On 1st of March 2020, the Securities & Exchange Board of India (SEBI) came up with a consultation paper to review the regulatory framework for independent directors (IDs). The existing framework for independent directors includes sections 149, 150 and schedule IV of the Companies Act, 2013 and the SEBI Listing Obligations & Disclosure Requirements (LODR) Regulations. The SEBI has sought suggestions on 8 proposals, here the author shares his thoughts on 3 of them on the appointment, removal and remuneration of IDs and why the proposals are insufficient to further the cause of good corporate governance in India.
Proposed Reforms & Comments
First, proposal number two provides that the appointment of IDs would now require a two tier vote – approval of shareholders and approval of ‘majority of minority’ shareholders. While this is a welcome step to further the independence of IDs, it doesn’t necessarily do so.
This is because firstly, there is no detailed framework in law which provides for how the information is to be reported by Key Managerial Personnel (“KMP”) and promoters to the IDs neither is there any clarity on the power or authority of IDs to access such information as is necessary for them to exercise independent judgment. It is important to note that access to information of the company remains in hands of the promoters and KMPs, it is very easy for them to cut-off the IDs from accessing the same. This information asymmetry hamstrings them from their duty. There is a need for separate regulations to govern the functioning of IDs which can contain provisions like suggestions of ID being included in minutes of the meeting of the board and provide IDs with veto power to reject board proposals which are against the interest of minority shareholders or the company. Secondly, there is a requirement for prescribing different criteria for determining the eligibility and appointment of IDs in companies of different types of companies especially finance companies or those companies which are larger in size and complexity. As per the extant regulations the criteria for eligibility and appointment of IDs is same for all companies. However, since we have seen most of mismanagement in financial sector companies recently like IL&FS, PNB Bank fraud etc., it clearly shows a need for different and more stronger criteria for IDs in this sector. Thirdly, it is high time that regulators clearly draw a line of distinction between the obligations and liabilities (in terms of applicability of civil and criminal laws) of the executive directors and IDs. IDs need to be provided extra motivation and protection so that they are in a position to join or stay on boards and perform their duties diligently. As per the extant regulations it is not clear whether IDs can be subject to penalty or imprisonment for a violation that was made not by them but by accountants, auditors or others members of management. In the PNB fraud case for example, the personal assets of IDs were frozen even though they didn’t take part in the day to day management of the company. If such a stand is taken then the problem is that even if the ID comes to know of some mismanagement, he would prefer not to expose it but rather quietly resign and save himself from potential liability. In this regard, even the clarification from Ministry of Corporate Affairs dated 2nd of March 2020 is not sufficient since it provides for liability of ID if he/she had knowledge or was connivant. Moreover, they should not be assumed to be connivant when they were at best negligent. This is very subjective criteria and would most likely in all cases put the ID in jeopardy. What is being ignored is that IDs meet the board once every quarter and are largely dependent on information provided by board and auditors who in turn are appointed by the company. It is therefore, not possible for them to perform due diligence or any independent enquiry of their own.
Second, point number three of the proposal provides that the removal of IDs would now be subject to a two-tier vote requiring approval of both shareholders and ‘majority of minority’ shareholders. Again, this is a welcome step and would prevent the IDs from being removed at the whims of the promoter like in removal of Wadia from Tata. However, the same is not sufficient as regards the removal of IDs is concerned. This is because firstly, the Nomination and Remuneration Committee (“NRC”) which is entrusted with compulsory evaluation of IDs as per the extant rules provides that the outcome of such evaluation can be kept confidential. However, in the opinion of the author, it is suggested that since listed companies run on public money, the evaluation outcome should be made publicly available. This, is because the outcome of the evaluation decides whether ID should continue the directorship. If its negative then he/she will be removed. Therefore, while considering provisions relating to removal of IDs, SEBI has clearly ignored this aspect. Secondly, the approval of shareholders (in addition to majority of minority) in case of removal of IDs is not really a great idea because IDs exist mainly to protect the interest of the minority shareholders and if in a case, the minority shareholders want an ID to be removed but the other shareholders don’t, then under the current proposal other shareholders can stall the removal of an ID even if doesn’t have support of the ‘majority of minority’ shareholders in the proposed two-tier vote.
Third, as per point number eight, SEBI proposes it could provide ESOPs to revamp the remuneration structure and also would send some suggestions to MCA as the any change in remuneration structure would entail amendment of Companies Act, 2013. While there is a need to revamp the remuneration structure, the current proposal falls short on multiple aspects. Firstly, remuneration should be commensurate with the responsibility and liability to which IDs are exposed. Therefore, it is better if the upper limit on fixed fee of Rs. 1 lakh is removed (SEBI itself has noted this probability in paragraph 4.8.3 but it is not mentioned in the proposal at the end). The effect of this would be to ensure availability of qualified people for the post of IDs. Secondly, the compensation structure should be under the dual control of shareholders and majority of minority shareholders otherwise it would be easy for the shareholders to harass the IDs by setting very less remuneration causing them to resign or a very high remuneration and compromising their integrity. Thirdly, the remuneration structure of IDs can be revised and limited to a cap of 20% of his total income as has been suggested by the ‘Report of the Committee to Review Offences under the Companies Act’ on page 64, point number 18 by way of an amendment to Companies Act, 2013 section 149(6)(c). As the SEBI itself has noted that, in case of amendment, it will suggest changes to the Ministry of Corporate Affairs (“MCA”) in paragraph 4.8.5 of consultation paper, this is one suggestion the SEBI could send to the MCA. Fourthly, while ESOPs are being be allowed, in case they are exercised by the IDs, it could be a viable for a regulation to mandate that the stocks held by the independent directors in the company, should be so held for a certain period of time after the expiry of their term as an independent director. Finally, the SEBI should look into the issue of whether such ESOPs could be misused by way of stock option backdating. This would mitigate risks in relation to insider trading and avoid ID from gaining undue advantage to himself.
As provided throughout the course of the paper, while the SEBI is trying to fill loopholes in regulations relating to IDs, it clearly ignores the larger and more holistic picture and this effort can at best be said to be insufficient for the causing of ensuring good corporate governance in India and ensuring the independence of IDs. With the government focusing more on ease of doing business and foreign investment pouring in the country post pandemic, it is necessary that IDs not be subject to onerous conditions without adequate safeguards and rewards. The current institution of IDs can at best be said to be a toothless tiger.
Author Details: Amar Singh, 2nd year B.A., LL.B. (Hons.) student at Gujarat National Law University, India.