Background
The Securities and Exchange Board of India (SEBI) has issued
a Guidance Note on Board Evaluation on 5th January 2017. While not
intended to act as interpretation of the law, it serves as a great and much
needed road map for implementation of several provisions in the Companies Act,
2013, and SEBI Regulations on corporate governance. Auditors have guidance from
the Institute of Chartered Accountants in respect of several areas of their
work and increasingly Company Secretaries have from their alma mater.
However, the Board of Directors and individual directors generally find their
role, obligations and even liabilities having increased manifold but yet do not
have detailed formal guidance as to how they are to carry on their work. This
knowledge gap is felt even more, since most directors may not be well
conversant with the law.
The Guidance Note, to reiterate, does not have a binding
effect. However, I submit that diligent compliance in letter and spirit can be
a good defence in case of action against independent directors by regulators.
Such action can be expected to be manifold considering that corporate governance
is now a law with severe consequences for violations. Indeed, it is possible, I
submit, as also elaborated later, that gross non-compliance of this Guidance
Note could lead to a presumption of violation.
Overview
Requirements of corporate governance earlier were mainly in
the erstwhile Clause 49 of the Listing Agreement. However, now, they are part
of the statutes and indeed they are not only elaborate and detailed but
overlapping too. They are now contained in the Companies Act, 2013 (“the Act”),
and the SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015
(“the Regulations”).
On the subject matter of the Guidance Note, there are
requirements on how the Board, its Committees and its members would be
evaluated, selected, recommended for removal, etc. The requirements of
corporate governance in this sense are intended to be self-regulating. The law
lays down that such evaluation should take place, who should carry out such
evaluation and what should be disclosed in respect of such evaluation. However,
the manner in which the evaluation should be carried out has not been specified
leaving a gap which companies may fill in different ways, some more elaborately
and in detail and some summarily or even perfunctorily. The Guidance Note is
intended to fill this gap to help companies and their boards to carry out this
function.
Requirements of law relating to board evaluation
The law prescribes categories of companies to which the
requirements apply. Some important provisions in such law in relation to Board
evaluation, functions of Board, Committees are as follows:-
1. There has
to be a Nomination and Remuneration Committee. It is this Committee that
carries out functions relating to setting up criteria for selection &
evaluation of Board/Directors and related matters.
2.
Independent Directors are also expected to carry out certain evaluation of the
Board, of non-independent directors, the Chairperson, etc. The
Independent Directors, in turn, are evaluated by the Board as a whole, excluding
the director being evaluated.
3.
Generally, detailed functions of Board are laid down including the manner in
which it will function.
However, as is seen above, the law lays down the basic
structure of who shall perform and what functions shall they perform. How they
should perform is left largely unsaid. The Guidance Note provides these
details.
Aspects covered by the Guidance Note
The Guidance Note covers the following aspects
Subject of Evaluation i.e. who is to be evaluated. This
includes the Board as a collective unit, various Committees, independent
directors, executive/non-executive directors, the Chairman and senior
management.
Process of Evaluation including laying down of objectives
and criteria to be adopted for evaluation of different persons. Depending
on who is to be evaluated, the criteria differs. Thus, the Chairman may be
judged, inter alia, on his leadership qualities. The Board be may judged on how
it performs its strategic functions, how diverse it is in terms of
experience/seniority, cross functional expertise, gender, etc., whether
it allows all members to freely participate, etc. The Independent
Directors would also be evaluated in terms of their distinguishing functions.
Feedback to the persons being evaluated; While the
evaluation may give some clear finding about suitability for continuation or
unsuitability (and hence removal), more often the evaluation may highlight
areas for improvement. Feedback to such persons is helpful.
Action Plan based on the results of the evaluation
process; Post evaluation, a plan would have to be suggested to fill in the
deficiencies observed by training, etc.
Disclosure to stakeholders on various aspects;
This can be critical as evaluation would not only have to be done but seen to
have been done. The law requires that the policy relating to some of the
evaluation parameters should be disclosed in the Board’s Report. However, it
would be up to the Company whether or not the actual results of the evaluation
are disclosed, the action taken on the evaluation, etc. and the Guidance
Note keeps this discretionary.
Frequency of Board Evaluation; The law requires that
the board evaluation has to be done once in a year. The Guidance Note suggests
that this should be a continuous process in terms of regular feedback.
