Financial Daily from THE HINDU group of publications
Thursday, Jan 02, 2003
Corporate - Corporate Governance
In the interest of better governance
P. H. Arvindh Pandian
GOOD corporate governance would include an independent board of directors reporting to shareholders effectively. The purpose of constituting such a board is to supervise the management, expand the business of the company and maximise both corporate and shareholder value. The Naresh Chandra Committee, appointed to recommend a defined role of auditor-company relationship, has also examined various issues in respect of good corporate governance.
What follows is a discussion on the role of independent directors in India and the changes required to remove the shenanigans.
Though Clause 49 of the listing agreement defines the term "independent director" effectively, a new definition has been proposed to include a non-executive director who fulfil the following: Apart from receiving remuneration, the director a) does not have any material pecuniary relationship with companies and their promoters, the senior management, and holding, subsidiary and associate companies; not be related to promoters, or management at the board level or one level below the board (spouse and dependent parents, children or siblings); has not been an executive of the company for the last three years; has not been a partner or executive of the statutory audit firm, internal audit firm of the company for at least three years this also applies to legal and consulting firms which are materially associated with the entity; is not a significant supplier, vendor, customer of the company; is not a substantial shareholder, owning 2 per cent or more having voting rights; has not been a director, independent or otherwise, for more than three terms or nine years in any case.
While calculating the number of independent directors, nominee directors of banks, financial institutions, and so on, shall be excluded. However, if an executive in company X becomes a non-executive director in company Y, while another executive of company Y becomes a non-executive director of company X, then neither will be treated as an independent director.
The Committee says that these conditions shall apply only to a listed/unlisted company with paid-up capital and free reserves of Rs10 crore, or a company having a turnover of Rs 50 crore and above for the financial year beginning 2003. The number of independent directors who are to be on the board shall not be less than 50 per cent of its total strength for these companies. However, this norm will not apply to an unlisted public company having less than 50 shareholders and not having any debt from the public, banks or financial institution and to any unlisted subsidiary of a listed company. In any case, nominee directors are to be excluded while computing the percentage of the independent director. The minimum number of directors for a listed company, and to the categories to whom these rules are applicable, shall not be less than seven, of which, four shall be independent directors.
Proceedings of the board meetings reflected in the form of minutes should clearly disclose, apart from the members who are in attendance, the timing of each meeting and the details of the proceedings thereof. In view of the technological advancement, the Committee has recommended the avoidance of unnecessary costs and the holding of board meetings through tele/video conferencing if a director is unable to be physically present but would still like to participate. The signed and confirmed minutes by the directors who attended the meeting through video/tele conferencing shall constitute conclusive proof of their participation. However, an amendment to the Companies Act with regard to this specific but essential feature appears necessary at the earliest.
Apart from various information specifically mentioned in clause 49 of the listing agreement that are required to be placed before the board of directors, the Committee suggests that all press releases and presentations be transmitted to all the board members so as to help the independent director. Another key role of the independent director is being a member of the audit committee of a company.
As regards the three categories of companies to which the various recommendations apply, it has been specifically stated that the audit committee would only constitute independent directors. However, it is not mandatory for unlisted companies having 50 or less shareholders, companies not having debts from institution, banks, and so on, and unlisted subsidiaries of listed companies.
The audit committee should also lay out a charter as to whether its recommendations and advice were discharged and to what extent they have been implemented so as to serve as "action taken report" to the shareholders. It should also give a specific report on adequacy of internal audit, perception of risk and, in the event of any qualification, why the audit committee accepted and recommended the financial statement. Such qualification should also reflect whether it met the statutory and internal auditors of the company without the management and whether such meeting revealed material/significant issues or risks.
Another important proposal is with regard to the current minimum statutory sitting fee of Rs 5,000 per meeting for non-executive directors. A loss-making company should also be permitted to pay a special fee to any independent director, subject to reasonable cap, in order to attract the best of talent to its board. Also, the Committee wants the statutory limit on sitting fees to be reviewed, although it is a matter that should ideally be sorted out by the management and its shareholders.
The single-most important recommendation is that non-executive/independent directors are to be exempted, in the definition chapter of various legislation (particularly the Companies Act, the Negotiable Instruments Act, the PF Act, the ESI Act, the Factories Act, the Industrial Disputes Act and the Electricity Supply Act), from criminal and civil liability. It is also suggested that independent directors be indemnified from the cost of litigation by the company under any of these legislation. This important recommendation should be implemented quickly, the absence of which has been a "deterrent for the best talent to join the board as independent directors".
The Committee has also defined the role of the Centre for Corporate Governance, to be set up by the DCA for training independent directors through various programmes.
The independent directors should compulsorily undergo at least one such training course before assuming responsibility or within a year from the date of becoming an independent director. Directors failing to undergo such training would be disqualified under Section 274(1)(g) of the Companies Act after having been given reasonable notice. However, considering that enough training institutions and programmes might not be available in the initial years, the training would initially cover listed companies only.
The various recommendations, while highlighting the role of an effective independent director, do not saddle him/her with any criminal/civil liability, prosecution, and so on. The report has also brought out a detailed analysis of the relationship of auditor vis-à-vis clients and companies, revamping of the DCA and setting up a Corporate Serious Frauds Office.
These far-reaching recommendations need to be implemented quickly, as this would help improve corporate governance and protect investors' interests.
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