This article is written by Yashasvi Jain pursuing a Diploma in General Corporate Practice. This article has been edited by Ojuswi (Associate, Lawsikho).
This article has been published by Sneha Mahawar.
Table of Contents
Introduction
In 2017 the Securities and Exchange Board of India ( hereinafter SEBI) Committee, Uday Kotak Committee, was formed with the aim of improving standards of corporate governance of listed companies in India. The Committee was requested to provide recommendations on various issues relating to corporate governance. Based on the recommendations provided by the Committee, SEBI released a consultation paper in early 2021 proposing amendments to the Listing Obligations and Disclosure Requirements (hereinafter LODR) Regulations, 2015. The objective behind proposing such amendments was quite clear, to modify the corporate governance structure. The consultation paper examines various proposed amendments to the regulations regulating independent director appointment and removal, along with their responsibilities and remuneration, to bring more transparency into the processes.
While several of the recommendations in that report have been diluted, SEBI approved a set of amendments to the LODR Regulations, in its board meeting held on 29th June 2021 concerning the regulatory provisions related to independent directors. This article aims to analyze the role of Independent Directors post such amendments.
What is an independent director
An Independent Director is a non-executive director of a company who does not have any kind of relationship with the company or any related persons that may affect the independence of his/her judgement. An Independent Director has no hand in the day-to-day activities of the company.
The provisions relating to Independent Directors are contained in the Companies Act, 2013 and the SEBI LODR Regulations, 2015.
Role of an independent director
An Independent Director is the one who acts as a coach or a mentor to the company. The role includes working as a watchdog, one who oversees and improves the corporate credibility and governance standards of a company. They are responsible for ensuring better governance. They also play a pivotal role in risk management for the company, among other things.
SEBI’s latest LODR amendments and the role of independent directors
With these amendments, the impact on corporate governance in Indian companies is yet to be seen; independence is a subjective issue and holds different meanings and parameters, so it can’t be achieved solely through regulations. SEBI has introduced these changes to empower independent directors. The key changes cut across five broad themes:
Eligibility of independent directors
Previously, the LODR Regulations prescribed different cooling-off periods for different eligibility conditions for an independent director (based on the relationship viz. pecuniary relationship or other association viz. KMP/employee/ relative of KMP). Through these amendments, SEBI extended the cooling-off period across all eligibility conditions for a person to be appointed as an independent director to 3 years. It is important to have a uniform cooling-off period to ensure uniformity and ease of compliance with the regulations.
The amendment laid down that KMPs (Key Managerial Positions)/ relatives of such KMPs or employees of promoter group companies, cannot be appointed as independent directors in the company unless there has been a cooling-off period of 3 years. it also highlighted that To establish the independence of the directors it is important to exclude such persons from acting as independent directors. In addition to this, it has significantly reduced the limitations on the relatives of independent directors of a listed company, who are employed in roles other than the KMPs. This means that the provision did not allow the relatives of independent directors to be employed in positions other than the KMPs, in the listed company, or in any organization referenced to the promoters, for a period of 3 consecutive financial years immediately before such proposed appointment, no longer applies.
Appointment, re-appointment, and removal of independent directors
The Kotak Committee on corporate governance recommended that while selecting Independent Directors organizations should map the skills and competencies vital for the board in the context of its business/sector, it was to push companies to think it through while selecting Independent Directors. To perform a detailed assessment of the skills required by the board and ensure that the board’s composition is well suited, including the right set of competencies and complementary skillsets to the board. This focuses on developing a disciplined selection process that focuses on the board’s requirements. The process followed by the Nomination and Remuneration Committee (NRC) lacked transparency, so through these amendments, SEBI necessitates a structured procedure to be run by the NRC and amplifies its function and transparency to ensure that a suitable candidate is appointed as an independent director ( instead of someone simply nominated by the promoter).
