Submitted By: Akash Gupta
Paper XII Corporate Law Are Independent Directors Truly Independent? The term "Independent Directors" was introduced after the publication of the Kumar Mangalam Birla committee report which resulted into intr introd oduc ucti tion on of clau clause se 49 in list listin ing g agre agreem emen ents ts.. The The comm commit itte tee e mentioned that 'independent directors' are those directors who apart from from rece receiv ivin ing g dire direct ctor ors s remu remune nera rati tion on do not not have have any mate materi rial al pecu pecuni niar ary y relat elatiionsh onshiip or tran transa sac ction tion with ith the the comp compan any y, its management or its subsidiaries which in the judgment of the Board may affect their independence of judgment. Clause 49 also prescribes that Audit Audit Commit Committee tee should should compri comprise se of major majority ity of indepe independe ndent nt directors. With the integration of the Indian economy into the world economy, there is consensus among the corporate leaders that the corporate governance in India should conform to international norms. Barring a few few exce except ptio ions, ns, in Indi India a the the appo appoin intm tmen entt of inde indepe pend nden entt or nonnonexecutive directors has become a matter of mere legal compliance. Most of the companies still function in the same old fashion and the non-executive directors has hardly any say in the management of a company. In most of the companies, hardly any relevant information is passed on to the directors and the meetings of the Board discuss minor and routine matters. The Board meetings are normally held once in three months and that too for 2 to 3 hours only. It is obvious that promoters would prefer to appoint their cronies and faithful persons on their board to have minimum interference interference of the outside directors.
Who is an Independent Director? All All liste sted com compani panie es in Indi India a nee need to compl omply y with with the the Listi sting Agreement which mandates that the number of independent directors shou sh ould ld be at leas leastt oneone-th thir ird d of the the stre streng ngth th of the the Boar Board d wher where e Chairman is a non-executive director or one half where Chairman is an execut executive ive direct director. or. The concep conceptt of indepe independe ndent nt direct directors ors was first first
brought to India by the 1999 Kumar Mangalam Birla committee on corp corpor orat ate e gove govern rnan ance ce.. Thre Three e year years s late laterr the the Nare Naresh sh Chan Chandr dra a comm commit itte tee e gave gave gove govern rnanc ance e more more thou though ght. t. Fina Finall lly, y, in 20 2004 04 the the Narayanmurthy committee affected changes to clause 49 of the listing agree agreeme ment nt.. As it stand stands s toda today, y, the the exis existi ting ng comp compan any y law law has has no mention of independent directors. It's SEBI who defines an independent director as a person who: •
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Has no material pecuniary transactions with the company or its associates. Has no relationship with the promoters or senior management. Has not been an executive with the company in the preceding 3 years. Neither is, nor has been for the past three years, a partner with an audit firm, legal firm or consulting firm to the company. Is not a material supplier or lessee to company. Does not own more than 2% of the company’s shares. Is over 21 years of age.
One One thi third of a liste isted d compa ompany ny's 's dir directo ctors are are requi equirred to be indepe independe ndent. nt. The erstw erstwhil hile e Company Company's 's (Amend (Amendmen ment) t) Bill Bill 20 2003 03 had stat stated ed that that a majo majori rity ty of the the mini minimu mum m seve seven n dire direct ctor ors s of publ public ic companies having share capital in excess of Rs. 5 crore should be independent. The key difference between a non-executive and nonexecutive independent director is that the latter is forbidden to have any pecuniary relationship with the company apart from receiving a sitting fee which at the time of writing that clause was Rs. 5000/- and has since been raised to Rs. 20,000/-.
Why have Independent Directors on the Board? The There re are are seve severa rall dist distin inct ct bene benefi fits ts that that an inde indepe pend nden entt boar board d of directors can bring to a company, ranging from long-term survival to improved internal controls. Independent directors in the board can: • •
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Counterbalance management weaknesses in a company. Ensure legal and and ethical behavi avior at the company any, while strengthening accounting controls. Extend the “reach” of a company through contacts, expertise, and access to debt and equity capital. Be a source of well-conceived, binding, long-term decisions for a company.
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Help Help a comp company any su surv rviv ive, e, grow grow and and pros prospe perr over over time time thro throug ugh h impr mproved ved su succ cces essi sion on plan planni ning ng thr through ough membe emberrsh shiip in the the nomination committee etc.
