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New Clause 49: Y2K 2.0

Published on Mon, Feb 24,2014 | 21:57, Updated at Tue, Feb 25 at 22:45Source : Moneycontrol.com 

By: Menaka Doshi, Executive Editor, CNBC TV18

Clause 49 must have seemed like the unanticipated governance version of a Y2K bug that hit corporate India on the turn of the century. It was in 2000 that SEBI amended its Equity Listing Agreement to add a new clause to specify certain corporate governance standards for listed companies. And  thus was born the requirement that half the directors on a listed company’s board be non-executive or Independent Directors. It was in that same circular that SEBI laid out the responsibilities of an Audit Committee, which was to have a majority Independent Directors.  By the year 2003 Clause 49 had become applicable to most listed companies  and had come to include additional features like a non-mandatory whistleblower policy. It’s been a decade since then and while India may not boast of the highest standards of corporate governance there is no denying that SEBI’s first moves ushered in a new era of accountability to all shareholders. It hasn’t been an easy ride…promoter led India Inc. has often put majority owners before the minority, compromised director independence by keeping them on board for decades, reduced audit committees to rubber stamps and used related party transactions to profit. What spirit violated… the law is now trying to fix, albeit in a heavy handed way sometimes. Last year the newly enacted Companies Act, 2013 ushered in new safeguards such as independent director rotation and audit firm rotation. All material RPTs now need approval of a majority of the minority, independent directors have defined duties and responsibilities and a whistleblower mechanism is mandatory for all companies to put in place. So SEBI started the marathon, company law picked up the baton and now it’s SEBI’s stretch again. Earlier this month SEBI’s board decided to revise Clause 49, to bring it in line with the provisions of the Companies Act, 2013. But SEBI could not resist adding a few of its own touches… here’s the list of provisions in the NEW CLAUSE 49 that go beyond the Companies Act, 2013


NEW CLAUSE 49: 2/3rd members of the Audit Committee and the Chairman shall be Independent
COMPANIES ACT, 2013: Audit company must have majority Independent Directors


NEW CLAUSE 49: An Independent Director who has already served on a company’s board for 5 years can serve only one more term of 5 years
COMPANIES ACT, 2013: An Independent Director can serve up to 2 terms of 5 years each.
 
NEW CLAUSE 49: Companies to disseminate Independent Director’s resignation letter to Stock Exchanges & on company website
COMPANIES ACT, 2013: Independent Directors must disclose reason for resignation to the Registrar

NEW CLAUSE 49: A person shall not serve as Independent Directorships on more than 10 listed company boards
COMPANIES ACT, 2013: A person shall not serve as Director on more than 10 public company boards

NEW CLAUSE 49: Every listed company must have a Risk Management Committee
COMPANIES ACT, 2013: Every company shall have a Risk Management Policy

NEW CLAUSE 49: Quarterly disclosures of all RPTS
COMPANIES ACT, 2013: --

NEW CLAUSE 49: Sale of shares in all ‘material’ subsidiaries require shareholder approval via a special resolution
COMPANIES ACT, 2013: --

SEBI has released details on the internal and external discussions that led to these changes, I have excerpted the portions that pertain to the changes listed above as well as some other interesting conversations regarding succession and the separation of powers. I have no doubt companies are not going to like these changes one bit…but about that in another column.

6.9 Constitution of Audit Committee
Proposal in the Consultative Paper - To retain the existing provisions in the Listing Agreement regarding the constitution of the Audit Committee.

Provision in the Listing Agreement – Listing agreement provides that two-third members of the Audit Committee and the Chairman of the Audit Committee shall be Independent.

Provisions in the Companies Act, 2013 - The Companies Act 2013 provides for constitution of Audit Committee with majority of Independent Directors.


Recommendation of SEBI - The existing requirements in the Listing Agreement regarding requirements of two-third independent members and independent chairman in the Audit Committee, being stricter than that provided in the Companies Act, 2013, may be retained.

6.11 Mandating maximum tenure for Independent Director
Proposal in the Consultative Paper - To mandate maximum tenure of Independent Directors in line with the provisions of the Companies Act, 2013.

