Fortifying independent directors: Sebi's proposal may fail in practice

One of the unintended fallouts of the Tata-Mistry corporate boardroom battle has been that it exposed the vulnerabilities of independent directors if they happen to be on the wrong side of the principal shareholders. Perhaps taking a cue from this high-profile board-cum-court drama that played out over the last five years, the capital market regulator, the Securities and Exchange Board of India (Sebi), has thrown open for public discussion proposals for fortifying the position of independent directors (IDs).

Key suggestions include: A greater say for minority shareholders in the appointment/removal of IDs through a “dual approval” process; more transparency in the selection process of ID candidates; replace profit-linked commission paid to IDs with employee stock ownership plans to attract fresh talent; a mandatory cooling-off period of one year before an ID can join another board, or transition to a whole-time director position; employees of promoter group companies have to undergo a three-year cooling-off before being appointed as ID.

Most corporate law experts and independent board members agree with the thrust and spirit of the suggestions in enhancing the “independence” of IDs, but concerns remain around practical challenges in implementing these rules.

Greater freedom for IDs to raise their voice brings with it attendant risks. But the regulator’s proposals are conspicuously silent on the directors’ liabilities. There is also a difference of opinion among legal experts on how the stock option-related remuneration component may play out. The impact of these proposals on board dynamics, especially those between IDs and the primary shareholders, remains an uncharted territory in Indian context.

These measures — if they were to come through — would certainly mitigate promoter influence on IDs, said Umakanth Varottil, associate professor at National University of Singapore. On a lighter note, he adds, it may well be that, say, a powerful businessman such as Nusli Wadia’s removal as an ID on various Tata group companies (a direct fallout of the Tata-Mistry melee) could have played out differently if these reforms were to materialise.

The “dual approval” process for IDs exists in several markets, including the United Kingdom. “Our experience in these markets suggests that the process creates an effective safeguard against excessive promoter influence — particularly in cases where directors who have a close affiliation with the promoter group are appointed in independent capacities,” Debanik Basu, vice-president and head of India research at Institutional Shareholder Services, pointed out.

Most experts feel the proposals should help improve accountability of boards, including those of primary shareholders. Shailesh Haribhakti, who is on the board of several blue-chip companies, including L&T Financial Holdings, Blue Star and NSDL e-Governance, said the overarching thrust of the proposals is to find the true definition of “independence”. “Distance from promoters, distance of self and family from the entire ecosystem of the entity, any hint of pecuniary benefits that may influence the future are all welcome elements of independence,” he added.

But this statement comes with a qualification. Though the measures may strengthen IDs’ freedom to act independently, the fact remains that “independence” is a state of mind, Haribhakti pointed out. It will all boil down to what the IDs make of the “freedom” from promoter influence.

Amit Tandon, founder & managing director, Institutional Investor Advisory Services (IiAS), does not expect any dramatic change in the way boards operate, or the way they vote for or against a resolution. “Instances of resolutions being defeated will remain sporadic,” he said. However, he does expect the engagement between companies and investors to pick up, with companies having to explain themselves and their choices.

Experts pointed to certain gaps in the “dual approval” mechanism that Sebi has suggested. The second vote option, which allows for the same independent director to be brought in subject to a special resolution (after initial proposal is rejected), may in practice nullify the potency of the rights being vested in the hands of minority shareholders, said Shruti Rajan, partner at law firm Trilegal. “A lot will depend on how the company utilises the second vote option in practice, and the respect it accords to the minority’s decisions,” she added.

Shriram Subramanian, founder and managing director, InGovern Research Services, thinks dual approval for appointment and removal of IDs will enhance the accountability of promoters to shareholders. It is for this reason that he expects some degree of pushback from India Inc on these proposals, citing compliance overload.

Most experts thought Sebi’s proposal for offering long-term stock option to IDs as part of remuneration package is a positive one. “This would help align the incentives of IDs with that of all the shareholders of the company,” said Varottil, but cautioned that they could create governance concerns if they are improperly designed and implemented.

While most agree that stock options would help attract better talent into the boardroom, they remain divided over how it may play out in the Indian context.

Basu pointed out that such instruments may reduce transparency for shareholders on the remuneration framework for IDs. “It would probably be prudent at this stage to pause on this and have a broader discussion on the full ramifications of long-term awards, before introducing ESOPs for independent directors in the market,” he said.

Tandon is in favour of the introduction of a long-term stock option as part of IDs’ remuneration package with sufficient safeguards. “These could be exercised only, say, 18 months after the ID has stepped down,” he suggested. Subramanian thinks similarly, suggesting that the vesting rights should be exercised only after the end of the term of the ID.

Haribhakti favours retaining an option for 1 per cent cap on ID commission. This may be more appropriate for some multinationals and tightly-controlled companies that may not want a dilution of their equity stake, he said.

Experts point out that the Sebi proposals are curiously silent on aspects of independent director liabilities. “The responsibility cast on IDs is increasing significantly and there will be hesitation on the part of many respectable professionals to walk into situations where the liability is, at the outset, difficult to size up,” said Rajan. He suggested that a good way to plug that uncertainty is to have more clarity around independent director liability.