The Truth About Independent Directors
This is a show unlike any other we have done. Because even though it focuses on pet issues of independent directors and corporate governance, it doesn't attempt to judge. Instead today we try and understand the gap between expectations and reality.
The role that shareholders expect independent directors to play and what in reality is the scope of that role. Hello & welcome to The Firm. Today we bring you the truth about independent directors from the perspective of 3 battle hardened veterans - RA Shah, Suresh Talwar and Sougata Ray.
Located in a lane near Mumbai’s Horniman Circle is one of India’s oldest law firms- Crawford Bayley. The over 100 year old firm may have outlived this space but time has not shrunk the stature of its 80 year old Senior Partner.
In the world of commercial law, RA Shah is an institution unto himself and as independent director for more than 30 years, his is a voice that is rarely taken lightly. When I talked to him about board politics his response is careful and yet candid.
Doshi: How have you seen the role of independent directors’ change over the last 30 years?
Shah: Leopard seldom changes its spots. There are promoters dyed in wool who has got the least respect for laws and regulations. They have used the new regulations- the new regime of having an audit committee and independent directors- as an umbrella and a protection, as an excuse and cover for what goes on in some of those companies.
That is why he says he is very selective in his choice of directorships.
Shah: I am mostly involved in multinational companies and their subsidiaries where most strategic decisions are taken extra-territorially in the headquarters of that multinational company concerned and they come up for reporting, ratification and knowledge and information of the local board whether it is the local managing director or whether it is local independent director or other directors.
Yes, the managing director participates in that decision making process when he goes abroad or when they come here but so far the other directors are concerned, their role is rather limited and this is a fact of life which pervades all through multinational companies.
Doshi: Why is it that you have preferred to be on boards of multinational companies? Is it because, as a lawyer, you understand that that in a sense because of all these safeguards that you have spoken about, this limits the potential liabilities that you may have to face? Is it because you have a deep distrust of Indian promoters?
Shah: Let me explain my role. I am mainly involved in industries which are highly regulated; pharmaceutical industry is probably amongst the most regulated industry in India whether it is price control, whether it is in licensing, patents and various other regulatory issues. It requires highly specialized expertise to be able to advice a pharmaceutical company.
So there are few such specialists who have got that expertise in the pharma industry and the same holds good for the chemical industry, companies like BASF, Clarient and so on. FMCG industries like Proctor & Gamble, Colgate and some of the other FMCG companies. Crawford Bayley is the advisor even to Hindustan Unilever on strategic matters like their mergers and acquisitions.
In 2010 Crawford Bayley advised Piramal Healthcare on the sale of its domestic formulations business to Abbott Laboratories for $3.7 billion. RA Shah was then an independent director on Piramal’s board. Crawford Bayley advised Colgate Palmolive, Asian Paints, P&G, Clarient, Pfizer India, Century Enka, Abbott India, Godfrey Philips, Wockhardt, Lupin, Bombay Dyeing and BASF. RA Shah serves as independent director on the boards of all of these companies. This was pointed out by proxy advisory firm ingovern earlier this year in a report that questioned the independence of independent directors.
Doshi: Crawford Bayley, your firm offers legal advisory services to those 13 companies on the boards of which you sit as an independent director.
Shah: Not necessarily always.
Doshi: Do you see this as a position of conflict? How would you respond to flags and questions being raised saying this is not good practice?
Shah: In some of those companies, where there are possible irregularities, if the question is brought to my attention, I would unhesitatingly advice that this is not a good practice. But, often as I mentioned, the CEO and the CFO provides a certificate of total compliance and auditors, the big four are statutory auditors.
There are internal auditors; there is an independent audit committee. I may not be involved in those audit committees of those companies but they all certify that everything is without blemish. So I do not feel either I am doing anything improper, incorrect or I am protecting any wrong doing.