Provision in the Companies Act, 2013 - Section 149(10) states that "Subject to the provisions of section 152, an independent director shall hold office for a term up to five consecutive years on the Board of a company, but shall be eligible for reappointment on passing of a special resolution by the company and disclosure of such appointment in the Board's report.
11) Notwithstanding anything contained in sub-section (10), no independent director shall hold office for more than two consecutive terms, but such independent director shall be eligible for appointment after the expiration of three years of ceasing to become an independent director:
Provided that an independent director shall not, during the said period of three years, be appointed in or be associated with the company in any other capacity, either directly or indirectly.
Explanation.—For the purposes of sub-sections (10) and (11), any tenure of an independent director on the date of commencement of this Act shall not be counted as a term under those sub-sections."

Comments received -Most of the comments received are in favour of the proposal in the Consultative Paper. The details of the comments received for and against the proposal are as under:

Recommendation of PMAC - PMAC recommended that a person who has already served as an Independent Director for 5 years or more in a company as on the effective date of the relevant section of the Companies Act, 2013, may be treated as independent only for one more term of 5 years.
In the event an Independent Director continues on the Board of a company after the above mentioned period, he shall not be considered as ‘independent’ for the purpose of complying with the requirement of ‘minimum number of Independent Directors’ under the Listing Agreement.

Recommendation of SEBI - It is proposed to mandate that an Independent Director shall hold office for a term up to five consecutive years on the Board of a company and shall be eligible for reappointment on passing of a special resolution by the company. Further, a person who has already served as an Independent Director for 5 years or more in a company as on the effective date, on completion of his present term, shall be eligible for appointment for one more term of 5 years only. However, an Independent Director, who completes the term as stated above, shall be eligible for appointment as Independent Director in the company after the expiration of three years of ceasing to become an Independent Director.

6.12 Requiring Independent Directors to disclose reasons of their resignation
Proposal in the Consultative Paper - To mandate Independent Directors to disclose the reasons of their resignation. Provisions in the Companies Act, 2013 - Section 168 (1)of the Companies Act, 2013 states that "A director may resign from his office by giving a notice in writing to the company and the Board shall on receipt of such notice take note of the same and the company shall intimate the Registrar in such manner, within such time and in such form as may be prescribed and shall also place the fact of such resignation in the report of directors laid in the immediately following general meeting by the company:
Provided that a director shall also forward a copy of his resignation along with detailed reasons for the resignation to the Registrar within thirty days of resignation in such manner as may be prescribed."

Comments received - Most of the comments received are in favour of the proposal in the Consultative Paper. The details of the comments received for and against the proposal are as under:
Proposal For Against
Non-executive directors to submit reasons for resignation 19 6

Recommendation of PMAC - PMAC recommended that the Company should disclose to the Stock Exchanges, the reason for resignation of any Independent Director and the same shall be disseminated on the website of the Stock Exchanges. Further, the company shall disclose on its website, the communication sent to the Stock Exchanges and the letter of resignation of
the Independent Director.

Recommendation of SEBI – It is proposed that the companies shall forward a copy of resignation letter of all directors along with detailed reasons for the resignation, as submitted to them, to the Stock Exchanges along with the copy of the resignation letter. Further, companies and the Stock Exchanges shall disseminate the resignation letters along with detailed reasons of resignation of directors on their respective websites.

6.14 Restriction on the number of Independent Directorships
Proposal in the Consultative Paper - To examine whether there is a need to restrict the number of Independent Directorships.

Provisions in the Companies Act, 2013 - Section 165(1) of the Companies Act, 2013 provides that "No person, after the commencement of this Act, shall hold office as a director, including any alternate directorship, in more than twenty companies at the same time :
Provided that the maximum number of public companies in which a person can be appointed as a director shall not exceed ten."
Comments received - The comments received are a mixed response. The details of the comments received for and against the proposal are as under:
Proposal For Against
Whether to restrict number of Independent Directorships 17 10

Recommendation of PMAC - PMAC recommended that a person should not act as an Independent Director on the board of more than five listed companies. Further, in case a person is serving as a Whole Time Director in any listed company, he/she should not act as an Independent Director on the board of more than two listed companies.

