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Independent Director in Tata Group cos. raises issues on Strength of Independent Directors - An Overview

February 13, 2017[2017] 78 144 (Article)

T.N. Pandey

Ex-Chairman, CBDT


1. Few weeks back, media was agog with the news regarding Tata-Mistry feud and removal of Cyrus Mistry from the position of Chairman and Managing Director in Tata Group Companies because of differences with Ratan Tata, Chairman Emeritus of such companies (who, after Mistry's ouster, assumed charge as Working Chairman). Along-with Mistry, Nusli Wadia, who was an Independent Director (ID for short] in Tata Group Companies since years, was also made to quit from the position of ID because, according to reports, he supported Mistry's case and made allegations of violation of Corporate Governance norms, which was not to the likening of the management of such companies. This incident raises the broader issue whether the institution of 'independent directors' (IDs), introduced to improve corporates' functioning and take care of the interest of various stakeholders in companies has served the intended purpose for which such directors are appointed in the Boards of various companies. No empirical studies, to my knowledge, have been made to evaluate the usefulness of such directors and their roles in the governance of Corporations. Nusli Wadia's incident, however, shows that their roles as watchmen for overall for good governance of the companies can be neutralized by the management. Hence, in later paragraphs, an appraisal is made of the existing provisions relating to IDs in the Companies act, 2013 (referred to as '2013 Act' for short) and SEBI Regulations to find out about their strengths and weaknesses for achieving the objectives for which the same have been enacted/prescribed.

How the need for Independent Directors arose?

2. Focus on 'Corporate Governance' (CG) as the phrase is presently used and understood, attracted attention as an aftermath of Watergate Scandal in the USA. Investigations revealed many irregularities in the functioning, including widespread evil of political contributions and bribing of Govt. officials by several major Corporations. As a result, the Fraud and Corrupt Practices Act, 1977 was passed, containing specific provisions regarding the establishment, maintenance and review of the system of internal control of the corporations. In 1979, the US Securities and Exchange Commission proposed the mandatory reporting of internal financial controls. In 1985, following a series of high profile business failures in the USA, the most notable being the Savings and Loan collapse, the Treadway Commission was formed. The role of this Commission was to identify the main causes of misrepresentation in financial reports and to recommend ways to reduce the incidence thereof. In its report published in 1987, the Treadway Report highlighted the need for a proper controlled environment, independent audit committees and an objective internal audit function. It called for published reports on the effectiveness of internal control and the need to develop an integrated set of internal control criteria to enable companies to improve their control systems.

The Committee of Sponsoring Organizations (COSO) in its report in 1992, stipulated a control framework, which has been endorsed and refined in the four subsequent UK reports, namely, Cadbury, Ruthman, Hampell and Turnbull. While developments in the United States stimulated debate in the United Kingdom, a spate of scandals and corporate collapses in the late 1980s and 1990s led shareholders and banks to express concern about the safety of their investments. With a view to prevent the recurrence of business failures, Cadbury Committee under Sir Adrian Cadbury was set up by London Stock Exchange in May 1991 to draft a Code of Best Practices for the UK Corporations. In its report and associated 'Code of Best Practices published in Dec., 1992, it spelt out the methods of governance needed to achieve a balance between the essential powers of board and their proper accountability.

Studies were conducted in various other countries also on the need of strengthening CG and norms for the same. In the course of various such discussions, the need for IDs in Boards of Directors (BODs) of various companies was felt. It was said that balancing of the persons in the BODs of companies can, inter-alia, improve their governance and in this context, the need to integrate independent professionals in the BODs was emphasized. It was said that the outside directors could be a vehicle for disciplining monitoring and, if necessary, for displacing operating management. The feelings expressed in various discussions on the concept of IDs were that inclusion of outside director is a definite protection against myopia and abuse of power. The exact proportion of insiders and outsiders would depend on circumstances of the company. The principal advantages of outside directors include their capacity to make objective and independent evaluation of company's policies, practices and performance; a fresh approach to problems; more broad and diverse experience.

Indian Expert Committees' views on IDs

3. In India, the issue relating to IDs has been extensively discussed in reports of various Committees such as CII's Task Force, Kumar Mangalam Birla Committee, Naresh Chandra Committee, SEBI constituted Committee on CG under the Chairmanship of N.R. Narayan Murthy, who recommended the definition of the term 'ID' on the lines of Naresh Chandra Committee in a comprehensive way as under:-

An ID means a non-executive director, who:-

*apart from receiving director remuneration, does not have any material pecuniary relationships or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associated companies,

*is not related to promoters or management at the Board level or at one level below the Board,

*has not been en executive of the company in the immediately preceding 3 FYs,

*is not a partner or an executive of the statutory audit firm or the internal audit firm that is associated with the company and has not been a partner or an executive of any such firm for the last 3 years. This will also apply to legal firm(s) and consulting firm(s) that have a material association with the entity,

*is not a supplier, service provider or customer of the company. This should include lessor-lessee type relationships also, and

*is not a substantial shareholder of the company i.e. owning 2% or more of the block of voting shares.

