Sunday, October 8, 2017

October 08, 2017
Coming straight to the key point, a high-profile Committee of the Securities and Exchange Board of India (SEBI) on October 5 recommended a slew of measures, including increasing the number of directors on boards of listed companies, the appointment of at least one woman independent director, and a higher frequency of board meetings to enhance corporate governance standards at India Inc. It is widely anticipated that this panel will usher in the much needed corporate governance overhaul. But right now it would be premature to guess how effective it will be in ushering corporate governance overhaul. Uday Kotak who is the head of SEBI’s panel on corporate governance presented the report to SEBI Chairman Ajay Tyagi on October 5.
SEBI Panel Pushes For Corporate Governance Overhaul

                                           While craving for my esteemed readers exclusive indulgence, let me inform them that the 25-member panel on corporate governance, headed by Uday Kotak who is Vice Chairman and Managing Director of Kotak Mahindra Bank has also called for separating the roles of chairman and managing director and creating a formal framework for sharing sensitive information between the board and entities not part of the board. Pushing strongly for greater transparency, the panel said that sound corporate governance helped companies generate “significantly greater returns”, compared to companies, which exhibited poor corporate governance standards. It further said that well-governed companies could command a premium between 10 and 40 percent over not-so-well-governed companies.
                                          For my esteemed readers exclusive indulgence, let me also inform them that the panel headed by eminent banker Uday Kotak also suggested the government assess an “independent holding structure” for public sector undertakings (PSUs). The panel in its 178-page report submitted to SEBI said that, “The government should consider consolidating its ownership and monitoring PSUs into independent holding entity structures by April 1, 2020.” I am sure that the government will seriously consider this recommendation as well as other recommendations.
                                         Let me hasten to add here that the move, the panel said, would help remove conflicts between the government and the regulator. The panel also said that an autonomous environment would enhance the shareholder value and act in the best interests of all stakeholders noting several public sector undertakings (PSUs) were trading at a sharp discount to their private peers. It is thus incumbent that an autonomous environment should be created soon so that it can help in more ways than one.
                                               To put things in perspective, while suggesting a major overhaul of corporate governance norms for listed companies, the Kotak panel rightly recommended limiting chairmanship to only non-executive directors and appointing at least one woman as independent directors. Presently, we see that 637 companies (38.1%) don’t have a single independent woman director. This is certainly most concerning!
                                           It also must be added here that the panel has recommended that the requirement to have at least one woman director should exclude promoter’s relative to be truly independent. M Damodaran who is former Chairman of SEBI says that, “My view has always been that there should be at least two women directors on the board, with at least one being independent… There is nothing wrong with a promoter’s relative being one of the women directors since no such question is raised when the promoter’s son or nephew is appointed to the board.” While the proposal for only non-executive director being allowed to be made chairman would eventually lead to a split in the posts of chairman and managing director, the panel also suggested increasing the minimum board strength to six members and the number of board meetings to five in a year. Earlier the minimum number of board members were three and minimum number of board meetings were four.
                                           As things stand, the current rules require that there must be one woman on board, irrespective of her being on board, irrespective of her being an independent or executive director. They also call for having at least half of board members as independent directors, up from one-third currently. The suggestions assume immense significance when considered in the backdrop of alleged corporate governance-related issues at Tata Group and Infosys and the ugly slugfest that broke out between those persons who are in the helm now and those who were earlier in the helm which even saw many heads rolling!
                                          Simply put, the panel also suggested a minimum remuneration of Rs 5 lakh per annum for independent directors and a sitting fee of Rs 20,000 – 50,000 for each board meet. It also sought to make it mandatory to seek public shareholders approval for annual remuneration of executive directors from promoter family if the amount exceeds Rs 5 crore or 2.5 percent of the company’s net profit. No doubt, this would check arbitrary actions and act as a safeguard against misuse of money.
                                          Briefly stated, in case of more than one such director, the same condition would apply for aggregate annual remuneration exceeding 5 percent of the net profit. The approval of shareholders will be required every year in which the annual remuneration payable to a single non-executive director exceeds 50 percent of the total annual remuneration payable to all non-executive directors. The companies would be required to disclose the list of competencies/expertise that its board members actually possess. This will ensure increased accountability and compliance with rules which will undoubtedly be good for the system. Besides, public shareholders nod would be mandatory for non-executive directors over 75 years of age. 972 non-executive directorship positions occupied by directors who are more than 75 years of age.  