Responsibility of Board Evaluation: As stated earlier,
depending on who is to be evaluated, the person who carries out this evaluation
changes. Obviously, there cannot be self-evaluation as a rule. Indeed, the
person being evaluated is required to be absent when he or she is being
evaluated. There also ought not also be conflict of interest generally. The
Guidance Note places higher emphasis on the Chairman in terms of steering the
process of Board evaluation generally.
Review of the entire evaluation process periodically.
The evaluation process itself needs to be evaluated from time to time! The
manner in which the evaluation is carried out thus requires a periodic review
and improvement.
Internal vs. External evaluation:- Evaluation can be
internal with each group evaluating the other. Internal evaluation has
advantage of familiarity and close observation over extended periods of time.
However, there may be concerns here whether this can result in mutual back-scratching
or even otherwise whether the evaluation is sufficiently
well-informed/professional. External evaluators may not only bring objectivity
but also professionalism as well as experiences from other evaluations.
Evaluation of Committees
The Committees are required to be evaluated in terms of their
constitution, the functions assigned to it, its actual functioning, its
effectiveness in terms of its objectives, etc.
Detailed guide to board functioning
The Guidance Note talks in great detail about the evaluation
of the Board. While this is meant to be a guide to evaluate it, it by itself
serves also as good guidance on how a Board should function. The Guidance Note
throws detailed light on several aspects such as agenda to be circulated
including how early and how detailed, the manner in which discussions take
place and how they are recorded, the role the Board should really play such as
formulating strategy, relation with the CEO and senior management, what role it
should play in risk management, etc. Thus, while serving as a benchmark for
evaluation, it also actually serves as a road map of actual functioning of the
Board.
Consequences of
non-evaluation/non-following of the Guidance Note
The Guidance Note and the covering circular to it of SEBI
clearly specifies that it is intended to provide guidance and is not to be
interpreted as a law. However, consider some consequences of
non-compliance relating to these matters. For example, section 178
(which deals with constitution and role of Nomination and Remuneration
Committee and other matters) has a sub-section (8) that states that in case of
non-compliance, the company is punishable with fine. Further, officers in
default may be punishable with imprisonment upto a year or fine or both. This
may sound fairly serious for a provision relating to corporate governance.
Non-compliance with the SEBI Regulations too has consequences in terms of
penalty and prosecution. SEBI also has powers, and indeed has in the past
applied these powers, to debar persons and has other wide powers too.
It may also happen that wrongdoing in various forms may be
found in a Company. In such an event, the role of every board member would be
examined minutely. If provisions relating to board, directors, etc.
evaluation are not observed, adverse consequences may follow on those who have
defaulted. In such a situation, question will arise whether these provisions
were duly complied with in terms of law.
It is obvious then that the Guidance Note should be taken
seriously. Even if not meant to be a law, it may be a good preliminary
defence of non-compliance if the provisions of the Guidance Note are observed.
Gross non-compliance could be prima facie evidence of violation of the
provisions.
For example, section 178(2) of the Act provides that “the
Nomination and Remuneration Committee…shall carry out evaluation of every
director’s performance”. In context of the Guidance Note, it may not be
sufficient to show that some evaluation was carried out. The evaluation
itself may be questioned if the provisions of the Guidance Note were not
followed and otherwise it was not found to be sufficiently detailed.
Following the Guidance Note may help meet the preliminary onus.
Conclusion
There is criticism, which is valid to an extent, that many
western practices of corporate governance may not have direct application in
India where there is dominant position of Promoters both in terms of large
shareholding and board control. However, even in this context, it is recognised
that corporate governance serves a very valuable purpose. Hence, it is now
implemented not as a voluntary code but as mandatory and comprehensive law. The
liability of the Board, directors generally and, in particular, Independent
Directors, key managerial personnel, is ever increasing. Guidance is thus
needed not just on how they should perform but also, in case of any wrong doing
found, how will their actions – which are often subjective and circumstances
based – be judged.
The Guidance Note serves a good purpose in this.
It will not be surprising if more Guidance Notes will be released in the future
for functioning of other pillars of corporate governance. For example, the role
of the Audit Committee is very important, almost next to the Board itself. A
Guidance Note on how SEBI expects it to function would be helpful as an active
guidance as also a benchmark for defence when things go wrong.
