SEBI's Proposals on Independent Directors' Framework - Flawed and Complex?

Sebi has recently issued a Consultation Paper for comments from public for amending the regulations related to Independent Directors (ID). The key purpose is to amend the regulations to address the concerns on efficacy of independent directors and to further strengthen the institution of Independent Directors for better governance and protecting the interest of minority / small shareholders.

Salient amendments proposed are as follows : -

Eligibility

Extending the coverage of 3 years cooling period to employees and key managerial personnel of Promoter group companies, holding company, associate company of the listed entity and extend the coverage to relatives of key managerial personnel as well to become eligible for nomination as ID.

  A.   Mechanism of Appointment, Removal and Resignation

      i.  Proposal to introduce a dual approval system of taking separate vote on resolution from minority / small shareholders as is prevalent in Israel or UK.  

     ii.  In the event of rejection of proposed ID by the minority shareholders, a special resolution of general body without any distinction of minority or majority would be sufficient to appoint the person hitherto rejected by minority shareholders by merely giving information of such rejection in the notice of general meeting.

    iii.  Removal of IDs shall also be subjected to dual approval system juxtaposed to currently prevailing system of general body approval by ordinary or special resolution as the case maybe. In case of minority not approving the resolution of removal, the collective general body by special resolution mirroring the system of appointing the ID.

     iv.  NRC to carry out a formal screening of the skills and profile of ID followed by disclosure to the shareholders the basis of the selection and the source of identifying the ID ie private reference, assistance of search agency, proposal by an institutional shareholder etc. Constitution of NRCs is also proposed to be changed by adding the IDs to be two third of the total strength.

     v.  Appointment of IDs will be possible only by general body resolution and interim appointments by Board subject to regularization at the annual general meeting is proposed to be done away with.

     vi. Resignations from office by IDs will be subjected to full disclosure of the letter of resignation and a cooling off period of one year is proposed to be imposed for taking up role as whole time director.

  B.   Reconstitution of Audit Committee

Revising the composition of audit committee by having two third IDs and one third non-executive directors not related to promoter. 

  C.   Remuneration to IDs

Proposing to introduce Esops with vesting after five years and do away the current system of commission on profits.

Comments and Suggestions

While improving the efficacy of IDs is a laudable effort, the amendments proposed would not only give rise to complicating the process and procedure but also pose several practical difficulties in doing business coupled with giving birth to constituting bodies with the agenda of activism elaborated as follows.

  A.   Dual approval from Shareholders

• Firstly, creating a two tier approval system would only give rise to a tacit growth of minority shareholder activism, albeit not intended so by the regulator. If we look at the history of industrial growth, concept of trade union per se looked very noble and worthy of pursuit. However, this very institution caused the death of otherwise flourishing industries when unionism was abused to activism. Today, Sebi is trying to improve the efficacy of IDs without realizing that we already have informal bodies of minority shareholders who constantly cause mischief inter alia seeking personal benefits through private negotiations with the majority shareholders i.e., managing shareholders.  
• Moreover, first stage rejection by minority shareholders would carry no consequence since passing a special resolution would not be difficult for most of the companies and except adding procedural length with space for newspaper columns, the substantive part of being able to appoint the ID rejected by minority carries no more signal of higher efficacy or better protection of interests of minority / small shareholders. The Context of Israel and UK is not comparable to inspire a change on their pattern. In India we must keep the procedures simple while introducing better strength to the institution of ID.    
• It would be enough to subject appointment of all IDs by way of special resolution whether through the annual meeting or a specially convened meeting.

  B.   Selection Criteria and Name Proposal for ID

Business pragmatism would demand that rules are not framed to cause inadvertent embarrassment to proposed IDs.It may not be appropriate to bracket the name of proposer while appointing several eminent personalities superannuating from high public offices or corporations as “known to promoter”. Usage of Search agencies for getting IDs is not very appropriate, since MCA has already created a large pool of IDs data bank. All listed companies are not of same size, stature, shareholding and it makes no sense to prescribe “one size fits all” kind of regulations. IDs cannot become antibodies to the Promoters or managing shareholders and the best system of governance would aim at creating shareholder value rather than dividing the class of shareholders to compulsorily wear a black hat. It would be sufficient to have at least one or two IDs being selected from a random list of ten or twenty options emerging from the pool of database. Why should regulator overlook their own initiatives of setting eligibility test, database of qualifying directors and enlarging the scope of this useful repository?

  C.   Remuneration and Esops

Whereas it is desirable to have the skin of IDs in the game of business and be rewarded by contributing to the wellbeing by long term commitment. However, prescribing a modality of Esop is once again taking the freedom away from the company management. There are large number of listed companies with significantly high percentage of promoter shareholding who are not comfortable with any increase in shareholding. For sake of good governance or providing room to IDs, it would be grossly unfair to dictate terms for remaining listed to issue Esops in lieu of sharing commission on profits. It would be desirable to provide additional option of issuing Esops and leave it to the Shareholders including the respective board of directors to choose their unique method of compensating the IDs. There are some companies where being on the board itself becomes a matter of high prestige notwithstanding any incentive in the form of commission or esop and vice versa. Sebi has no locus –standi to continue to use the power of Listing Agreement to usurp the freedom, prerogative and privileges of board / governing management by being micro prescriptive to emphasize a point.   

Conclusion

Regulation cannot enforce governance and attempting to do so would only translate to either suffocating the ease of doing business by too much of procedural red tape or shift the focus away from the substantive part to birth of undesirable parts of “activism” even leading to corruption. It would be important to keep in mind that over complicating the mechanism to run a listed company would only result in many good companies attempting a delisting. There are many simple and alternative options to add muscle to doing greater justice to the office of independent director while maintaining trust in overall universe of listed companies.