Recommendation of SEBI – The Companies Act, 2013 restricts the maximum number of companies in which a person can be appointed as a Director to ten which includes unlisted public companies as well. However, considering the greater time commitment expected from Independent Directors of listed companies, it is proposed to mandate that a person shall not serve as an Independent Director in more than seven listed companies. This is also in line with the Corporate Governance Voluntary Guidelines, 2009 issued by MCA, Further, in view of the considerable time required to be devoted by Whole Time Directors, number of listed companies in which a person serving as a Whole Time Director in any listed company may serve as an Independent Director may be restricted to three.

 
6.15 Risk Management
Proposal in the Consultative Paper - To examine (a) whether risk management be made the ultimate responsibility of the Board or the responsibility can be delegated to the Risk Management Committee or to the Audit Committee and to examine (b) the feasibility of appointment of Chief Risk Officer/Risk Manager for large listed companies and whether more specific parameters/requirements such as framing a risk management plan, its compulsory monitoring and reviewing by a Board/Board Committee and the disclosure thereof to the shareholders at periodic intervals be laid down in the Listing Agreement.

Provisions in the Companies Act, 2013- Section 177(4) of the Companies Act, 2013 states that "Every Audit Committee shall act in accordance with the terms of reference specified in writing by the Board which shall, inter alia, include,—  
vii) evaluation of internal financial controls and risk management systems;
5) The Audit Committee may call for the comments of the auditors about internal control systems, the scope of audit, including the observations of the auditors and review of financial statement before their submission to the Board and may also discuss any related issues with the internal and statutory auditors and the management of the company."

Further, Section 134(3) of the Companies Act, 2013 provides that "There shall be attached to statements laid before a company in general meeting, a report by its Board of Directors, which shall include— (n) a statement indicating development and implementation of a risk management policy for the company including identification therein of elements of risk, if any, which in the opinion of the Board may threaten the existence of the company."

Comments received - Most of the comments received are in favour of the proposal in the Consultative Paper. The details of the comments received for and against the proposal are as under:
Proposal For Against
Laying down specific responsibility of Board for Risk Management
15 9
Constitution of Risk Management Committee 18 6

Recommendation of PMAC- PMAC recommended that the Board should be made responsible for framing a risk management plan for the company and the task of implementing the risk management plan, its monitoring and reviewing may be delegated to a Risk Management Committee in the case of large corporates (based on market capitalization) and to the Audit Committee in other cases. The Committee also recommended that the Board's report to the shareholders should contain a statement on the existence and adequacy of the risk management plan.

Recommendation of SEBI - In line with the PMAC recommendation, it is proposed to mandate that the Board shall be responsible for framing, implementing and monitoring the risk management plan for the company. Further, top 100 listed companies as per market capitalization as at the end of the previous financial year, shall be required to constitute a Risk Management Committee. The Board of such companies shall define the roles and responsibilities of the Risk Management Committee and may also delegate monitoring and reviewing of the risk management plan to the committee and such other functions as it may deem fit.

6.17 Board diversity
Proposal in the Consultative Paper - To examine whether to make the Nomination Committee responsible for ensuring that persons from diverse background and gender are nominated for maintaining Board diversity.

Provisions in the Companies Act, 2013 - Proviso to Section 149(1) of the Companies Act, 2013 provides that such class or classes of companies as may be prescribed shall have at least one woman director. Further draft rules which have been hosted on the MCA website prescribe that all listed companies shall comply with this provision. Page 26 of 159

Comments received - Most of the comments received are in favour of the proposal in the Consultative Paper. The details of the comments received for and against the proposal are as under:
Proposal For Against
Nomination Committee to be made responsible for ensuring Board diversity
22 3

Recommendation of PMAC - PMAC recommended that the Board of a company should be diverse in thought, experience, knowledge,
understanding, perspective, gender and age and this requirement may be included in the Principles of Corporate Governance. The Nomination Committee of a company may be mandated to devise a policy for Board Diversity. It was further recommended that all listed companies must appoint at least one woman Independent Director on their Board and such companies may be given a transitional period to comply with this requirement, say, 1 year for top 100 listed companies based on market capitalisation and 3 years for the remaining companies.

