This article has been written by Shubhanshu Singhai, pursuing Diploma in US Corporate Law for Company Secretaries and Chartered Accountants and has been edited by Shashwat Kaushik.
It has been published by Rachit Garg.
“Surveillance for a probe into the credibility and accountability of independent directors” is a topic that is related to corporate governance. The role of independent directors is to make sure that the affairs of the companies are managed ethically and legally. Recently, there has been an increased focus on the credibility and accountability of independent directors, particularly their financial relationship with the company or any other personal affairs. The focus on independent directors has increased due to increased scams and frauds.
The era of scams has raised concerns over the decades after multiple scams that have rippled through the system and economic bones of the country. These bones are considered to be its companies. They are considered the bones of a country because they are responsible for bringing prosperity to the country. But what if they are all involved in scams and fraud?
As we all know, big corporations have a major impact on a country, its people, and its economic policies. So, even a small disturbance in the company can have a severe impact.
To maintain the structure and transparency of the company for its investors and general public, the Companies Act of 2013 has a person named ‘Independent Director’ as mentioned under Section 149 (6) of the Companies Act, 2013.
An independent director is an unrelated person to the company who does not hold any interest in the company and is responsible for looking after the workings of the company without even participating in the daily workings of the company. He is, as his name suggests, ‘independent’ from any external influence, has an advisory role, and consults the company so that it does not do something unlawful that could be harmful in the future.
Who is an independent director
According to the ministry of corporate affairs, an independent director is an outside person who is not related to the people of the company. He is mandatory to be appointed in companies with significant public interest and can give a boost to corporate governance. Independent directors play a vital role in the formation of corporate governance. Though experts still raise questions about the independence of these directors, it is important to strike a balance between them and the stakeholders.
They must be made properly aware of their duties, functions, powers, and expectations of the members or stakeholders so that the company can flourish. While discharging their duties, they must adhere to the Guidance Note on Independent Directors that was issued in the year 2020. This guidance note brought about a few amendments to the SEBI Regulations and the Companies Act.
They are also expected to attend the company’s board meetings and other committee meetings to maintain the quorum in the case of listed companies. Where the company is not listed they are under no obligation to attend such meetings.
Qualifications of an independent director
An independent director should preferably possess appropriate skills, experience, and knowledge in one or more domains of finance, law, management, sales, marketing, administration, research, corporate governance, technical operations, or other domains that are related to the company’s business.
An independent director must be:-
- He/she must be a person of high integrity and must have the required expertise and experience;
- He/she must not be or have any close relation with the promoters or directors of the company;
- His/her relatives must not have any interest in the company’s holdings, subsidiaries, etc. during the immediately preceding two financial years or CFY;
- He/she must not be indebted to company in any way during the immediately preceding two FY or CFY;
Appointment of an independent director
The appointment of independent directors should be made by the company’s shareholders, and they must be very diligent while choosing their directors because they are considered to be the backbone of the company. The independent director could be an Indian or from any other country, but the company appointing an independent director from some other nation must obtain prior permission from the Central Government as mentioned under the Companies Act. However, there are a few terms and conditions attached to the appointment of an independent director who’s not of Indian origin.
Every director of the company must disclose his name, residence, and other particulars as may be listed. The director also has the option to resign from his/her post. When the director has resigned, he has to prove the delivery of such information to the company to discharge him/her from liability.
The Companies (Appointment and Qualification of Directors) Rules, 2014 have authorised the Ministry of Corporate Affairs to maintain a record of people who are willing to work as independent directors, and they can register or add them to the databank at https://www.independentdirectorsdatabank.in/.
After the expiration of the appointment term, the director can be reappointed at the next board meeting if the board is satisfied with their performance and would like to see them function more.
What is meant by accountability and credibility of an independent director
Section 149 in Schedule 4 of the Companies Act, 2013 talks about the code of conduct of the independent director and its duties.
Accountability, in layman’s language, means ‘responsibility.’ Here the term refers to the responsibilities of the director, or we can say “for what an independent director be questioned off.”
Directors’ responsibilities reflect the director’s role in the misconduct and the severity of the problem. Investors are likely to hold those directors accountable who have greater roles in the finances of the company. As they set out the financial structure of the company and are responsible for all the major expenses.
Credibility and accountability go hand in hand. If one of them collapses, the other is questioned. If a person is credible, then only he will get the responsibility, and only after that will he be held accountable in the case of any irregularity.
