Making independent directors count

Natarajan Srinivasan | Updated on July 10, 2020 Published on July 10, 2020

Question time: Independent directors need to bring more to the table   -  istock/PeopleImages

Given the recent scams, they are in the eye of a storm. A separate body under the MCA to oversee their functioning may help

In the aftermath of several corporate frauds and mis-governance witnessed world over, various authorities introduced provisions giving statutory recognition to the position of independent directors in the overall governance framework.. It was believed that a larger say for independent directors in boardrooms would be an effective deterrent to fraud, mismanagement, and mis-governance.

In India, the Companies Act, 2013 not only defined ‘independent directors’ but also codified their duties and responsibilities. Schedule IV of the Act lays down the guidelines for professional conduct, role, functions, and duties of independent directors. The Schedule lists nine specific guidelines, eight actionable items and 13 specific duties to be discharged by independent directors. Section 166 lists seven specific duties for directors.

The Directors’ Responsibility Statement under Section 135 requires an affirmation by directors on the adherence to accounting standards, accounting policies, and maintenance of adequate accounting records for safeguarding of a company’s assets and prevention of frauds, adequacy of internal financial controls, and their effectiveness and compliance with applicable laws. The Listing Regulations exhaustively list out the specific responsibilities of the directors.

If one looks at the exhaustive duties and responsibilities enshrined under the Act and under the regulations, one gets a feeling that that the legislation has done its part more than adequately. It is only the implementation, adoption and compliance by the various constituents that have led to gaps.

Being an independent director is no more an easy task. The law casts onerous duties, obligations, and responsibilities on directors and collectively on the board. To comply and discharge the several responsibilities one needs a thorough understanding of the provisions of law and the various regulations. These can be acquired only by a combination of formal training, experience, and knowledge sharing. Further, in practical working, several challenges do arise. Some instances are: (a) Directors face difficulty when a company has conflicts with society or the public at large. This happens when their working or the company’s products/services create an issue with the interests of the public

b) Since promoter-shareholders have a strong say on the selection of independent directors, how can they function with independence and effectiveness at the board qua promoters?

c) Access to information remains in the hands of the promoters and the KMP (Key Managerial Personnel) reporting to them, which makes it challenging for independent directors to exercise independent judgment.

Despite the rigour in the legal framework, corporate mishaps continue to happen — the recent ones being the PNB fiasco, IL&FS, DHFL, PMC Bank, CG power, and sudden collapse of Jet Airways. These have shaken the confidence of the market participants, regulators and other stakeholders. A soul searching is on as to how these failures continue to occur.

The problem and solutions

What could be seen across these cases are lack of integrity and fraudulent practices. Again, majority of the cases are in the financial sector, which are regulated and classified as systemically important companies.

How did they escape the several layers of checks and balances — namely, the professionals or the management running the company independent of the promoters; the audit and risk committees; the internal auditors; the statutory auditors; the board; and the regulators wherever applicable.

Obviously, what has been done in terms of regulations and supervision do not appear to be enough and at least till such time the system gets established and well oiled, micromanagement appears to be the need of the hour. The recent regulation calling for mandatory registration of independent directors and prescribing a qualifying examination for them are in the right direction.

While this may be a beginning, many other things may have to be put in place. Here are some thoughts:

Strengthening of the audit committee, risk committee and the nomination and remuneration committee may only mean the independent directors chairing/manning them need to be strengthened. The eligibility, role responsibility, and the authority of the independent director need to be reformed/ strengthened.

There need to be separate regulations governing the entire functioning of independent director.

Currently, the rules/regulations relating to the eligibility and appointment of independent director are the same for all applicable companies. This will have to change. Companies in the financial sector need to have a stronger criterion; systemically important companies need to have a different set of independent director ; again, larger companies in terms of size, complexities need to have a different criteria for choosing and appointing independent director . These will have to cover key managerial personnel as well.

Independent directors, to be effective, should possess knowledge of the regulations, working of the company and the ability to speak out. A formal authority to help independent director to speak out is necessary. Training to acquire the skills shall be made compulsory.

I would list 10 criteria based on which the independent directors need to be rated. The rating once obtained are not sacrosanct but has to be reviewed by a specially constituted body.

The remuneration structure for independent director need to be overhauled providing for differential remuneration as per grade in the regulations. Remuneration shall be commensurate with the responsibility and liability to which independent director are exposed. If this is not addressed, quality directors will cease to be available.

A separate body needs to be constituted under the Ministry of Corporate Affairs to oversee the functioning of independent director. The funding required can be collected as an annual cess and subscription from the corporate sector.

Hopefully, more involvement and micromanagement will deliver the desired results. We will need a large number of competent independent directors to meet the demand of the next decade to man several positions from companies to trusts, NGOs, and organisations where public interest is involved.

The writer is a senior management professional

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Published on July 10, 2020
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