We talked some more, mainly about the proposals in the Companies Bill 2011- fixed tenure, director rotation, no employee stock option plan (ESOPs) and remuneration, a reduction in the maximum number of board position a director can hold and so on.
RA Shah is nonchalant about most of these new curbs. In all his responses, he emphasizes that ultimately governance comes down to individual integrity.
RA Shah: I will not compromise my conscience. I can give you any number of examples in which I have acted as a watchdog for minority shareholders, widows and pensioners. In one company, we had proposal emanating from a large chemical company.
They wanted to pay 30% of the profits of the company as administrative charges to the head office and I put my foot down. I said this is an outlandish arrangement - either you should curtail the scope of your services or you curtail the scope of the fees and I must say that the multinational company was very responsive.
The President of that company attended the next board meeting and accepted our recommendation that the total charge will not exceed 10% of the profit before tax (PBT) of the company. This is only one example which I am giving; there are many examples where we have acted as custodian of minority shareholder and as watchdog. So this impression that this is a collusive arrangement which is not in the best interest of the minority shareholders, I think this is a misconception.
Doshi: So you are not in favour of a mandatory rotation or a fixed term. You would rather leave it up to companies, boards and their shareholders to determine how long an independent director should continue to serve the board?
Shah: I believe firmly that you cannot inculcate character and independence through legislation.
My next stop is at one of India’s youngest law firms - Talwar Thakore & Associates. 73 years old Suresh Talwar is a name partner. Before co-founding Talwar Thakore & Associates in 2007, he was with Crawford Bayley & Company for 30 years. The avid golfer plays it straight when asked about the independence of independent directors. He should know; after all Suresh Talwar has been one for decades.
Talwar: The public now assumes that the independent director is there to protect them in a sense.
Doshi: Isn’t it but?
Talwar: It is but remember, independent directors - the Company’s act says probably it overwrites Clause 49- it says a public listed company shall have at least 3 independent directors. Let’s say we have a board of 9 directors, I am outgunned, I may express my views but 6 directors will overrun me.
The other flaw which I mentioned is there is nothing which says they must attend all the meetings to constitute quorum. It is difficult no doubt but if you were to say that at least there must be 2-3 independent directors at every board meeting but you may have to increase the number of independent directors which again is a tough preposition.
Doshi: If you are 50% of the board and you speak out, then of course, you can very reasonably block a resolution that you believe is not to the advantage of all shareholders.
Talwar: Yes, as I mentioned to you, one voice sometimes can change the course of events and they can mull over it and say okay lets revisit it. We’ll come back to you with a revised proposal. It has happened, I am not giving you instances. But generally speaking when you have these discussions you are in a minority, you will express your views and there are others also.
So you can't ignore their views by saying ‘you are not independent guys’. I was pulling a leg sometime back- black coats and white coats but leaving that aside we have to respect, they are directors. They also hold a fiduciary position not withstanding what the Companies Bill says. I mean ignoring them completely and saying only independent directors will comply with these that means they don’t have to comply with that?
The room bears evidence of his sense of humor. Emboldened I get straight to the point.
Last year proxy advisory firm IIAS recommended that L&T shareholders vote against the reappointment of Suresh Talwar because he is on 55 company boards. That includes 14 listed companies, 33 Indian private companies and 8 foreign companies.
Doshi: Why are you on the boards of 55 companies?
Talwar: It’s come down to 46 but it’s still a huge number. As I explained to you, there are only 14 listed companies and you should ask them what my record of attendance is. How often have I missed any of these meetings. I have paid due attention to all these companies whether it is L&T, Blue-Star, Merck of which I am the Chairman for so many years probably I haven’t missed out a single meeting. So my attendance at these meetings is very good.
Doshi: But how much time are you able to devote to being able to do justice to the several resolutions that come up to the board, understanding what they mean for shareholders, therefore applying your mind to it, you participate in several committees that must take up your time.