                                      As it turned out, the capital markets regulator SEBI has sought public comments till November 4 on the panel’s recommendations which runs into 178 pages and covers a plethora of issues. The panel has suggested at least half of board members to be independent directors at listed companies, while all directors must attend at least half of board meets. Presently, a board needs to have at least a third of its directors as independent.
                                           What is of immense significance is that the panel also called for a better compensation for independent directors in order to balance the “risk-reward” and make it attractive for “competent people” to become independent directors. It also called for exclusive meetings of independent directors. It suggested for new disclosure norms, where listed entities would have to give detailed reasons for resignation of an independent director. This without doubt would strengthen the position of independent director.
                                      As of now, according to the figures obtained by Prime Database, till date 851 independent directors would resign from various companies. Going ahead, many companies may even find it hard to find independent directors. In the last two years, many independent directors have been resigning from companies they feel could land them in trouble.
                    It is laudable that the panel recommended to disclose detailed reasons for resignation of independent directors while earlier there were no such specific rules. This will ensure that independent directors before quitting would lay bare the stark truth of all what was going wrong due to which he/she had to resign! So no one can take them for granted. We all know fully well how in the aftermath of Cyrus Mistry’s ouster as Chairman of Tata sons, Nusli Wadia – an independent director on the boards of three listed Tata companies had asked SEBI to inquire into unpublished material and price sensitive information shared by the companies with Tata trustees and Tata sons. Wadia showed how an independent director can assert himself and work without getting influenced by anyone!
                           Also, interestingly enough,  where chairperson is not independent, the panel recommended that independent director should be the lead while earlier there was no such provision. Now, independent directors could face more scrutiny which will ensure that they work more transparently and sincerely. It is also laudable that the panel has proposed a minimum remuneration in the case of independent directors depending on the size of the economy.
                              It has also proposed more powers to independent directors. The chairperson of a listed company will be a non-executive director to ensure that s/he is independent of the management. An independent director cannot be in more than eight listed companies and a managing director can hold the post of an independent director in only three listed firms. The minimum sitting fees of independent directors has been halved from the current Rs 1 lakh per meeting stipulated by Companies Act, 2013 to Rs 50,000 for the top 100 companies by market capitalization. Detailed reasons would need to be furnished when an independent director resigns. This is to ensure that they remain independent of the company management.

                                       More importantly, every board meeting would require the presence of an independent director. The committee has recommended that the number of independent directors on a company board be increased from 33% to 50%. This would ensure that undue patronage and arbitrary actions are checked firmly.
                                      Most importantly, the panel has proposed that directors attend at least half the total board meetings held in a financial year. If they failed to do so, they would require shareholder’s nod for continuing. This would certainly compel them to be on their toes and not take things for granted.
                                No less important is the recommendation to increase the number of meetings to five a year. The fifth meeting would discuss among other things, whether the company has a succession plan in place. This issue cropped up most recently after the recent boardroom battles at the Tata group and Infosys Ltd. Other issues that would be discussed in the proposed fifth meeting include adherence to governance standards, board evaluation and strategies for the company.         

                                         Truth be told, the panel which submitted so many of its landmark recommendations was set up by SEBI in June 2017 with a view to enhancing the standards of corporate governance of listed entities in India. The committee consisted of officials from the government, industry, professional bodies, stock exchanges, academicians, lawyers and proxy advisors. The panel was asked to submit its reportwithin four months which it did on October 5.
                                        Truly speaking, the terms of reference of the committee were to make recommendations to SEBI on various issues including ensuring independence in spirit of independent directors and their active participation in functioning of the company. Besides, the suggestions are aimed at improving safeguards and disclosures pertaining to related party transactions. They also cover issues in accounting and auditing practices by listed companies and seek to improve effectiveness of board evaluation practices. The report also seeks to address issues faced by investors on voting and participation in general meetings, and disclosure and transparency related issues. 
                          Needless to say, the panel also suggested that all listed entities which have public shareholding of 40 percent or  more at the beginning of a fiscal year should ensure that the chairperson should be a non-executive director from April 1, 2020, while chairperson should be a non-executive director for all the listed companies from April 1, 2022. It is commendable that it also recommended that the top 100 companies by market capitalisation should webcast their shareholder meeting. It also suggested that the minimum number of audit committee meetings be increased to five every year from the present four.
                            Be it noted, the panel also recommended the adoption of a transparent framework for exchanging unpublished price-sensitive information (UPSI) with promoters or any significant entity not part of the board. It called for the creation of special agreements enabling the management to share any UPSI with designated persons. Under the current framework, such information can be shared with members only if they are part of the decision-making process.  
