Sarbanes Oxley in India Independent Directors
The term "independent Directors" became a part of the Indian corporate lexicon after the publication of the Kumar Mangalam Birla committee report which resulted into introduction of clause 49 in listing agreements. The committee mentioned that 'independent directors' are those directors who apart from receiving directors remuneration do not have any material pecuniary relationship or transaction with the company, its management or its subsidiaries which in the judgment of the Board may affect their independence of judgment. Clause 49 also prescribes that Audit Committee should comprise of majority of independent directors.
Of late there has been great emphasis in appointing independent directors on the Boards of companies. On the basis of Naresh Chandra Committee Report, in the new Companies Bill introduced in the Parliament, certain provisions have been made in relation to independent directors. These provisions do not define an independent director but only specify grounds which would disqualify a person from being considered as an independent director. The rationale of having independent directors on the Board of a company is with an idea to keep a special eye on the finances of a company particularly through the audit committee.
With the integration of the Indian economy into the world economy, -there is consensus among the corporate leaders that the corporate governance in India should conform to international norms. Once Mr. Rosie Catherwood, director of Dewe Rogerson had said that " while Indian companies were rated high on ability, they continued to suffer from low credibility amongst shareholders. He further mentioned that only multinational and public sector units operating in India have been rated highly on management credibility. While MNCs score for the quality of management that they offer, PSUs are rated highly for the transparency of management."
1.1 Definitions:
According to Kumar Mangalam Birla Committee on Corporate Governance (January 2000) :
“Independent directors are [those] who apart from receiving director’s remuneration do not have any material pecuniary relationship or transactions with the company, its promoters, its management or its subsidiaries, which in the judgement of the board may affect their independence of judgement.”
The Non Executive Independent Director is a person not burdened with the responsibility of administering a business. He is "a director of a company who is not employed full-time by the company, but brought is in as an advisor."
1.2 Relationship with company
An Independent director should first understand his relationship with the company and the shareholders as this relationship is what shapes his roll and responsibilities vis a vis the company and the shareholders. Unfortunately, there is no statutory provision to define this relationship. It is the judiciary which has over a period of time defined the relationship. As early as in 1866, that is about a century and half back, in Ferguson Vs. Wilson, the Chancery Division held that a company though a legal entity, cannot act by itself. It can act only through its directors and as such the relation of a director with the company is that of principal and agent and therefore general principles of law of agency would govern the relationship between the company and the directors. The relationship was further defined in Forest of Dean Coal Mining company case by Chancery Division in 1878 that directors, having been entrusted with the affairs of the company, are trustees of the company and therefore they are in a fiduciary relationship with the company. These judicial pronouncements have been universally accepted and applied all over and now the position of directors' vis-à-vis the company is that they are not only agents but also trustees. This relationship would mean that the directors should always act in the interest of the principal that is the company and in discharge of their fiduciary responsibilities, they cannot benefit at the cost of the company.
1.3 True Independence
This Question always arise that are the independent directors made to only turn up at the board meeting every month, eat the lunch and then leave ?
A critical element of a director being independent is his independence to the management both in fact and perception by the public. In considering the independence, it is necessary to focus not only on whether a director's background and current activities qualify him as independent but also whether he can act independently of the management. In other words, the independent directors must not only be independent according to the legislative and stock exchange listing standards but also independent in thought and action i.e. qualitatively independent. Such qualitative independence will ensure that directors think and act independently without regard to management's influence. Qualitative directors' independence should include the will and ability in terms of knowledge and experience to ask the hard questions required to provide effective oversight and character and integrity in general and especially in dealing with potential conflict of interest situations. When the board determines that the director is independent in character and judgment and there are no relationships or circumstances which could affect or appear to affect the director's judgment'. Such relationships or circumstances would include cases where the Independent director :
Is a former employee of the company or group - the Director will only be treated as independent five years after the employment has ended;
Has a material business relationship with the company either directly, or as a partner, shareholder, director or senior employee of a body that has such a material relationship - the Independent Director will also cease to be independent if he has had such a relationship within the last three years;
Receives or has received additional remuneration from the company beyond the director's fee;
Participates in the company's share option scheme or a performance-related pay scheme;
Is a member of the company's pension scheme?