SEBI's decision

4. On the basis of recommendations of various committees regarding IDs, the SEBI issued directive to the stock exchanges to amend the listing agreement to provide for insertion of new clause relating to CG. By virtue of said clause, it was made compulsory for the Board of listed companies to have combination of executive and non-executive directors. The number of IDs would depend upon, whether the Chairman is executive or non-executive.

Implementation of suggestions regarding IDs vide Companies Act & SEBI Regulations

5. Briefly, the various steps taken in this direction are stated in later discussion. The Companies Act, 1956 did not contain any reference to IDs, though discussion on this subject had started when the 1956 Act was in force. This concept for the first time found mention in section 149(6) of the 2013 Act, read with (revised) clause 49(11)(B) of SEBI Regulations.

The concept of ID has been elaborated in sub-section (6) of section 149 broadly to mean –

"(6) An ID in relation to a company means a director, other than a managing director or a whole-time director or a nominee-director –

(a)   who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience;
(b)   [i] who is or was not a promoter or the company or its holding subsidiary or associate company;
  (ii) who is not related to promoters or directors in the company, its holding, subsidiary or associate company?
(c)   who has or had no pecuniary relationship with the company, its holding, subsidiary or associate company or their promoters or directors during the two immediately preceding financial years or during the current financial year;
(d)   none of whose relatives has or had pecuniary relationship or transaction with the company, its holding, subsidiary or associate company or their promoters or directors amounting to two % or more of its gross turnover or total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year;
(e)   who, neither himself nor any of his relatives –
(i)   holds or has held the position of key managerial personnel or is or has been employee of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed;
(ii)   is or has been an employee or proprietor or a partner, in any of the 3 financial years immediately preceding the financial year in which he is proposed to be appointed of –
(A)   a firm of auditors or company secretaries in practice or cost auditors of the company or its holding, subsidiary or associate company; or
(B)   any legal or consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to ten percent or more of the gross turnover of such firm;
(iii)   holds together with his relatives two percent or more of the total voting power of the company; or
(iv)   is a Chief Executive or director, by whatever name called, of any non-profit organization that receives 25% or more of its receipts from the company, any of its promoters, directors or its holding subsidiary or associate company or that holds 2% or more of the total voting power of the company.
(v)   A person, who is not less than 21 years of age and who possesses such other qualifications, as may be prescribed.

6. What Schedule IV of 2013 Act Prescribes?

  Appointment process of IDs shall be independent of the company management;
  While selecting IDs, the Board shall ensure that there is appropriate balance of skills, experience and knowledge in the Board so as to enable the Board to discharge its functions and duties effectively;
  The appointment of IDs of the company shall be approved at the meeting of the shareholders;
  The explanatory statement, attached to the notice of the meeting for approving the appointment of ID, shall include a statement that in the opinion of the Board, the ID, proposed to be appointed, fulfills the conditions specified in the Act and the rules made there-under and that the proposed director is independent of the management.

New Clause 49 is silent on the above aspects covered by Schedule IV.

In order to align the existing Clause 49 of the Listing Agreement with the requirement of new Act i.e. 2013 Act, the revised clause 49 of the Listing Agreement, dealing with Corporate Governance norms has been issued by SEBI.

Saving clause for IDs

7. Notwithstanding anything contained in this Act –

(i)   an ID;
(ii)   a non-executive director not being promoter or key managerial personnel,

shall be held liable, only in respect of such acts of omission or commission by a company, which had occurred with his knowledge, attributable through Board processes and with his consent or connivance or where he had not acted diligently.

ID as per new clause 49 of SEBI's Listing Agreement

9. New Clause 49 of the Listing Agreement applies to listed companies w.e.f. 01.10.2014. Clause 49(II)(A)(1) provides that the BODs of the company shall have –

  An optimum combination of executive and non-executive directors (NEDs)
  With at least one woman director and
  Not less than 50% of the BODs, comprising non-executive directors