Inde Indepe pend nden entt dire direct ctor ors s are are ther theref efor ore e also also seen seen as a chec check k on the the management of companies, as an oversight mechanism, apart from the value addition that they bring to board deliberations. This is to ensure that action for wrongdoing by the majority stake holders, who control the management by holding a majority of their own shares, is not hamper hampered. ed. A direct director' or's s fulfil fulfillm lment ent of fiduci fiduciary ary respon responsib sibil iliti ities es requires more than the mere absen sence of bad fait aith or fraud. Repr Repres esen enta tati tion on of the the fina financ ncia iall inte intere rest sts s of othe others rs impo impose ses s on a director an affirmative responsibility to protect those interests and to oversee with a critical eye. The The sh shar areh ehol olde ders rs,, espe especi cial ally ly the the mino minori rity ty sh shar areh ehol olde ders rs,, look look to inde indepe pend nden entt dire direct ctor ors s prov provid idin ing g tran transpa spare renc ncy y in resp respec ectt of the the disclosures in the working of the company as well as providing balance towa toward rds s reso resolv lvin ing g conf confli lict ct area areas. s. In eval evalua uati ting ng the the boar board’ d’s s or management decisions in respect of employees, creditors and other suppli suppliers ers of major major servi service ce provid provider ers, s, indepe independe ndent nt direct directors ors have have a signif sig nifica icant nt role role in protec protectin ting g the stakeh stakehold olders ers inter interest ests. s. One of the mandatory requirements of audit committee is to look into the reasons for default in payments to deposit holders, debentures, non-payment of declared dividend and creditors. Further they are required to review the functioning of the “Whistle Blower mechanism” and related party tran transa sact ctio ions ns.. Thes These, e, esse essent ntia iall lly, y, safe safegu guar ard d the the inte intere rest sts s of the the stakeholders.
Can Independent Directors really direct the Company? The recent Satyam Fiasco has brought this question to many people’s mind minds. s. This This even eventt has has rais raised ed ques questi tion ons s abou aboutt the the inte integr grit ity y of the the boards of many companies in India, even the blue chip ones. It has put light on the system of independent directors in India, and how the Indian concept is impractical. The following points highlight the gaps: •
In India, India, indepe independe ndent nt direct director ors s are handpi handpicke cked d by the promot promoter er himself, who then puts the name to the nominations committee, which the nomination committee of the independent directors then generally approves. If a company truly needs independent directors, they they have have to be nomi nomina nate ted d by the the SEBI SEBI whic which h is a regu regula lato tory ry
authority. If they have a right to regulate, then surely they have a right to even suggest the appointment of certain directors. So, in the case of listed companies, SEBI must have the right to nominate independent directors, and if such legislation is brought in, a lot of people good competent independent people will apply to SEBI and ask for nominations. There are a lot of people who are prepared to work as independent directors and are truly independent because then they'll be accountable to SEBI, and not to the promoter. •
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On the contrary it can be argued that the authority may not be given to an outside party to place a director on a company. There may be some merit in having an approved list which means that the SEBI SEBI could could perhap perhaps s decide decided d that that there there are certai certain n qualif qualifica icatio tions ns which directors need. They could screen them for positive negative attr attrib ibut utes es and and have have a pane panell to say say that that thes these e are are inde indepe pend nden entt direct directors ors that can be on liste listed d compani companies es and let manage manageme ment nt select or the nomination committee select who they want. Then there's the question of how long an independent director can remain independent. Doesn't familiarity breed dependence? There are several instances where independent directors have served for several decades. But that's because currently the law doesn't lay down a limit. All directors are appointed for a term of three years and and when hen the term erm expir pires, they they can offe offerr the themsel selves for for reappointment. The pending company bill seeks to change that by limiting independent directors to a maximum of three terms or nine years, after which they can stay on board but can no longer be defi define ned d inde indepe pend nden ent. t. Nara Naraya yana na Murt Murthy hy,, when when he was was on the the committee of corporate governance, said that independent directors should not function on a board for more than nine years.
Henc Hence, e, it can can be said said that that the the noti notion on of inde indepe pend nden entt dire direct ctor ors s is actually beneficial for a company, but only in concept. The system with which independent directors are appointed and regulated is the major gap that has been put to a harsh test because of the Satyam case. If the the sy syst stem em can can be impr improv oved ed in its its core core and and its its obje object ctiv ive e can can be expanded, there will be a far lower chance of another embarrassment like Satyam ever happening again.