                                    It is a no-brainer that this issue had assumed immense significance during the no-holds-barred tussle at Tata sons between their erstwhile chairman Ratan Tata and Cyrus Mistry and the latter had to quit under unrelenting pressure exerted  on him by the former. Panel member Keki Mistry who is Vice Chairman and Chief Executive Officer HDFC said that, “These measures would bring clarity and create a pathway where promoters can access sensitive information, subject to certain restrictions.”   
                                         It must be brought out here that addressing the issue of high royalty payments by domestically listed multi-national companies (MNCs) to their parents, the panel recommended that payments amounting to over 5 percent of the revenues would require the approval of public shareholders. It also recommended high frequent disclosures of related party transactions (RPTs), often a bone of contention between public shareholders and promoters. 
                              Of course, it called for the presence of at least one independent director at every board meeting. Also, it sought disclosure of the expertise of the directors being appointed and capping the maximum number of directorships to seven by April 2020. It further suggested the separation of the roles of the chairperson and the CEO and managing director for listed entities, with public shareholding over more than 40 percent by April 2020 and extend it to all companies by April 2022. The move could impact companies like Reliance Industries where Mukesh Ambani holds the post of both Chairman and MD. Same is the case with Pawan Munjal at India’s largest motorcycle maker Hero MotorCorp and RD Shroff at the country’s largest agrochemicals producer United Phosphorus. Of the 50 companies on the benchmark Nifty, at least 12, including Reliance Industries, ONGC and Wipro, have the same person occupying both posts.     
                                             To be sure, the Kotak panel also made several proposals for effective functioning of board committees which includes audit, remuneration and stakeholder relationship committee. It also advised setting up of information technology committee to focus on digital and technological developments. It also recommended that SEBI should have clear powers to act against auditors under securities law. For government companies, the panel has recommended that the company law board has final say on the appointment of independent directors and not the nodal ministry.
                                           In a bid to improve transparency among group entities, the panel suggested revising the definition of a “material subsidiary”. It said an entity will be termed as a material subsidiary if its income or net worth exceeds 10 percent, up from the current 20 percent, of the consolidated income or networth respectively of the listed entity. This also apply to unlisted foreign subsidiaries.
                                          Going forward, the panel stipulates that the maximum number of directorships held by a person will be capped at 8 by April 1, 2019 and 7 by April 1, 2020. It also stipulates that the auditor shall have the right to independently obtain external opinions from experts. It recommended that for listed entities in India, the auditor of the holding company should be made responsible for the audit opinion of all material unlisted subsidiaries.  
                                     Let me bring out here that the panel has recommended that chartered accountants apex body ICAI (Institute of Chartered Accountants of India) should have powers to punish audit firms and impose a fine of up to Rs 1 crore on erring auditors. This would go a long way in deterring them from erring intentionally.  Presently, the ICAI can only impose a maximum of Rs 5 lakh fine on its members for violations.
                                               Let me also bring out here that it also stated categorically that, “On the audit firm – punishment or impose penalties of up to Rs 5 crore in case of repeated violations (that is where the number of violations exceed three). Besides, it has suggested that the institute should make increased disclosure about actions taken against members which would ensure more transparency and act as a deterrent. Another suggestion is for the institute to have a separate team for enforcement pertaining to listed entities in order to reduce the turnaround time for disciplinary proceedings.
                                       It cannot be lost on us that the panel proposed stricter rules and disclosures for related-party transactions. It stated that, “All material related-party transactions shall require approval of the shareholders through resolution and no related parties shall vote to approve such resolutions whether the entity is a related party to the particular transaction or not.” It also said that, “All entities falling under the definition of related parties shall not vote to approve the relevant transaction irrespective of whether the entity is a party to the particular transaction or not.”  
                                     It also has to be borne in mind that the panel suggested companies should disclose in the annual report key financial ratios or sector-specific equivalent ratios. It also proposed the release of consolidated results every quarter and cash-flow statements every six months.
