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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.
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 –
6. What Schedule IV of 2013 Act Prescribes?
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 –
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 –
9. Appointment of IDs & Manner of appointment
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:-
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:-
Additional aspects that need to be kept in view in the cases of IDs
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:-
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.