Recommendation of SEBI – Though PMAC has recommended that there should be one woman Independent Director on the Board of the companies, it is felt that such a requirement may not be mandated considering the shortage of sufficient number of woman Independent Directors. There are also concerns that such a requirement may reduce the opportunities for qualified internal women candidates to be elevated to the Board. In view of the above, it is proposed to align the requirement regarding Board diversity with the provisions in the Companies Act, 2013. In line with the PMAC recommendation, it is also proposed to incorporate the requirement of Board diversity in the Principles of Corporate Governance. Further, Nomination Committee may be mandated to devise a policy for Board diversity.

6.19 Succession Planning
Proposal in the Consultative Paper - Board of a listed company to ensure that plans are in place for the orderly succession for appointments to the board and senior management and to examine the viability of mandatory disclosure of Succession Planning to Board/Shareholders at periodic intervals.

Comments received - Most of the comments received are in favour of the proposal in the Consultative Paper. The details of the comments received for and against the proposal are as under:
Proposal For Against
Board to ensure existence of a Succession Plan 23 4
Periodic disclosure of Succession Plan to Board 19 6

Recommendation of PMAC - Companies should ensure existence of a Succession Plan and the same should be periodically reviewed by the Board /Nomination Committee. It was further recommended that existence of succession plan and not the plan per-se should be disclosed in the companies’ Annual Report.

Recommendation of SEBI – It is proposed to mandate that the Board of the company should satisfy itself that plans are in place for orderly succession for appointments to the Board and to senior management. However, Succession Plan or its existence, being an internal management matter and considering the confidentiality involved in the matter and the adverse public comments received for the said proposal, disclosure of the existence of Succession Plan may not be mandated.

6.21 Separating the position of Chairman and that of the Managing Director(MD) / CEO
Proposal in the Consultative Paper- Examine whether there is a need to separate the position of Chairman and MD. Provisions in the Companies Act, 2013 - Section 203(1) of the Act states that "Every company belonging to such class or classes of companies as may be prescribed shall have the following whole-time key managerial personnel,—
(i) managing director, or Chief Executive Officer or manager and in their absence, a whole-time director;
(ii ) company secretary; and
(iii ) Chief Financial Officer :
Provided that an individual shall not be appointed or reappointed as the chairperson of the company, in pursuance of the articles of the company, as well as the managing director or Chief Executive Officer of the company at the same time after the date of commencement of this Act unless,—
( a) the articles of such a company provide otherwise; or
( b) the company does not carry multiple businesses:"

Provision in the Listing Agreement- Clause 49 (i)(A)(ii) of the Listing Agreement states that " Where the Chairman of the Board is a non-executive director, at least one-third of the Board should comprise of Independent Directors and in case he is an executive director, at least half of the Board should comprise of Independent Directors."

Comments received- Most of the comments received are in favour of the proposal in the Consultative Paper. The details of the comments received for and against the proposal are as under:
Proposal For Against
Mandatory separation of the post of Chairman and MD/CEO
13 8

Recommendation of PMAC - PMAC noted that the existing requirement under Clause 49 requires companies to have a higher percentage of Independent Directors in case it has an Executive Chairman. In view of the above, PMAC recommended that a separate post for the Chairman and the CEO may not be mandated. However, concerns were raised that companies are trying to circumvent the requirement of Listing Agreement of not having at least half of the Board as independent by not appointing a permanent Chairman. To address this concern, it was recommended that companies which do not have a Non-Executive Chairman may be mandated to have majority of directors as independent as against the extant requirement of not less than 50%.

Recommendation of SEBI - In line with the recommendation of PMAC, it is proposed that a separate post for the Chairman and the MD/CEO may not be mandated considering the extant provisions in Clause 49 which mandates higher number of Independent Directors in case of executive Chairman. However, it is proposed that the separation of the post of Chairman and MD/CEO may be implemented by companies as a good governance practice. The recommendation of PMAC to have majority of Independent Directors in the absence of a regular Non-executive Chairman appears to be too onerous. It is proposed to address the concern of PMAC by incorporating the provision that Boards of companies which do not have a regular Non-Executive Chairman shall have at least half the board as Independent