9. Appointment of IDs & Manner of appointment

  Appointment process of IDs shall be independent of the company management, while selecting IDs, the Board shall ensure that there is appropriate balance of skills, experience and knowledge in the Board so as to enable the Board to discharge its functions and duties effectively.
  The appointment of IDs of the company shall be approved at the meeting of the BODs and then by the shareholders.
  The explanatory statement attached to the notice of the meeting for approving the ID shall include a statement that in the opinion of the Board, the ID proposed to be appointed fulfills the conditions specified in the Act and the rules made thereunder and that the proposed Director is independent of the management.
  The appointment of IDs shall be formalized through a letter of appointment, which shall set out:-
(a)   the term of appointment;
(b)   the expectation of the Board from the appointed Director; the Board level committee(s) in which the director is expected to serve and its tasks;
(c)   the fiduciary duties that come with such an appointment along with accompanying liabilities;
(d)   provision of directors and officers for insurance, if any;
(e)   the Code of Business Ethics that the company expects its Directors and employees to follow;
(f)   the list of actions that a director should not do while functioning as such in the company; and

The terms and conditions of appointment of IDs shall be open for inspection at the Regd. Office of the company by any member during normal business hours.

The terms and conditions of appointment of IDs shall also be posted in the company's website.

Reappointment of IDs

10. The reappointment of ID shall be on the basis of report of performance evaluation conducted by the Nomination & Remuneration Committee of the Board and the Board itself. As per the guidance note of SEBI with the Circular letter dt. SEBI/HO/CFD/CIR/I/2017/004 dt. Jan., 2017, NRC shall formulate criteria for evaluation of performance of IDs and the BODs. NRC shall carry out evaluation of every director's performance. NRC shall determine whether to extend or continue the term of appointment of the ID, on the basis of the report of performance evaluation of IDs.

Tenure of IDs

11. Sub-sections (10) & (11) of section 149 provides as under:-

*No ID shall have a tenure, exceeding in the aggregate, a period of 5 consecutive years on the Board of a company.

*He shall be eligible for reappointment on passing of a special resolution by the company and disclosure of such appointment in the Board's report.

*No ID shall hold office for more than two consecutive terms, but such ID shall be eligible for reappointment after the expiration of 3 years of ceasing to become an ID.

*An ID shall not, during the said period of 3 years, be appointed in or be associated with the company in any other capacity, either directly or indirectly.

*Any tenure of an ID, on the date of commencement of this Act, shall not be counted as a term.

The rule relating to retirement by rotation will not be applicable in respect of IDs [section 152(6)/(7) of 2013 Act].

Limit of number of IDs

12. Clause 49(II)(B)(2)(2) of SEBI provides that it should also be ensured by a listed company that ID is not an ID in more than 7 listed companies. Further, any person, who is serving as a whole-time director in any listed company shall serve as ID in not more than 3 listed companies. It may be noted that such person, by definition, cannot be ID in the company in which he is a whole-time director.

Resignation or removal of IDs

13. The IDs can cease to be so by resignation. Such a director's resignation does not require company's acceptance. For their removal, it has been provided that they can be removed as per the provisions of section 169 of the 2013 Act, which is the same as in the cases of other directors. Thus, an ID can be removed by an ordinary resolution in the manner prescribed by section 169.

Remuneration of IDs

14. The 2013 Act expressly disallows IDs from obtaining stock options and remuneration other than sitting fees and reimbursement of travel expenses for attending the board and other meetings. Sitting fee can be paid to the IDs maximum upto Rs.1 lac. Profit-related commission may be paid to the IDs but subject to the approval of the shareholders. As per the revised Clause 49, all fees/compensation, if any, paid to IDs, shall be fixed by the BODs and shall require previous approval of shareholders in general meeting.

Guidelines for professional conduct as IDs

15. An ID is expected to:-

  uphold ethical standards of integrity and probity;
  act collectively and constructively while exercising his duties;
  exercise his responsibilities in a bonafide manner in the interest of the company;
  devote sufficient time and attention to his professional obligations for informed and balanced decision making;
  not allow any extraneous considerations that will vitiate his exercise of objective independent judgment in the paramount interest of the company as a whole, while concurring in or dissenting from the collective judgment of the Board in its decision making;
  not abuse his position to the detriment of the company or its shareholders or for the purpose of gaining direct or indirect personal advantage or advantage for any associated person;
  refrain from any action that would lead to loss of his independence;
  where circumstances arise, which make an ID loss his independence, the ID must immediately inform the board accordingly;
  assist the company in implementing the best corporate governance practices.

Evaluation of the work of the IDs by the BODs of the company

16. The SEBI has issued a Circular dt. 5th Jan., 2017 (supra), containing Guidance Note on evaluation of Board, IDs, Committees of the Board, frequency of evaluation, responsibilities in this regard and various other matters connected there-with or incidental thereto. In the present discussion, only the aspects relating to IDs are being considered.

