More Independence for Independent Directors

INTRODUCTION 

The Securities and Exchange Board of India (SEBI) has recently proposed changes to the rules pertaining to appointment, eligibility, removal and remuneration of Independent directors (IDs). IDs are directors who do not have any monetary relationship with the company or persons related to it (except sitting fee). An independent directorial board is crucial to keep a check on the executive action of the company. IDs are appointed to prevent biased decisions or decisions influenced by material or other factors. The presence of IDs therefore becomes important to ensure the interests of small and minority shareholders. However, overtime it has been felt that the independence of IDs has been compromised due to factors like executive influence or bias towards promoters. In order to make sure that IDs are actually independent and can work without undue influence these rules have been proposed. The rules include additional safeguards for the minority shareholders like dual-approval system where a separate approval from the minority shareholders is required. There are also provisions for “cooling off” period which specify the required time for which an ID has to wait to join another board of directors after resigning from one. A longer cooling off period has been specified for those persons to be appointed as IDs who are either employees of promoter companies or relatives of such employees. Changes have also been proposed to their remuneration structure by allowing payment through long term stock options. Overall efforts have been made to ensure that any kind of pecuniary, personal or any other sort of influence over the IDs is minimized. 

To ensure complete independence of the IDs, the SEBI regulation proposes that persons who have been employees or have been key managerial personnel (KMPs) or if their relatives have been KMPs, listed entity / its holding company / subsidiary / associate company in the past 3 years should be excluded from acting as independent directors. Currently, the Regulation provides for a cooling off period in case the members fall under any two of these categories. There is a cooling off period of 3 years if the person sought to be appointed has been an employee  /  KMP  or  his  /  her  relative  has  been  a  KMP of  the  listed entity. The proposal by SEBI is to uniformise the cooling period and make it 3 years across the board.

The consultation paper has also proposed a dual-approval approach to the process of appointment and re-appointment of Independent Directors. The process would now require approval from both the shareholder and minority stakeholders which would include shareholders  other  than the promoter and promoter group. If the approval fails, a new candidate can be proposed or the same candidate can be proposed. However there needs to be a cooling off period of 90 days. The approval in this case  shall  be  through  special  resolution. Notice shall also be given to shareholders which will  include reasons  for proposing the  same  person despite not getting approval of the shareholders in the first vote. Under the existing process, the Nomination and Remuneration Committee (“NRC”) makes a suggestion as to who could be appointed as an ID. Subsequently, shareholders approve the appointment through an ordinary resolution (special resolution in case of re-appointment). The dual approval process has been proposed keeping in mind the interests of minority shareholders and to reduce the influence of promoters on IDs. This system would provide the IDs with the authority to intervene in case the interests of the promoters and minority shareholders are at odds. Similar to appointment, the removal process of an independent director is prone to influence by the promoters. Modelled on the lines of greater involvement of minority shareholders, a dual-approval process is proposed for the removal process as well.

The proposed regulations also seek to enhance and bring more transparency to the role of the Nomination and Remuneration Committee (NRC). It proposes to introduce a change in the composition of the NRC by including  2/3rd of the board as IDs  instead  of the current majority (1/2) of IDs. The proposed regulation seeks to lay down criteria for shortlisting the candidates. The candidate must have a balance of skills, knowledge and experience on the board. It also provides that disclosure must be made to shareholders which explain qualifications of the proposed person and how they fit the criteria. Drawing from this process, the proposed regulations also seek to reduce the time gap between appointment of the independent director and approval of shareholders. This again proves to be a threat to interests of the minority shareholders. It is hoped that reducing this gap will also give more say to the shareholders. The regulation further provides that in case there is a vacancy, the approval of shareholders must be secured within 3 months. 
With respect to resignation of IDs the current stance of law is such wherein there is lacunae in the disclosures. IDs usually resign due to reasons which could range from being occupied with commitments to reasons personal to the ID. The proposal seeks to put forth a solution for the same by making the letter put forth by ID while resigning available. Additionally, a “cooling-off period” is proposed. Such steps are truly commendable while trying to reduce compromising of independence of IDs. 

The proposed regulations also propose changes to the composition and working of the audit Committee. The Audit Committee plays an important role in terms of the financial matters. Keeping this crucial aspect in mind, the audit committee is composed of two-third Independent Directors and ⅓ Non-Executive Directors who are not related to the promoters. 
In accordance with the prevalent law with respect to the remuneration paid to the Independent Directors, they are paid through sitting fees as well as commission linked to profit. Currently, they are not offered any kind of stock options. This is done with the view to retain the independence of IDs. The paper debates alternatives of how remuneration should be given. The idea of providing Employee Stock Options (ESOPs) to the independent director could reduce conflicts and get IDs to commit for a longer period of time.  

Bringing about any of the changes would require introducing changes to the Companies Act. Therefore, this document is being circulated for public comments. With the public comments and the analysis, SEBI will then make recommendations to the Ministry of Corporate Affairs.

Thus, to conclude the SEBI’s regulations related to independent directors is an effort to protect minority shareholders. The different changes made such as the “cooling off ” period for an ID to join another board after resigning from one board, the dual approval approach for appointment and removal which needs approval from both the shareholder and minority stakeholder are potentially good steps. This regulation also tries to bring more transparency to the NRC and tries to enhance the process followed after. It also brings a change in the composition and working of the Audit committee. Further, the possibility of the ESOPs has been introduced through the paper. Thus, all these regulations are made as an effort to minimize any and all influences related to the job of the IDs.

SEBI is seeking feedback on these provisions until 2nd April 2021, share your views with SEBI: Click Here

By 
Vaibhav Yadav, Kopal Mital,  Arushi Sethi, Rajvi Sanghvi, and Ghanavi, Research Fellows at Civis