Making directors truly independent

Sometime back, a promoter of a leading group asked me, “I urgently need two names for independent directors. Can you suggest?” I immediately came up with two names. Pat came the next question: “I hope they will toe my line and not ask any uncomfortable questions in board meetings?” I was stumped, and after a pause, said: “I withdraw the two names and you may kindly source them elsewhere.”

The above conversation effectively sums up the journey of independent directors (IDs) in the past few years. While the law and the related regulations are clear in terms of providing the framework and the direction, the problem is clearly in the manner of implementation. The vexatious issue of law vs spirit stared at our face in most cases where IDs got appointed.

The recent Consultation Paper floated by SEBI comes at the right time and has in all fairness suggested a course correction in the process of appointment of IDs worthy of serious consideration, but it also requires all stakeholders to come together to make it work.

The paper states that the present system of appointment of IDs is influenced by promoters and, therefore, hinders the independence of the IDs in question and undermines the ability of the ID to differ with the promoter, especially in cases where the interests of the promoter and minority shareholders are not aligned.

In effect, the role of the ID is to protect the interest of all stakeholders, notably the minority shareholders. Hence the proposal is to give the minority shareholders a greater say in the process of appointment and reappointment of IDs. The suggested model is a two-step process or a “dual approval” model. The said ID, after the approval of the board, has to pass the test of an ordinary resolution of all shareholders and thereafter pass the test of majority approval of the minority shareholders other than the promoter group shareholders.

If either of the approval thresholds are not met, the appointment of ID fails. The paper has suggested alternative modes on how to deal with situations if the ID appointment fails but that is not the subject for the present discussion.

Pros and cons

The thrust of the proposal is to squarely deal with the issue of dealing with minority shareholders and making them the centrepiece for appointing IDs.

To that extent it has served its purpose. History has documented several instances where minority shareholders have blocked several laudable initiatives of companies, thereby thwarting progress and development.

Recently, a group of shareholders voted out the appointment of a director representing a private equity (PE) investor on the ground of lack of adequate attendance at board meetings. A spate of corporate failures and scandals have raised questions on the role of IDs in not playing the watchdog role, notably in the areas of related-party transactions and diversion of funds.

In effect, the interests of minority shareholders were not protected in such cases. There is a palpable fury and pent-up anger amongst a sections of minority shareholders. It should not be the case that for the above reasons the majority of the minority shareholders negate the appointment of a meritorious ID for whimsical reasons and spoil the career of the ID in question. And this at a time where the supply of quality IDs is inadequate to fill up the increasing demand.

All said and done, for someone whose appointment is being questioned and nullified in public domain, there is a social stigma which is difficult to erase at least in the short term. The issue is to strike the right balance and attain the realms of proportionality so vital to make this institution of IDs succeed in the interest of all concerned.

While there is no doubt that promoter appointed and aligned IDs have been generally found wanting in discharging the statutory duties cast by the regulations and the code of conduct, by involving the minority shareholders in the process has the downside of swinging to the other extreme, which could have dangerous ramifications.

. While no doubt this course correction must be tested in right earnestness, it is imperative that all the players in the arena cooperate to make it succeed. If this experiment fails, and hopefully it should not, then the only recourse is to have a central panel of prospective IDs selected the regulator and allotted to the respective companies. One hopes the regulator is not driven to this extreme step of taking over the responsibility of appointing IDs.

The writer is a chartered accountant

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