'Paper'ing over the cracks

Independent directors - cats on a hot tin roof

The comparison is odious, but it best explains the situation. The concept of an independent director (ID) is like a fishbone, stuck in the throat, which cannot be easily swallowed or spat out. Unlike in the case of the fishbone, where the intent to deal with it swiftly is unambiguous, the case of the ID is shrouded in confusion and avoidable complexity.

One way that has been found to deal with the problem of the ID is to put out yet another paper for consultation. The armchair commentariat, with their feet firmly in their mouth, will then pronounce on matters of which they neither have had, nor are likely to have, first-hand experience. In this process, the ID has become one of the favourite punching bags of the Regulator, the reader and the reviewer alike.

The Securities and Exchange Board of India’s (Sebi’s) latest consultation paper (the Paper) addresses many matters from birth (appointment) to death (resignation or removal) of IDs. What it mercifully does not attempt to hold forth on is what happens between birth and death, namely, how they conduct themselves in the universe of the boardroom.

The Paper starts with yet another attempt to define the concept of ID. The specific provisions that are sought to be added in the present Paper relate to the restrictions sought to be imposed on Key Managerial Personnel (KMPs) or employees of promoter group companies, to the effect that they cannot be appointed as IDs in the company, unless there has been a cooling off period of three years. The same restriction, for the same period, is proposed to be extended to the relatives of such KMPs. There are two problems with this formulation. Firstly, this restriction applies only to KMPs or employees of promoter group companies. This perpetuates the myth that all promoters and promoter groups ought to be tarred with the same brush of distrust, while proceeding on the assumption that all non-promoter companies are bathed in milk. Secondly, while the restriction applies to KMPs or employees, it is limited to the relatives of “such KMPs”. Presumably, relatives of employees, other than KMPs, can get appointed without being subjected to the said cooling off period.

Having established the nature of the baby to be born, it is now appropriate to look at the process of birth. The background to the proposal states inter alia that “considering that the primary duty of Independent Directors is to protect the interest of minority shareholders, there is a need for minority shareholders to have greater say in the appointment/ re-appointment process of IDs” (emphasis supplied).

A plain reading of the provisions in the Companies Act, 2013 (the Act) and the Sebi Lis­ting Obligations and Disclo­sure (LODR) Regu­lations, 2015 (the Regulations) gives the lie to the statement that the primary duty of IDs is to protect the interest of minority shareholders. Section 166(2) and Articles I and II of Schedule IV of the Act are relevant.

Premised on this misunderstanding is the new proposal stating that the appointment and removal of directors should be subject to “dual approval”, the new element being approval by the majority of the minority (simple majority) shareholders. Minority shareholders would mean shareholders, other than the promoter and promoter group. While the proposal might be seen by some as laudable, at least in theory, it is useful to look at how this will play out in companies where institutional shareholders have far more shareholding than retail shareholders. It is the institutional shareholders who will determine significantly the decisions of the majority of the minority. Recently published figures indicate that while institutional shareholding, especially foreign institutional investor (FII) shareholding, has gone up in the larger companies, the percentage of retail shareholders has gone down. There are no prizes for guessing whether the small shareholder will have any significant voice in determining the appropriateness of a director coming up for appointment or re-appointment. It is also important to note that the large majority of IDs have got elected with more than 95 per cent of the votes being cast in their favour. This clearly demonstrates that at least until now, non-promoter shareholders have not thought it fit to vote in large numbers against the candidates put up by the management/promoter.

If the intention is to ensure that the small shareholders’ voice must be directly heard in the boardroom, the provisions of Section 151 of the Act, which contemplate the appointment of a small shareholder director, could be made mandatory.

The role of the midwife is important in the process of birth, and it is through that lens that we should look at the additional provisions relating to the role of the Nomination and Remuneration Committee (NRC). The objective seems to be to bring in more transparency. The Paper states that “while the law requires NRC to lay down detailed criteria of qualifications and attributes for directors, apparently there is a lack of transparency in the process followed by NRC”.

The present legal and regul­a­tory provisions require the NRC to identify the gaps in skill and experience that are requ­i­r­ed to be filled in the Board. The­­re­fore, the need for additio­nal transparency is not clear. What is necessary is for the NRCs to address, in letter and in spirit, what the Act and the Regulations mandate.

While quite a few specific details have been sought to be provided, one major omission needs to be mentioned. With increasing responsibilities cast on the Board, it logically follows that Board committees will be required to do the deep dive into an increasing number of complex issues. Therefore, it is important that every person being considered for a Board appointment should be willing to serve on one or more Board committees. A survey recently brought out by Excellence Enablers (disclosure — I am associated with the survey) brings out that in the Nifty 50 companies, 40 IDs do not serve on any Board committees, and 45 serve on all Board committees. The resultant asymmetry of information among IDs renders the Board dysfunctional and suboptimal.

The author is Chairperson, Excellence Enablers and Former Chairman, Sebi, UTI and IDBI 

> Tomorrow: ‘Paper’ing over the cracks — Part 2