So 14 listed companies by itself is a fairly large number and probably sucks up most of the time that you have outside of the fact that you are a practicing lawyer and have a very reputed law firm in Mumbai. Over and above that, you have got 33 Indian private companies; the number may have come down, 8 foreign companies. It is almost like you are probably attending a board meeting everyday.
Talwar: No that’s an impression that I would give by virtue of these numbers but that’s not true. What takes my time away are the listed companies. In these 33 private companies, they are mostly 100% subsidiaries, the meetings are held in my room and they finish in 10 minutes.
Because you need a board of these 100% subsidiaries that you have 2 directors and they come and have a cup of tea, we sign the register, the minutes are recorded, they are sent to the multi-national parent who looks at it, clears it and that’s the end of it. So there is hardly any time spent on those. And on those foreign companies, I have to attend only once a year, the rest of the time it is by video conference or by teleconference.
Doshi: They are all Mauritius based companies based on what is listed here.
Talwar: Exactly, there the law is that you must have one physical board meeting in a year.
Doshi: If you were a shareholder in a company as a private investment of yours and there was a substantial amount of your money invested in a company, would you be comfortable if the independent director on board of that company held 46 board positions?
Talwar: But if these companies don’t have any problems with me being on that board, I don’t think why a shareholder should have any objection.
Doshi: If you were a shareholder?
Talwar: You are right, I am in agreement with that perception, I can't deny that. If I was sitting on the other side, I would say how the hell will he have time? He is a full time partner of Crawford Bayley in those days and now with TTA, how is he managing all this?
But I can say with great amount of pride that I have managed it very successfully. And I want you to check with these companies my attendance. They will tell you that they also sometimes express surprise how I can attend all these meetings.
The conversation moves on to the new takeover code that directs independent directors of the target company to provide a reasoned recommendation on an open offer. Esab India’s Board was amongst the first to implement this when its foreign parent Charter was acquired by Colfax triggering an open offer to Esab’s Indian shareholders. Suresh Talwar was on the Esab independent director committee that recommended…well, nothing. Its report simply said that the offer price is in line with SEBI’s pricing guidelines.
Talwar: That experience was, as I said, it was for the first time we had to do that and we were shocked when we finally found that the prescribed form let us off that easily. As I told you I would have perhaps engaged - someone say corresponding to HSBC and say will you please give us an independent report on the credentials of all facts.
Doshi: But the prescribed form must be a minimum. I am sure, as a group of independent directors, you all could have gone beyond that, engaged an outside party, scrutinized track record of this acquirer and therefore offered a more informed opinion to shareholders as opposed to just tick box.
Talwar: I agree with you and on hindsight I perhaps would have done that but as I said we had limitations of time. The offer was due to opening in a short time and when we looked at it we tried. I personally tried to get it from other jurisdiction but I didn’t get it in time and even now I haven’t got it.
And then we were told that all it requires is validation of the offer price. So we got 3 firms to do that. Elaborate opinions were given to us by those 3 firms confirming that the price range was fine.
Doshi: I was very hopeful when I saw that SEBI adopt that recommendation of the Takeover Regulatory Advisory Committee (TRAC) and made it now mandatory upon independent directors because I though that this will give a) independent directors more voice in a transaction, you keep making the point that we are a minority on a board.
Well now you can make your opinion heard through the advice that you have to offer shareholders or the opinion that you have to offer to shareholder. And b) it would provide shareholder with a little more guidance whether they choose to take it or not.
Doshi: So I was hopeful. Did you feel the exercise lived up to its expectations?
Talwar: No because as I said that form was absolutely useless if you ask me.
Doshi: But why couldn’t you go beyond the form?
Talwar: No we didn’t have the time for it and we did think that we may have to go and get report from a third party because we would have our own limitations. What would we know an American company; they bought over Charter and through Charter, Esab. So it is not that they directly acquired Esab. Charter had a majority.