                                        It is noteworthy that the panel proposes to put in place a common stewardship code that might compel Life Insurance Corporation (LIC) and top mutual funds (MFs) to play a more active role in this regard. Sai Venkateshwaran who is partner and head of accounting advisory services at consultancy KPMG India says that, “The (proposed) code will make it a formal mandate for institutional investors to play a stewardship role, rather than remain silent spectators with respect to the affairs of their investee companies”. Several countries such as the UK, Japan and Malaysia have prescribed detailed Stewardship Codes to be followed by institutional investors voluntarily. These include principles which require that institutional investors have comprehensive policies on –
1.  Discharge of their stewardship responsibilities;
2.  Management of conflicts of interest in fulfilling stewardship responsibilities;
3.  Monitoring of investee companies;
4.  Intervention in investee companies;
5.  Collaboration with other institutional investors;
6.  Voting and disclosure of voting activity;
7.  Periodical reporting on their stewardship activities.
                                    It is also noteworthy that the panel has also recommended that the market regulator, SEBI, will have the right to pull up auditors for any lapse in corporate governance norms and penalize them. In the past, we saw how some of India’s top auditors, including some from the Big Four firms, were found clearing annual reports despite companies being accused of corporate governance violations as the case of United Spirits. This recommendation would undoubtedly make sure that auditors, who are seldom taken to task by their self-regulated body, do a thorough job while certifying accounts as not doing so would land them in a deep trouble.
                             Be it noted, the panel has proposed a formal framework for listed companies to share unpublished price sensitive information with promoters and large shareholders as this issue hit the headlines with the recent boardroom battles at Tata Group and Infosys. The Infosys Board had criticized its founder Narayana Murthy of inappropriate interference. The panel now entails that a listed entity may enter into the agreement in relation to providing access to material information, including unpublished price sensitive information, to the promoter or someone with more than 25% shares.
                                     It also makes it clear that is the duty of the promoters and large shareholders to maintain strict confidentiality of all material information, under the terms of agreement. Safeguards to be put in place in respect of procedures of communication and procurement of information. The promoters and large shareholders will have to provide an undertaking that it will use the information received in accordance to the securities laws and access of information does not undermine the independence and autonomy of the board of directors of the listed entity in any manner.
                               It must be noted here that the listed entity shall have the right to unilaterally terminate the agreement with the consent of majority of directors of the listed entity representing three-fourths in number, provided that the counterparty on the board of directors of the listed entity shall abstain from such voting. The panel also said that the business reality in India is that a majority of the listed entities are controlled by a single promoter where the lines of control, influence and information flow do not necessarily follow the formal and distinct corporate structure. The listed entity shall have the right to withhold communication and access to material information in case the board of directors determines that it is not in the interests of the listed entity or there is a conflict of interest in it sharing the material information with the promoter or there has been a breach of the agreement by the promoter.
                                   It is quite troubling to see that even though currently there are no provisions to grant leniency by SEBI but the panel has proposed to provide powers to the Central Government based on recommendations by SEBI to grant immunity both from prosecution and imposition of penalty under the SEBI Act and the SCRA for the alleged violation subject to certain conditions. One only hopes that this is reviewed and even if not changed is not misused to favour wrongdoers.
                                  It is also proposed that the top 100 companies by market cap would hold annual general meetings (AGMs) within five months and the same may be extended to other entities in a phased manner. Over time, this timeline would be reduced to four months. Presently, companies hold AGM within six months from the end of the financial year.
                                    Strictly speaking, the panel also recommended that enhanced disclosure requirements related to abrupt resignation of independent directors and auditors should be put in place. It stated that, “The audit committee should also review the utilisation of funds of the listed entity infused into unlisted subsidiaries, including foreign subsidiaries”. It added that, “The requirement be applicable in instances where the total amount of loans/advances/investment from the holding company to the subsidiary exceeds Rs 100 crore or 10% of the asset size of the subsidiary, whichever is lower.” The recommendation assume significance in the wake of SEBI’s January order barring Vijay Mallya and six other entities from the securities market after a probe found that funds were diverted from United Spirits to group companies, including Kingfisher Airlines. It rightly proposed that audit committees must monitor flows to unlisted units.

                                              All said and done, it needs no rocket scientist or Einstein to conclude that the panel led by Uday Kotak has really submitted laudable recommendations. We have discussed here just few of them. There may be a few shortcomings but overall it seems to be a very good and carefully drafted report in which about 25 experts have tried to bring in the best. So it would not be proper to just dismiss it as yet another report! It still remains to be seen how many recommendations are finally accepted by the SEBI. But it is certainly a watershed moment which promises many changes for the better in corporate governance if they are finally accepted!
Sanjeev Sirohi, Advocate,
s/o Col BPS Sirohi,
A 82, Defence Enclave,
Sardhana Road, Kankerkhera,
Meerut – 250001, Uttar Pradesh.