6.24 Adopting a wider definition of RPTs
Proposal in the Consultative Paper- To adopt the definition of 'related party' as provided in Ind-AS24 for the purpose of compliance with Listing Agreement requirements.
Provisions in the Companies Act, 2013 - Section 2 (76) of the Act states that “related party”, with reference to a company, means—
( i) a director or his relative;
( ii ) a key managerial personnel or his relative;
( iii ) a firm, in which a director, manager or his relative is a partner;
( iv ) a private company in which a director or manager is a member or director;
( v) a public company in which a director or manager is a director or holds along with his relatives, more than two per cent. of its paid-up share capital;
( vi ) any body corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;
( vii ) any person on whose advice, directions or instructions a director or manager is accustomed to act:
Provided that nothing in sub-clauses (vi) and (vii) shall apply to the advice, directions or instructions given in a professional capacity;
( viii) any company which is—
(A) a holding, subsidiary or an associate company of such company; or
(B) a subsidiary of a holding company to which it is also a subsidiary;
( ix ) such other person as may be prescribed; Page 34 of 159

 
Comments received- Most of the comments received are in favour of the proposal in the Consultative Paper. The details of the comments received for and against the proposal are as under:
Proposal For Against
Adopting a wider definition of RPTs 13 02

Recommendation of PMAC - PMAC recommended that IndAS-24 may be adopted for defining RPTs to maintain consistency.

Recommendation of SEBI – The ownership structure of Indian companies is concentrated. The widespread use of company groups and a number of levels create incentive for abusive RPTs which might violate minority shareholders rights. Prescriptive definition would lead to a mere compliance with the letter of law but not in spirit. Therefore, the definition of Related Party should not only be prescriptive but also highlight control and/or influence. Accordingly, it is proposed to lay down a comprehensive definition which would, inter-alia, cover the salient features of the definition in the Companies Act, 2013 and Accounting Standards. The proposed definition is given at Annexure-V.

6.26 Immediate and continuous disclosures of material RPTs
Proposal in the Consultative Paper - To mandate immediate disclosure of RPTs to Stock Exchanges. Comments received - Most of the comments received are in favour of the proposal in the Consultative Paper. The details of the comments received for
and against the proposal are as under:
Proposal For Against
Immediate and continuous disclosures of material RPTs 20 5

Recommendation of PMAC - PMAC recommended that material RPTs shall be disclosed to the Stock Exchanges on real time basis. It was also recommended that the Audit Committee should decide the policy on materiality which may be more stringent than the provisions in the Companies Act, 2013, and the same shall be disclosed in the Annual Report.

Recommendation of SEBI – Mandating real time disclosures of RPTs may be onerous and pose practical difficulties for the companies to comply with. The fragmented reporting of RPTs may also not serve the desired objective of the investors. Therefore, it is proposed that the companies may be mandated to disclose details of all RPTs on a quarterly basis along with the compliance report on Corporate Governance

6.29 Approval by shareholders for divestment of major subsidiaries
Proposal in the Consultative Paper- To mandate the listed companies to obtain shareholders’ approval, in case of divestment of shares in major subsidiaries. Comments received – Most of the comments received are in agreement with
the proposal. The details of the comments received for and against the proposal are as under:
Proposal For Against
Approval by shareholders for divestment of major subsidiaries
17 7


Recommendation of PMAC - PMAC recommended that listed companies shall obtain shareholders' approval through special resolution for divestment in ‘material’ subsidiaries.

Recommendation of SEBI - In line with the PMAC recommendation, it is proposed to mandate the following:

i) All listed companies shall have a policy for determining ‘material’ subsidiaries and such policy shall be disclosed to Stock Exchanges upon approval or subsequent modification(s) and also in the Annual Report;
ii) Notwithstanding anything contained in (i) above, a subsidiary shall be considered as ‘material’ if the investment of the company in the subsidiary exceeds twenty per cent of its consolidated net worth as per the audited balance sheet of the previous financial year or if the subsidiary has generated twenty per cent of the consolidated income of the company
during the previous financial year;
iii) Divestment of shares in all ‘material’ subsidiaries shall require prior approval of shareholders of the company by way of special resolution

 
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