Independent directors do not grow on trees

WITHOUT CONTEMPT

The Securities and Exchange Board of India (Sebi) has sought public comments on proposed amendments to the law governing independent directors in listed companies. Whether this was aimed at mitigating or adding to the ongoing bark-versus-bite debate is unclear. The widespread debate has participants ranging from eminent commentators to newspaper edit writers.

One can only hope that Sebi gets clear and candid feedback when it actually seeks it, and ultimately, quality feedback is used for proper implementation in law-making.

Of the five proposed amendments to the law on independent directors on which Sebi has sought feedback, only two would make any material impact.

The most important proposed amendment is one that would remove the most glaring iniquity relating to nominee directors of financial institutions. Currently, directors nominated by financial institutions are treated as "independent" regardless of the extent of vested interest of the nominating institution. For all other shareholders, a 2 per cent shareholding is all it takes to make a director non-independent. This obvious unfair position deserves urgent correction.

Another principle that would get endorsed by this amendment is that it is not the shareholding of the individual who is appointed as the director that should matter, but the shareholding of the shareholder nominating him that is relevant. While some consumers of this law are often worried about being in breach of the spirit, others are confident that the law does not go so far as to state that the shares held by the nominating shareholder ought to be taken into account. The proposed amendment would clean this up.

There also seems to be considerable confusion about how the regulator views the concepts of "non-executive director" and "independent director". While the former is a director who does not have a master-servant relationship with the company, the latter would have to conform to the additional stringency imposed on independent directors. By definition, every independent director would have to be non-executive while every non-executive director need not be an independent director.

Currently, if the chairman of the company were a "non-executive director", one-third of the board would need to comprise "independent directors". If the chairman were an executive chairman, one-half of the board would have to comprise independent directors. Sebi has now proposed that if the chairman were not an "independent director", then one-half of the board would need to comprise independent directors. If the chairman were an independent director, only one-third of the board would need to comprise independent directors.

The regulator ought to take into account that there is no requirement of any law for every company to necessarily have a "chairman". Under the law, any director of the board may act as chairman to conduct any board meeting. Therefore, nothing really turns on this amendment for companies that could choose not to have a stated chairman.

However, if a company desires to have a stated chairman and is unable to find an independent director to hold that position, it would need to find even more independent directors to occupy half its board.

The capital market ecosystem has failed to provide independent directors of the quality envisaged for them. There is also an abject lack of infrastructure to protect independent directors from the iniquities in the market system. Recently, a reputed retired Supreme Court judge, who could walk into any multinational board as a top-notch independent director, told me how he would never agree to be an independent director. He would never want to be in a position of having to explain that he was not a person "in-charge" of the day-to-day management, should a creditor prosecute the company for a bounced cheque, or an Enforcement Directorate official send him summons on the company's interpretation of an ambiguous exchange control law.

Insurance products protecting independent directors from liabilities face an enforceability risk. The Indian company law provides that any indemnity given to directors could be void in certain situations. It is only when a claim is actually made under such insurance policies that the defence of insurance companies would become clear. Today, one only meets the sales and marketing representatives of the insurers. Once the lawyers take over, the independent directors could be in for a nasty surprise.

It is very easy to accuse Sebi of being a watchdog that never bites. A watchdog can only stand guard but cannot add to the wealth of the property it protects by itself. Sebi's mandate from Parliament is to also develop the capital market ecosystem. Independent directors do not grow on trees. It is time to address the supply side for independent directors, rather than merely push up demand for them by a legal prescription.

Making laws to respond to noise levels in the media is a course best avoided. Instead, an environment where market intermediaries bravely provide candid feedback is crucial. A true test would be to see how Sebi deals with rampant greenmailing in the capital market, thanks to the reverse book-building process under the delisting guidelines. That too is under review after receipt of public comments.

The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own

somasekhar@jsalaw.com