment, nor in any subordinate law such as Regulations or Rules, but in the
Listing Agreement. What is the real status of the Listing Agreement as a law can
itself be the subject of a lengthy article. Two comments are, however, only made
here. Firstly, the Listing Agreement allows for quick amendment with a simple
direction to the stock exchanges by SEBI being sufficient. Secondly, however,
though purists will continue to question its status of ‘law’, where
non-compliance could have punitive consequences, in practice, there are several
real and serious consequences possible for a Listed Company for its violation.
Hence, it is assumed that listed companies will give this Clause of the Listing
Agreement all the seriousness any law deserves.
Clause 49 contains a myriad of requirements, many of which
are modelled on the UK and US models.
Independent Directors :
A pillar (though unduly emphasised in India) of Corporate
Governance is the concept of Independent Directors. The logic of having
Independent Directors is not far to see. The promoters or management of the
company control a company in most aspects. If there are persons who are not
connected with the promoters and are otherwise unbiased and have no conflicting
interest, they may be able to see the decisions of the promoter or management
from an independent context rather than from the Promoters’ self-interest. Thus,
the requirement of Independent Directors. The issue of the number and proportion
of Independent Directors has generated a lot of debate. Initially, the Western
model was almost blindly copied. However, over a period of time, some changes
have been made to suit Indian conditions. Prior to the recent amendment, and
very broadly stated, the requirement relating to the number of Independent
Directors was broadly as follows.
If the Company had an Executive Chairman, the Company should
have at least one-half of its Board consisting of Independent Directors. If not,
the corresponding ratio should be at least one-third. There are refinements to
these and other requirements and clarifications also, but this aspect is
focussed in this article, since that is the principal subject of the amendment.
Independent Directors to be at least 50% of the Board in case
of Promoter non-executive Chairman :
It is now provided where, even if the Chairman is
non-executive, if he is related or connected to the promoters in the
specified manner, then the ratio of Independent Directors of the total Board
size would have to be at least 50%.
The text of the new proviso creating this requirement is
given below :
“Provided that where the non-executive Chairman is a
promoter of the company or is related to any promoter or person occupying
management positions at the Board level or at one level below the Board, at
least one-half of the Board of the company shall consist of independent
directors.”
This amendment has far-reaching implications. In my view, the
amendment has been unduly glorified by the press and others, and on the other
hand its unfair side has not been seen. There is often a strong taboo in the
minds that as soon as ‘investor protection’ is stated as the intent of a
proposal, it becomes sacrosanct, forgetting for a time that promoters are as
much investors as any other — and more often than not, they hold more than half
of the share capital of a company. However, let us consider various implications
of this amendment.
Who is a ‘non-executive’ Chairman ?
The term ‘non-executive’, though not defined, is well
understood. It is obviously the opposite of a ‘executive’ director. Typically,
an Executive Director is a working director having executive responsibilities,
for example, a Whole-time Director such as a Finance Director is an Executive
Director. An Executive Director generally has his source of livelihood or at
least a material source of earnings from the Company. It would be safe to
conclude, though not so specifically laid down in the Clause, that a
non-executive director is, by definition, not independent.
Who is an ‘independent’ director ?
This term is easy to grasp, but difficult to define. Clause 49 attempts an elaborate definition of this term, but it is not proposed to analyse it here. A simple way to understand it is that an Independent Director should have at least two qualities. He should not be related or connected in specified ways to the Promoters. He should also not have financial or other specified relations with the Company. Thus, it is important to note that he has to be independent not only with regard to the Promoters but also with regard to the Company. To give an example of the latter connection, if he holds 2% or more of the voting shares, he is not an Independent Director.
Chairman – executive, non-executive, etc. :
An analysis of some of the ills in companies in the West showed that when the posts of the Chairman and the Chief Executive Officer were combined and held by the same person, there was undue concentration of power giving scope for misuse and domination of the Board and the Company. Thus, a serious thought was given in Western countries as to how to create a balance to this power centre. The thinking was that if these two posts were combined, there should be sufficient number of Independent Directors.
This concept was also adopted in India and till the recent amendment of April 2008, it was provided that where there was an Executive Chairman, at least half of the Board should consist of Independent Directors.
However, at least as per the Indian Company Law, the Chairman, solely by virtue of this post, has few significant powers. He is more of a titular head. One power sometimes forgotten is that he may have a casting vote and thus, where the votes are equally balanced, he gets an extra vote to settle the decision. However, even this can be easily taken away. Thus, except for certain powers, mostly administrative, he is like any other director and has just one vote on the Board.
Of course, the intangible impact of a Chairman cannot be underrated. Normally, it is difficult to convince the Promoter Group to have an external director as a Chairman. Even the shareholders and others would like to see the head of the Promoter Group as ‘Chairman’. Imagine an Anil Ambani group company without Anil Ambani as Chairman, or the Reliance Industries group without Mukesh Ambani as Chairman, the Tata Group without Ratan Tata and the Baja] Auto group without Rahul Bajaj as Chairman and so on.
Who is a ‘Promoter-connected’ Chairman:
The amendment now places an Executive Chairman at par with a Chairman who is connected with the Promoters or the management.
Under the following circumstances, the Chairman would become, what I have loosely termed as, Promoter-connected Chairman:
- If he is related to any Promoter.
- If he is related to a person occupying a management position at the Board level or one level below the Board.
Some comments and implications of the amendment:
I believe the implications of this amendment could be very far reaching. While I do not have statistics with me, typically, normally a Listed Company in India is promoter-controlled, the Chairman is from the Promoters’ Group. The first implication would be that all these companies would have to get a non-promoter Chairman or increase the number of Independent Directors to at least 50%.
It could be easy and simplistic to comment that, since the Chairman is only a titular head, the Board could simply appoint one of its existing Independent Directors as Chairman and solve the problem. After all, we Indians are supposed to be practical people! However, apart from some factors discussed earlier, prestige, ego and similar issues would also play their role. Hence, the change would require a change in ‘mindset’.
The amendments made by this Circular of SEBI dated 8th April 2008 have been brought forth with immediate force. The Circular of SEBI directs stock exchanges to amend the Listing Agreements to make these changes and no time has been given for making the changes by the companies in their Board. As this article goes to press, though, I could not lay my hands on the notifications of leading stock exchanges such as BSE and NSE amending the Listing Agreement.
Other amendments made by the Circular:
There are a few other amendments made by the said Circular of SEBI. For example, it is now required that a vacancy in the post of an Independent Director should be filled within 180 days. In a way, it is tightening of the norms since apparently some companies used to delay the appointment indefinitely. However, looked at in another way, the amendment now gives a reasonable time of about six months to get a new Independent Director .
There are few other changes including changes in the non-mandatory requirement.
Conclusion:
Listed companies would thus need to consider on how to restructure their Boards to come into line with the new requirements. I would dare comment that many Chartered Accountants will benefit by being appointed as Independent Directors since many companies would still want their Chairman to be from the Promoters Group. However, in other cases, Chartered Accountants also have a chance of being appointed as the Chairman of the Board. This is both an opportunity and challenge to the ‘professionals’, particularly Chartered Accountants.
