Trapped by conflicting loyalties?

SEBI chairman Ajay Tyagi’s angst over the state of independence of Independent Directors (IDs) seems well founded and may have been born out of the recent unseemly episode of removal of an ID from the boards of several listed companies of a particular group at the instance of the controlling shareholder.

On more than one occasion, the chairman has expressed his concern at the lack of independence among IDs in listed private companies and continuing vacancies of IDs in listed public sector enterprises. This may well have prompted SEBI to place independence amongst IDs as the topmost agenda for the Uday Kotak Committee on Corporate Governance.

The existing legal framework requires IDs to be appointed by shareholders at a general meeting based on board recommendation. But the irony is all shareholders including the controlling shareholder are entitled to vote on this, which essentially means without the support of the controlling shareholder no ID can be appointed. This goes against the concept of IDs appointed to represent interests of absentee /minority shareholders. This needs to be remedied for the institution of IDs to survive with credibility.

In the current practice, shareholders have to accept or reject a candidate proposed in the resolution; it is not election at all. Ideally, shareholders should get to know how the desired skills match the candidate’s competence to help them elect one from options made available by the Nomination and Remuneration Committee.

Inasmuch as the institution of IDs is evolving fast to become robust and respectable, instances are not uncommon where it has witnessed cosy, mutually comforting arrangements. By and large, the identification and selection process in many companies has been based on the level of comfort of the controlling shareholder(s). The question is — can IDs be expected to represent minority/absentee shareholders when they are identified, selected, recommended and appointed (albeit in compliance with the regulatory requirements) with the tacit blessings and overt approval of the controlling shareholders? Can they be reasonably expected to exhibit independence when their continuation on the board depends on the controlling shareholder?

In the case of transactions between related parties which require approval of the shareholders, the interested parties to the transaction are not allowed to vote. Similarly, in the election of directors from amongst shareholders in public sector banks, the government as the majority shareholder is not entitled to vote. In the case of election of shareholder directors of the only listed public sector bank which is incorporated as a company – IDBI Bank – the regulations provide that even those entities which are owned and controlled by the union government will not be allowed to vote on the resolution proposing appointment of shareholder directors.

A similar exercise can be made applicable to all listed companies wherein potential directors, whose names may be required to be registered/authenticated in/by a central agency established and run by regulators, may be permitted to contest the election of IDs . This process may also be delegated to existing agencies which are already functional, albeit without much effect. After their nominations are processed and accepted by the BoD or a committee thereof, communication about contesting candidates can be sent to all shareholders other than controlling shareholders. In addition, along with those chosen by the board or the committee, the controlling shareholder(s) may also recommend candidates for IDs with full disclosure by the company of relationships with them, if any. The controlling shareholder should not participate in the election. Candidates may be permitted to canvass through mails or other means and election can be held through the remote e-voting facility and also voting at the meeting. The candidates getting the majority of votes from amongst minority shareholders can be declared as elected. A similar method may be followed for removing IDs too.

This process at once eliminates the apparent nexus which seems to prevail between the controlling shareholder(s) and the IDs selected.

Of course, this process by itself cannot ensure independence in IDs; independence is a state of mind and cannot be mandated as of now. In the prevailing state of affairs, expecting independence from IDs may be a little far fetched.

Now, over to the Uday Kotak Committee on Corporate Governance.

The writer is former president of The Institute of Company Secretaries of India