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Independent Directors: Role Makeover!

Published on Wed, Sep 11,2013 | 14:57, Updated at Wed, Sep 11 at 14:57Source : Moneycontrol.com 

By: Satyavati Berera, ED & Leader Risk Advisory Services, PwC India

Introduction

The Companies Act, 2013, which replaces more than half a century old law, is a reform oriented, governance focussed and forward looking legislation. While on one hand it confers greater say in governance to the independent directors, one the other hand, it places greater demand on them – in terms of involvement, commitment levels and technical and industry knowledge. In order to make their presence felt and “make it matter”, Independent Directors would need to be agile, proactive, and equipped with industry insights.

Stricter criteria for Independence

While the government has attempted to bring harmony with provisions of clause 49 of listing agreement, there are some striking variations. The new law requires the board of directors to exercise their judgement on whether the independent director is a person of integrity and has relevant experience and expertise. In absence of clearly laid down criteria, it may be difficult to evaluate these attributes and demonstrate compliance. It could result in each company exercising its own judgement which would then become a subject of significant debate. Hopefully, the rules notified by the government would iron out the grey areas and pave the way for induction of talent on the Board   

The criteria of not having a pecuniary relationship, has been extended to relatives as well. Further, prohibiting all pecuniary relationships instead of just the ‘material pecuniary relationships’, would mean that independent directors would no longer be able to take up even small consulting or other engagements as it may adversely impact their independence. Since independent directors are required to make a declaration w.r.t their ‘independence’, it is important for them to be absolutely certain about not having a conflict of interest.

The move to exclude nominee directors from the definition of independent directors is welcome. Independent Directors are supposed to bring in an independent judgment on the affairs of the company, safeguard the interests of minority shareholders and give priority to company’s interest as a whole. But this principle is in danger of being compromised if the director is appointed, under an agreement by a institution or body, as precedence may be given to the interest of the nominating body. Companies having nominee directors would have to look at the composition of their board to ensure that it is constituted in consonance with the new requirements. Right to nominate directors under Joint Venture Agreements would need to be closely looked at.

Code of Conduct

Under the new law, there is an elaborate code of conduct which independent directors are expected to abide by. The code lays down certain broad guidelines like upholding ethical standards of integrity, acting objectively and most importantly devoting sufficient time and attention for informed and balanced decision making. There are certain critical functions entrusted to them – to scrutinise the performance of management and to satisfy themselves on the integrity of financial information and robustness of financial controls and risk management.  The role of audit committee has been enhanced thereby placing greater responsibilities on independent directors. The audit committee will now have to ‘examine’ financials (currently ‘review’) and approve related party transactions (currently they are ‘reviewed’).

By defining responsibilities and duties in a mandatory code of conduct, onus has been placed on independent directors thereby reducing their chance of getting the ‘benefit of doubt’ in case of non compliances. This casts an important fiduciary responsibility on Independent Directors towards investor community and other stakeholders. Discharging this responsibility, would require orientation, knowledge and involvement. To be effective contributors, independent directors have to bring in knowledge, insight and skill, industry expertise; most importantly they have to remain connected. 

Independent meetings and performance evaluation

The independent directors of the company would have to meet at least once in a year, without the presence of non-independent directors and members of management.  Apart from reviewing the performance of chairperson of the company, the meeting shall review the performance of non-independent directors and the Board as a whole. The principle of separate meetings of independent directors is already prevalent in US and UK. The performance evaluation of independent directors shall be done by the entire Board of Directors, excluding the director being evaluated. This report would form the basis of re-appointment. Factors which may contribute to this assessment are attendance and participation in meetings, inputs in deliberations and decision making, communication with senior management, involvement in affairs of the company etc.

An attempt has been made to strike a fine balance by putting in place checks and balances to ensure that empowerment does not lead to unbridled power and authority is exercised with accountability.

Liability

The new law seeks to provide immunity to independent directors and non executive directors by making them liable only in respect of such wrongdoings which had occurred with their knowledge, attributable through Board processes, and with their consent or connivance or for lack of due diligence. Proving due diligence could be a tricky and subjective matter. The shield available to independent and non executive directors would therefore have limited impact and may not completely insulate them.

Nominee directors, despite not being considered as ‘independent’ under the new definition, would nevertheless be eligible for immunity, as long as they are non-executive.

Conclusion

Greater empowerment coupled with accountability of Independent Director is a step in the right direction; one which reflects the government’s resolve to strengthen corporate governance. While earlier, the independent directors had their ‘voice’, in the new regime, they may now have their ‘say’. It is now the turn of India Inc to chip in with concrete action in certain vital areas - selection and onboarding process, training and orientation, dissemination of information to help bridge the gap between expectation and performance. Independent directors are strong pillars of corporate governance which is vital to attract investment and bolster the economy.

(Pankaj Tewari, Senior manager - Risk Advisory Services, PwC India also contributed to this article)

 
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