Independent directors, as the name suggests are directors on Board of a company who are independent individuals, not having any further relationship or business with the company. The concept of Independent directors gained momentum in the late 1980s and early 1990s due to the finding of various corporate frauds and transgression. In India, Clause 49 of the listing agreement mandates appointment of independent directors on Board of a listed company. With the passage of the new Companies Act of 2013, the concept of independent directors has found place in the Companies Act itself. The requirements prescribed under the Companies Act 2013 seem to be much stricter than that of the previous version of the act 1956.
Demand for independent directors got fuelled after the New Companies Act was passed. In fact, now being the chairman’s or any executive’s friend isn’t anymore the most important qualification to get a call from the company to be an independent director and fill up that position. Companies are increasingly looking to induct on board people who can add value to decision-making.
The regulatory environment in India around corporate governance is changing rapidly and those entrusted with governance i.e. the Board of Directors and the Audit Committee are being made responsible for the prevention and detection of any frauds.
The ownership structure of the companies is changing: In recent years, public financial institutions, mutual funds, etc. are the single largest shareholder in most of the large companies. So, they have effective control on the management of the companies. They are the ones who force the management to use corporate governance. They put pressure on the management to become more efficient, transparent, accountable, etc. They also ask the management to make consumer-friendly policies, to protect all social groups and to protect the environment. The changing ownership structure has resulted in corporate governance. Today, social responsibility is given a lot of importance. Growing number of scams, frauds and corrupt practices need to be wiped off completely. Misuse and misappropriation of public money needs to be strongly controlled. In order to avoid these scams and financial irregularities, many companies are following the path of corporate governance.
Who can be an ID? As per clause 49 of the listing agreement, an independent director is a non-executive director who does not have any financial relationship with the company, its promoters, and senior management or affiliate companies, and/or has not been an executive with the company in the three preceding financial years. It also says that an independent director should not have been a partner or executive director of the auditors/lawyers/consultants of the company in preceding three years or should not hold 2% or more of shares of the company. Further, he should not be a supplier, service provider or customer of the company.
Independent directors act as a guide to the company. Their roles broadly include improving corporate credibility and governance standards functioning as an overseer, and playing a vital role in risk management. Independent directors play an active role in various committees set up by company to ensure good governance.
Some famous IDs: Examples of some famous independent directors are former banker K.V Kamath served on the board of Infosys between 2009 and 2015. Kamath is one of the famous and rich independent directors in the global list. He, Damodaran and Ron Sommer are famous for doing excellent job and earning handsomely from companies as independent directors. Former SEBI chairman M. Damodaran sits on the board of Tech Mahindra.
Should IDs be held responsible? The current legislation framework does not differentiate between Independent Directors (IDs) and executive directors (EDs) as it fails to distinguish between their liabilities. The real question is, since independent directors only play a supervisory role, should they be penalized only in the event of a discrepancy that directly relates to their responsibilities? Several independent directors on boards of companies are now seeking legal advice to find out to what extent they can be held liable for any operational issues in those firms.
Kiran Mazumdar Shaw, Chairperson of Biocon, said the country is moving from poor governance to extreme governance. “It is unfair to place the entire onus on independent directors who are only privy to the information shared with them by the management.” She further added that instead of penalizing independent directors, the management and promoters should be penalized because they are the whole time controllers.
A corporate veteran who is on the board of several blue chip companies on the condition of anonymity has said that an independent director should be provided immunity and protection except in cases of willful fraud or gross neglect. IDs spend so much time and energy to understand issues although the compensation for the same is not adequate enough.
Healthy ratio of ID: A healthy ratio of the board of director of a company should have both executive and non-executive directors. At least 50% of the board should have non-executive directors. If the chairman of the board is a non-executive director, then at least one-third of the board should comprise independent directors. If the chairman is an executive director, then independent directors should make up at least half of the board. If an independent director resigns or is removed from the board, he/she has to be replaced by a new independent director within 180 days from the day of such resignation or removal.
IDs must bring objectivity: The corporate governance structure hinges on the IDs, who are supposed to bring objectivity to the functioning omission function of the board and improve its effectiveness. However, the problem is that an ID cannot play an effective role in isolation despite their commitment to ethical practices. They cannot stop a decision that is damaging to the members individually, but if they act collectively, then they can proceed prudently before arriving at any such decision. IDs may not be in a position to stop fraud at the highest level, but with a high level of commitment and due-diligence, they may be well placed to identify signals that indicate that the lot is not as it should be.
Prevent frauds: Globally, with the evolving regulatory landscape, which makes them responsible for the prevention and detection of fraud, directors have begun exercising adequate oversight on the management on account of the risk of fraud. Non-compliance with these regulations or guidelines can have serious repercussions for directors, including their reputational loss and personal liabilities. The role of IDs in fraud prevention and detection has come under the direct scanner of regulators, members and other stakeholders due to the recent exposure of high-profile instances of fraud in India. In the last few months, we can clearly see IDs taking direct interest in reviewing the
scam risk management framework put in place by their organizations to mitigate the risk of fraud.
IDs must have some important questions to ensure compliance with governance: Some questions like clarity in communication from top to bottom; effectiveness in assessing corruption risk; effective standards, policies and processes to address risks; effective training and development from top to bottom; what incentives are provided for compliance and penalties for non-compliance; regular monitoring and auditing to detect improper conduct; adequate clout for compliance officers, resources and independence; effectiveness of compliance program etc are important.
Thus, the IDs can play the crucial role of bringing objectivity to the decisions made by the board of directors by playing a supervisory role, while not taking part in the company’s day-to-day affairs or decision making. For IDs raising the appropriate red flags at the right time would help them in avoiding the occurrence of unwanted situations and their consequences to a great extent.
The need of the hour is for the legislature to draw a line between IDs and EDs by defining their roles and responsibilities, and distinguish their liabilities. Discretion lies with the enforcement authority to determine the extent of the liability that the IDs may incur.