SEBI through its consultation paper proposed a dual approval process involving the vote of the ‘majority of minority shareholders. Though this proposal did not go through, the amendments mandated the requirement for special resolutions for appointment, re-appointment, and removal of independent directors. The introduction of a special resolution is aimed at giving a greater voice to public shareholders, including institutional shareholders, who will now need to vote in favor of these resolutions relating to the appointment, re-appointment, and removal of independent directors.
The number of votes favoring the special resolution would have to be at least thrice the number of votes against it. This should help prevent independent directors from being replaced or selected according to the promoters’ whims. Further, it also requires additional disclosures to be made by listed companies, including the names of companies from which the director has resigned, to shareholders at the time of appointment/re-appointment of independent directors. This would throw light on the experience of the director and help the shareholders make an informed decision.
Committees of the Board
The amendment has modified the composition of certain committees of the board. As per the amendment, at least two-thirds of the members of the Audit Committee (AC) and NRC should be independent directors. This strengthens the role of independent directors and gives them more influence and a greater voice inside NRC and the audit committee. In addition to this, it also increases the independence of independent directors from the promoters. Although the proposal to limit the audit committee to directors who are not related to the promoters did not go through, raising the number of independent directors from just a simple majority to two-thirds is a positive step.
By increasing the total number of independent directors in the NRC, SEBI has harmonized the composition of directors in the NRC for listed entities that have issued SR equity shares with entities that have issued equity shares with equal voting rights.
Related party transactions
The role of an audit committee is to review financial statements, scrutinize inter-corporate loans & investments, and valuation of undertakings and assets of the listed entity, wherever applicable. In the case of related party transactions, prior approval of the Audit Committee is mandatory. One of the important amendments concerning related party transactions is that SEBI has mandated the approval of all such transactions only by independent directors on the audit committee. Although the original proposal was to not have any director related to the promoters on the audit committee to enhance the independence of independent directors, the amendments have made it the responsibility of independent directors to approve such transactions.
Remuneration to independent directors
Earlier, concerning both the Companies Act and the LODR Regulations, independent directors were not given stock options. There was a grave requirement to adequately compensate the independent directors for their time and value to the company. While there were concerns that a large remuneration may compromise the independence of ID, lesser compensation may also not attract competent IDs on the boards of the listed entities. In this regard, SEBI referred to the Ministry of Corporate Affairs (MCA), allowing flexible compensation structures while deciding on remuneration for independent directors, which may include ESOPs, profit-linked commission, etc. within the limit of the Companies Act, 2013.
These amendments also mandate the top 1,000 listed entities, by market capitalization, to undertake Directors and Officers Insurance for all their independent directors.
Conclusion
The role of independent directors has often been criticized for being incompetent in recognizing mismanagement, inadequate corporate governance, or even securing the funds of the corporate entity. These amendments were long overdue, to ensure the role, significance, and independence of independent directors in these listed companies. The major step towards this was the modification of the provisions governing the appointment, dismissal, and remuneration of the independent directors.
In the Indian context, where the promoters hold large dominance over the boards, the voice of independent directors is often overlooked or is not strong enough. These amendments appear to be promising in these aspects and bring a significant change. But more importantly, these improvements will direct the independent directors, the boards, and the shareholders to work towards bettering the standards of corporate governance. However, it is still too soon to judge whether these changes will bring any significant improvement in the independence of independent directors and change the corporate governance scenario for these listed companies.
References
- https://www.sebi.gov.in/legal/regulations/sep-2021/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-fifth-amendment-regulations-2021_52488.html
- https://www.sebi.gov.in/sebi_data/meetingfiles/jul-2021/1626155485805_1.pdf
- https://assets.kpmg/content/dam/kpmg/in/pdf/2021/09/firstnotes-lodr-independent-directors-audit-committee-nrc.pdf
- https://www.financialexpress.com/opinion/sebis-new-lodr-amendments-empower-independent-directors-but-allowing-for-a-lead-independent-director-is-crucial/2283723
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