So we would have probably asked Charter- look you must have made some investigation when you agreed to be taken by them, you would have some report. So again we would have got it from some interested parties. But if the clause was left as that then I would have said look if it is not HSBC, someone equivalent to HSBCs position should give us a report.
Doshi: But you could have gone beyond the prescribed format; so what is it that you all felt hymned in by the prescribed form?
Talwar: No we felt because of the time constraint.
Doshi: Or was it just simply the easier way?
Talwar: Not the easier way otherwise I wouldn’t have tried to contact friends in other jurisdictions.
Doshi: No it’s not just about you. What I am trying to understand is that when you have to put your opinion out there that opinion is going to be held accountable along with you right?
Talwar: Correct yes.
Doshi: Therefore will independent directors prefer to take the easy way out and say ‘alright the form is simple, I have ticked all the boxes, I need to provide some sort of price validation keeping in what the regulatory guidelines are but I am not offering you any further information on whether we can get a better price from another acquirer. I am happy not to offer all this to you because I don’t want to be held responsible for this opinion later at the court of law ever.’
Talwar: Even if I would have expressed an opinion based on information given to us by 3rd party, you can't expect independent directors to know it all. So therefore we would definitely rely on a professional consultant. Effectively we would rely upon the professional consultant’s opinion, isn’t it? Don’t forget there was no competitor inside who was going to make another bid. If there was then of course we would have taken this view.
Doshi: So what you are telling me in many words is that the expectations that outsiders, shareholders, the media have of independent directors are unrealistic.
Talwar: Absolutely. My sincere opinion is that unrealistic because the practicality of corporate life and the way its run it is very different from the understanding of the outside world.
Our final point of view comes from Kolkata. The serene campus of IIM Kolkata houses a fire brand independent director. Professor Saugata Ray was the lone independent director on board public sector undertaking (PSU) company IBP before its merger with IOC and when a committee of government secretaries ignored the swap ratio suggested by independent valuers, Professor Ray stood up for minority shareholders.
Sougata Ray, Independent Director, Professor – Strategic Management, IIM Calcutta:
The concern was not swap ratio per se because the swap ratio is not an exact science how do you arrive at a swap ratio but in the whole process, because the committee of the secretaries are basically the representative of the majority shareholders and the majority shareholders cannot decide what should be the swap ratio. So my concern was that the whole process is not fair and raised my concern on that. In a situation where you are the lone boys and all other directors are representing interest of the majority shareholders, it was voted out.
The professor emphasizes that the incident was not acrimonious and he also takes a kind view of the government flexing muscle than private sector promoters could do so.
Ray: Government, as a majority shareholder, has to look at the larger interest of the public and public sector are the arm for them to satisfy the interest of the majority of the public. Whereas the minority shareholder’s interest is self interest and the precarious situation for independent director is that my heart will say that let’s go with the public interest but my rationality will demand and my role will demand that I have to take care of the interest of minority shareholders which is a private gain but that is what you are promised in because when you are going through the listing, you have promised private shareholder whether individual shareholders or institutional shareholders from anywhere in the world, you promised that this organization will run like a business machine, all decisions will be based on business settlement, not extraneous interest of the nation etc
Professor Ray likes companies to democracy where majority opinion often prevails even if it doesn’t suite everybody. But he has little sympathy for those promoters who use that analogy to defend private gain.
Ray: It’s not their capital alone. You need to understand that there are others who are not majority, they are also contributing. So therefore it is important for the board to take the interest of both the promoters; majority promoters as well as the minority shareholders but the challenge that comes in a disperse shareholding- the role of the board is to keep a check on the executives whereas in context like India where most of the time the board have the promoter directors and many times the chairman also is the promoters or promoter appointed person.
Seeing such a situation and that’s the point I was talking about the independent director’s position is always unequal and they have less power and authority inside the board and therefore aping the Western model is not going to work but now within that if you suppose have a scenario that you do not have any independent directors at all then what happens.