The Guidelines contain various aspects concerning individual directors that have to be kept in view while evaluating their work. These are:-

(a)   Qualifications: Details of professional qualifications of the member
(b)   Experience: Details of prior experience of the member, especially the experience relevant to the entity.
(c)   Knowledge and competency:-
(i)   How the person fares across different competencies as identified for effective functioning of the entity and the Board [the entity may list various competencies and mark all directors against every such competency].
(ii)   Whether the person has sufficient understanding and knowledge of the entity and the sector in which it operates.
(d)   Fulfillment of functions: Whether the person understands and fulfills the functions to him/her as assigned by the Board and the law [e.g. Law imposes certain obligations on IDs].
(e)   Ability to function as a team: Whether the person is able to function as an effective team member.
(f)   Initiative: Whether the person actively takes initiative with respect to various areas.
(g)   Availability and attendance: Whether the person is available for meetings of the Board and attends the meeting regularly and timely, without delay.
(h)   Commitment: Whether the person is adequately committed to the Board and the entity.
(i)   Contribution: Whether the person contributed effectively to the entity, and in the Board meetings.
(j)   Integrity: Whether the person demonstrates highest level of integrity (including conflict of interest disclosures, maintenance of confidentiality, etc.).

Additional aspects that need to be kept in view in the cases of IDs

(a)   Independence: Whether the person is independent from the entity and the other directors and there is no conflict of interest.
(b)   Independent views and judgment: Whether the person exercises his/her own judgment and voices opinion freely.

Feedback, to be provided to the Directors in the process of evaluation

16. Providing feedback to the IDs is crucial for success of Board Evaluation. On collation of all the responses, the feedback may be provided in one or more of the following ways:-

(a)   Orally given by Chairman/external assessor or any other suitable person to –
(i)   Each Member separately
(ii)   To the entire Board
(iii)   To the Committees
(b)   A written assessment to every member, Board and Committees.

The active role of the Chairperson is desirable in providing feedback to the members. If members are not comfortable to open individual assessments, provision for confidentiality may be made wherever possible. For effectiveness of the evaluation, it is essential that the feedback be given honestly and without bias.

Final appraisal and concluding comments

17. Various aspects concerning IDs have been discussed in detail in the foregoing discussion concerning various areas of their work and the role that such directors are expected to play in the functioning of the companies, especially taking care of the interest of various stakeholders, who are in minority and unassociated with the promoters or majority shareholders. The objectives with which such directors have been thought of and about the rules that they are expected to play are noble. The 2013 Act and SEBI Regulations and Guidelines also aim to achieve such objectives. But, real life situations are different than the ideals that are sought to be achieved. Nusli Wadia's removal from the BODs of Tata Group Cos. illustrates that despite voluminous provisions, regulations and guidelines, IDs are not allowed to function in an independent manner and ultimately, the powerful managements get the things done in their way. Actually, the experience shows that the persons, who are really of independent mind or views never get picked for the BODs of the company. The promoters appoint only such persons, who are likely to toe their lines of work and thinking. And also, there are financial allurements given to designated IDs. Company reports in the past have shown that some IDs earned crores by way of commission, besides sitting fees for meetings, which now have been increased to the maximum of Rs.One lakh per meeting and many companies are paying such high fees. The financial allurements, thus, are substantial for being soft with their independence in the process, frustrating the very objectives of such Institution and not making the requisite impact for efficient functioning of the corporate sector that such directors are expected to make. There have been no report of IDs' mentioning about any malfunctioning noticed during the course of their tenures as IDs.

Some suggestions

  Besides the situation, being not very encouraging in regard to the forceful functioning of the IDs discharging the role expected of them and development in Tata Mistry disputes demonstrating this, some suggestions, which are expected to have some healthy impact on companies' functioning are made in the later discussion:-
  IDs appointment is to be approved by the shareholders in general meetings and their reappointments have to be made by special resolutions, but they can be removed by just an ordinary resolution. There seems to be no justification for this discrimination. Hence, their removal also needs to be made by a special resolution. A special resolution requires approval of at least 75% of shareholders, while 50% is needed in the case of ordinary resolution. More stricter norms are necessary for removal of IDs.
  An ID should be prohibited from accepting commission based on profits of the companies along-with non-independent directors. They should be entitled only for the fees for the meetings attended along-with expenses incidental for such attendance.
  A retired bureaucrat should be made ineligible for appointment in a company as ID, which had dealings with the Ministry/Dept. from which he retired. This is not for expressing any adverse views about the persons, but is justified on the principle that one should not merely be honest but also appear to be so.
  The Ministry of Corporate Affairs or BPE should draw up an yearly panel, out of which, companies can pick up IDs in the same manner as C&AG draws up a panel of CAs for audit work.
  The Ministry of Corporate Affairs' annual report should contain a portion, giving details about the good work done by the IDs.


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