[Somya Luthra is a fourth-year law student at Institute of Law, Nirma University]
The Securities and Exchange Board of India, over the years has strived towards strengthening the corporate governance framework, in which independent directors play a crucial role as they are seen as the ‘vanguards’ of minority shareholders and hold a ‘fiduciary’ position, which is paramount for corporate governance. Independent directors were appointed to ensure that the minority shareholders have an autonomous voice, and to bring in greater transparency, accountability, fresh perspectives and independent judgement on various issues ranging from strategy & risk management to performance evaluation of the board itself. Hence, constant steps are taken by SEBI to enhance the efficacy of independent directors and make them more efficient and independent through following recommendations of various expert committees and stakeholders.
In light of the above, SEBI released a consultation paper on 1 March 2021 titled ‘Consultation Paper on Review of Regulatory Provisions related to Independent Directors’ issued on 1 March 2021 with the objective of reinforcing the role of Independent directors. It recommends changes in rules dealing with the selection, removal, remuneration, and the part in audit committees of listed companies of independent directors.
The fundamental idea behind the system of corporate governance is greater participation of all shareholders in decision making. Day-to-day affairs of the firm are governed by management and the board of directors, however, shareholders is called on to vote on important issues like appointment and removal of directors, compensation plans, etc.
Role of Proxy Advisors
Proxy advisors or proxy advisors firms are appointed by the investors to advise them to vote for or against on matters which will affect the value of their shares, in the company’s annual meeting or extra ordinary general meetings. They back their advice with data and research and note on governance practices as well. SEBI recently released a circular which make it mandatory for proxy advisory firms to formulate voting recommendation policies and report it to their clients, along with their research methodologies, to ensure there is no conflict of interest and the independence is retained.
According the Companies Act 2013, one-third of the total board of directors must be independent directors, as they are impartial experts who do not have much financial stake in the company and can voice the interests of minority shareholders. Independent Directors have a notable role in the board meetings; hence the resolutions that concern their selection, removal, and reappointments are studied in great detail by the proxy investors, to be able to provide their clients with the best possible advice.
Key Takeaways from the Consultation Paper
The Consultation Paper’s first proposal is that ‘key managerial personnel’ or employees of promoter group companies and their relatives, can now only be appointed as ID after a cooling period of 3 years. SEBI seeks to ensure that the ID remains ‘independent’ of any relations with the listed entity, its holding, subsidiary and associate companies, shareholdings and the promoters, and the directors have no major financial interest in the company. SEBI also proposes to make unveiling of complete resignation letter of independent directors to the shareholders compulsory, which should be accompanied by a ‘list of his membership in committees of the Board of Directors’.
Further, it plans to impose a cooling period of one year for an independent director who resigns from the board stating pre-occupation, private obligations, etc. before joining any other Board of Directors. SEBI in its third proposal says that there should be dual approval of shareholders process for appointment and re-appointment of shareholders by way of special or ordinary resolution, respectively, taken through a single voting process. This move will ensure that the vote of the majority shareholders and promoters are not given extra weightage and the procedure of selecting independent directors remains ‘independent’. For removal of an independent director in the existing law, a simple shareholder majority in its first term and through a special majority in its second has to be attained. However, in this case, the promoters may ride over the wants of the minority shareholders as promoters are the controlling shareholders and can take undue advantage of their vote. To rectify this problem, SEBI in its fourth proposal holds that, just as in the case of appointment, removal of Independent directors will also require dual approval. If any of the requirements are not duly complied with, the Independent Director won’t be removed and the independent director will be removed through a second vote of all shareholders, within a period of ninety to one hundred and twenty days.
The fifth proposal in the consultation paper relates to the appointment of IDs on the board only with the prior approval of the shareholders at a general meeting. However, the approval of shareholders must be taken within a period three months, in case of a casual vacancy arising due to resignation, removal, death, failure to get re-appointed or other such reasons.
The sixth proposal suggested that audit committee should constitute 2/3rd independent directors and 1/3rd non-executive directors. These directors should not be related to the promoter, including a nominee director, if any. It also proposed that the remuneration and nomination committee should constitute 2/3rd independent directors.
In its seventh proposal SEBI suggested that granting of Employee Stock Option Plans (ESOP) to independent directors with a long vested period of 5 years should be explored. To this, they added that there should be a possible maximum limit of remuneration through ESOPs, instead of profit linked commission.
Impact of these recommendations on Proxy Advisors
SEBI released a circular on ‘Procedural Guidelines for Proxy Advisors’ on 3 August 2020 which mandated Proxy Advisors to disclose in their recommendation the legal requirement in relation to higher standards that they apply at time, which are more rigorous than the bare minimum legal requirement. They are also required to disclose the rationale behind such recommendation.
Instances of proxy advisory firms suggesting investors to vote against family members of independent director whose tenure has come to an end have been reported in the media several times. The rationale behind this recommendation was the closeness of family members and relatives to the company, which gave rise to the possibility of gratification.
Some Proxy Advisors self-adopt Proxy Advisory Guidelines which they formulate themselves, under which they examine the proposed candidate’s relationship with the company, promoters, senior management, directors, et al, to make sure that the independent candidate’s decision making is independent and raise a flag if they catch hold of a pecuniary relationship other than the directorship one. The Proxy Advisor doesn’t recommend the appointment of the partner or proprietor of a consultancy/firm as an independent director, if the company avails some service from the same.
Another higher standard adopted by these proxy advisory firms as mentioned in the Proxy Voting Guidelines (Benchmark Policy Recommendations), the Proxy Advisors back for independent directors who have no material connection to the company or the dissenting significant shareholder either directly or indirectly. The ‘material connection’ can be financial, personal, or any connection which a reasonable person can see has the ability to hamper the objectivity of the director. They also don’t recommend candidates who have been part of two or more board failures, as that reflects a candidate’s incompetency. To assess the candidate’s dedication, sincerity and the level of involvement with the company, they take into account the director’s attendance in board and committee meetings.
The recent SEBI Consultation Paper regulating independent directors which suggest changes in the law related to eligibility, appointment, reappointment and disclosure of the candidate will prove to be most beneficial to Proxy Advisors, as they recommend whether to vote in favor of the independent director or against. They can supplement the existing higher standards with the changes recommended in the Consultation Paper in matters related to appointment of an independent director who has relations to the promoter or promoters. The changes suggesting reconstitution of the remuneration, nomination or auditing committees will be relevant for Proxy Advisors as well. Proxy advisors can also suggest investors to deliberate with the company to strengthen its corporate governance based on the suggestions given in the SEBI Consultation Paper.
The Consultation Paper, if consolidated as a law, will ensure that the candidate is scrutinized vigorously by Proxy Advisors, which will further ensure they are fully independent. At the Consultation Paper level also, these suggestions can be adopted by Proxy Advisors as higher standards. These suggestions are a step in the right direction for paving the path for better corporate governance in companies.