Has close family ties with any of the company's directors, senior employees or advisors;
Holds cross-directorships or has significant links with other directors via involvement in other companies or bodies;
Has served on the board for more than 10 years; or represents a significant shareholder.
1.4 Role in developing a large Reputed Corporation
A strong board of independent director is possibly one of the best things a company’s management can constitute. Independent Directors, who bring with them a wider experience of industry practices, knowledge of the environment and have access to information, accomplish a vital role. A board with independent director must be the voice of caution, defender of the company’s conscience and a constant challenger to management and the CEO. In times of a crisis it act objectively with the company’s long term interest in mind, not necessarily that of its management. To enable this, its Constituents need a mind of their own and some robust experience to back it. Adding a particular 'name' to the board can add immediate credibility to a company. There is, however, no guarantee that all 'big-name' non-executive directors will add value. Indeed many shareholders (in both public and private companies) increasingly look for this informed and relevant background experience to enable mentoring, support and monitoring from pertinent possibly focused knowledge rather than just from general business experience.
1.5Role in developing high standards of competency, ethics and responsibility
The Cadbury Report has observed that 'every public company should be headed by an effective board which can lead and control the business.' The following propositions will highlight the importance of independent and non-executive directors in developing high standard of competency, ethics and responsibility:
1. The non -executive directors, when carefully chosen, can complement the Board's overall strength with their knowledge of best practice outside the company.
2. Their role should not be to do the job of the executive but to act as candid counselors to the guide the company in benchmarking standards and its level of ambition.
3. The non-executive directors concentrating on few companies rather being involved with up to fifteen companies which the companies act permits is a gem for company.
4. Non-executive directors can bring a broader view to the company. They bring external and wider perspective and independence to the decision making.
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10. Non-executive directors who are not qualified professionals (e.g. Chartered Accountants, Companies Secretaries etc.), should undergo proper training before they assume directorships.
2. Special Expectations
2.1 Educate how good governance is rewarding with market valuation for the company
2.2 Succession Planning in Companies
In organisational development, succession planning is the process of identifying and preparing suitable employees, through mentoring, training and job rotation, to replace key players (such as the CEO) within an organization as their terms expire. At least annually, the Board conducts a review of succession planning for the CEO and other senior executives.
2.3 Improving information placed before the board
2.4 Participation in board or meetings
Directors should view board meetings as an opportunity for strategic planning and creative suggestion and not just a monitoring
exercise. There is no doubt, however, that the routine sharing of information on company performance, plans and policies is an
important element of all board meetings.
The non-executive directors should meet as a group at least once a year without
the chairman or executive directors present and the annual report should include
a statement on whether such meetings have occurred. "Derec Higgs"
"There is a real conflict between needing their capital in your business and the requirement for them to be represented on the board."
Historically non-executives have been expected to spend about 17 to 20 days per year on each directorship, on the basis of up to 12 board meetings a year, a typical slice of Remuneration, Audit and Nominations committees, plus a strategy meeting or two and preparation and follow-ups to the meetings. Allowing for the wider activities suggested in this paper, we believe a further six days are appropriate for a committed and professional approach. This totals up to about 24 +days per year. Currently most non-executives plan on less, partially because the role is not defined in this way and partially because annual fees are often only related to the time needed for the formal Board meetings.
While non-executives can make such a contribution in board meetings, this is not enough. The effective and professional non-executive director needs to put in more time and involvement if they are to contribute fully to the company’s development. In a market moving as rapidly as the IT sector, a once-a-month checkpoint with some words of wisdom in the Board meeting is not a great deal of help to the executive management.