Credibility can also be called the perception that the independent director is trustworthy, reliable, and capable of taking on the responsibilities that are vested in him. To maintain credibility, a director must follow the code of conduct as per the Act and fulfil all the duties and responsibilities assigned to him.
Scanning of an independent director
Independent directors need to be scanned and checked, whether warranted or unwarranted, and we have learned this from various scams that have happened in the past, like the 2G Spectrum Scam, in which it was found that the independent directors, bureaucrats, and politicians were interested insiders who were responsible for the scam. Later, a probe was started against them. The CAG still doesn’t know the exact figure of the scam, but an estimated figure is Rs 1.76 lakh crore. This scam proved to be the downfall of the Manmohan Singh led government in 2014.
The credibility of the independent directors needs to be checked. Their sources, their contacts, communications, connections, checking for insider trading, and confidentiality must be checked from time-to-time to avoid any hassle. These scans are made on the directors by the company themselves, or by IT authorities, the CBI, etc.
The scanning does not allow getting into the privacy of the director; otherwise, no one will be willing to be an independent director. It should be kept in mind that there should be some kind of-
- Monitoring mechanism that does not hinder the privacy of the directors;
- The scan should done lawfully and should not hinder the privacy of the director;
- The limit for intervention must be clearly prescribed by the Central Government; and
- Their office shouldn’t be meddled with unnecessarily and there should be no secret wires installed in their office for surveillance purposes.
When can there be a probe over an independent director
There are many issues, problems, and reasons that may raise the issue of a probe against the directors of the company; some of them are as follows-
- Insider trading: Independent directors have much crucial information related to the company that can be used to gain an advantage over the people and earn an unfair profit from it.
- Lack of expertise: Independent directors are supposed to have expert knowledge in the fields in which they are in charge; if the director lacks the knowledge or expertise, this may result in wrong decision making by the directors and could land them in trouble.
- Breach of corporate governance norms: Independent directors are expected to comply with corporate governance. If a director fails to follow the norms as listed under various acts (governing companies in India) and is unable to discharge his duties, a probe could be ordered against him.
- Personal interest: If an independent director has any sort of personal interest in the affairs of the company, a probe could be ordered against him.
Some famous scams
- Satyam Scandal: ‘Satyam Computers’ was a jewel of the Indian IT sector. It was the 4th largest IT company in India at the time when the scam happened. Mr. Ramalingam Raju, Satyam’s CEO, took responsibility for the fraud and said that he had overstated the financial records and the revenue of the company. He also added that he had over-stated all the financial figures to make the company look more attractive to investors.
The independent directors were put into question after the probe because they were found handicapped in figuring out the financial frauds running in the company and looked incapable of performing their duties.
As a result of the negligence, several independent directors faced many legal actions, and a new board was constituted by the government to look after the company.
- Yes Banks 2020 crises: In March 2020, India’s leading financial bank faced crises because of which its administration was taken over by the RBI. All the independent directors of Yes Bank were put into question as they were unable to fulfil their duties and were unable to direct the management of the company to work within the necessary protocols.
After this, a new management team was set up by the RBI. Several of its top executives were arrested, including its founder, Mr. Rana Kapoor.
This crisis set up an example of how important it is for the independent director to perform its duties and look after the financial irregularities of the company; if they are unable to perform their duties, then a large chunk of the masses would be impacted by it.
- Nirav Modi Scandal: In this scandal, the employees of the Punjab National Bank issued a fake Letter Of Undertaking (LOU) to Nirav Modi and his company to get the loan from the overseas banks. The LOUs were issued without collateral. The fraud was worth around Rs. 14,000 crore. The negligence and incapability of the independent director were raised as they were incapable of identifying the financial fraud that had been running for years until a foreign bank put a question mark on the authenticity of the LOUs issued by the bank. They were negligent and not capable of performing their duty to scrutinise the finances of the company and could not detect the financial error of such a large amount. This had led to a probe against the independent directors of the company and the removal of most of them.
Independent directors are shown and represented as a non performing asset of the company; they have always been represented as an unnecessary requirement until their main work comes into place. They work like agents of the public in these big corporations and are responsible for creating a non fraudulent environment for business.
Like we have seen in the above cases, negligent and blind eyed independent directors were responsible for allowing such kinds of frauds to commence, and their negligence resulted in widespread losses for the economy. Their small look at those flaws could have made a big difference.
So it is very clear after this article that independent directors may look unnecessary at a glance but are very important for the stability of the company.
- Microsoft Word – Brochet Srinivasan June 2013 SSRN.docx (harvard.edu)
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