2.5 Educate terms of audit committee and other committees
2.6 Consider Trading Controls
2.7 Control on Financing and investments for efficient use of resources
According to Naresh Chandra committee Report Audit Committees are now mandatory under the Companies Act as well as Clause 49 of the listing agreement. Moreover, over three closely typed pages, Clause 49exhaustively sets out the role, composition, functions and powers of such a committee independent director has more responsibility as for as financial activities and control is concerned in clause 4.7 it is mentioned that Audit Committees of all listed companies, as well as unlisted public limited companies with a paid- up share capital and free reserves of Rs.10 crore and above, or turnover of Rs.50 crore and above, should consist exclusively of independent directors, as defined in Recommendation 4.1.
2.8 Related Party Transactions
What Narayan Murthy recommended was that the audit committee should approve related part transactions. Now, the audit committee is the only independent entity within an organization SEBI didn’t adopt it but the new clause 49 does require the audit committee to review related party transactions.
The Audit Committee with independent director will have greater power to review related party transactions such as:
Details of individual transactions with related parties, which are not in the normal course of business, should be placed before the Audit Committee. Details of individual transactions with related parties or others, which are not on an arm's length basis, shall be placed before the Audit Committee, together with management's justification for the same. J.J. Irani Director Tata Sons says on the issue that
“The directors’ Responsibility Statement should include a statement that all related party transactions have been entered into at arms length and if not, proper disclosure should be made with management justification. Audit committees are also required to review related party transactions.”
2.9Integration with CEO,CFO to asses effectiveness of internal controls
It is not uncommon that on the Board of directors of a commercial enterprise a retired bureaucrat , a celebrity like a film artist, a retired major general from the army, a retired judge from the High Court or the Supreme Court etc are nominated. There is nothing wrong in this approach per se but one must remember that more often than not these directors prove a decoration on the Christmas tree. In his though provoking book "The Brave New Manager" the author on page 142 has given an interesting example;
When one such Major-general, CEO of public sector company, enquired from the other Majors-turned-managers, as to how they found the assignment of building the dam for a hydroelectric project, the answer came- "Those who had spent their entire military career in demolishing dams are now being asked to build one. We were taught to demolish and not to build."
Effective independent will spend at least half a day examining materials provided by the CEO/CFO before attending the board meeting. Directors also spend a few hours a quarter discussing corporate business with the CEO.
We therefore propose that chairman/CEOs and the non-executives agree their briefs based on discussion of this fuller level of commitment, and that fees are related to a realistic and professional level of activity. As a result the number of directorships or other commitments that individuals take on will need to be limited to allow flexibility at this higher level of involvement per directorship. In this context a large number of non-executive positions is not viable.
2.10 Protecting interests and rights of all stakeholders
All non-executive directors, and in particular chairmen of the principal board committees, should attend the Annual General Meeting (AGM) to discuss issues that are raised in relation to their role.
The senior independent director should attend sufficient of the regular meetings of management with a range of major shareholders to develop a balanced understanding of the themes, issues and concerns of shareholders. The senior independent director should communicate these views to the non-executive directors and, as appropriate, to the board as a whole.
Boards should recognise that non-executive directors may find it instructive to attend meetings with major investors from time to time and should be able to do so if they choose. Moreover, non-executive directors should expect to attend such meetings if requested by major investors in the company.
On appointment, meetings should be arranged for non-executive directors with major investors, as part of the induction process.
A company should state what steps it has taken to ensure that the members of the board, and in particular the non-executive directors, develop a balanced understanding of the views of major investors.
Conclusion
In summary, corporate governance and the real strategic needs of IT companies need greater levels of contribution from effective and professional non-executive directors. While most contribute well, an improved structure will increase the professional nature of the contribution and encourage more experienced ex-executives of the right calibre to join the field. Just as non-executive directors can have different levels responsibilities beyond the core role through different committee assignments, so also they can have different levels of activity in reflection of their agreed contribution to wider company issues. Thus the non-executive directors can be considered a team whose members’ level of activity and focus can differ, but as a whole bring the effective external input to the board.
