SEBI’s Consultative Paper on Corporate Governance Norms in India: A Modified Hybrid Approach

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SEBI’s Consultative Paper on Corporate Governance Norms in India: A Modified Hybrid Approach

Shriram Subramanian | April 2013

THE CONTEXT

SEBI’s consultative paper on review of corporate governance (CG) norms, which released in early January 2013, seeks to revisit the existing clause 49 which was codified in 2004. Since 2004, SEBI has made minor modifications in the code of corporate governance, largely in disclosures in terms of promoters pledged shares, general information dissemination on websites, voting results disclosures, peer review of auditors and electronic voting enablement.

The Companies Bill, passed by the Lok Sabha in December 2012, has made significant changes that have corporate governance (CG) impact. SEBI is now seeking to align it with the CG changes proposed in the Companies Bill 2012 as well as other recommendations and best practices such as MCA voluntary guidelines, OECD principles and the recent Adi Godrej committee report. SEBI has stated that it intends to advance the implementation of the proposed changes and not await the passage of the Companies Bill 2012.

SEBI intends to introduce a set of principles of CG that will have an overriding effect on any specific rules of corporate governance. This implies a modified hybrid approach, which is being envisaged: principle-based, which all listed companies will have to abide by, in addition to being governed by the rules under clause 49 of the listing agreement. A difference from the previous regime is the doing away of nonmandatory provisions, except for the one relating to training of directors.

GUIDING PRINCIPLES

SEBI has listed 26 overriding guiding principles, which can be classified into six broad categories:

Shareholder and stakeholder interest related – 6 principles
Board composition – 2 principles
Board appointment, induction, training, evaluation and succession – 4 principles
Board conduct – 2 principles
Board responsibilities – 8 principles
Informed decision making & disclosure – 4 principles

These principles are fairly comprehensive and cover almost all aspects of the company’s governance from a shareholder and stakeholder perspective. Making them mandatory and overriding will help define the boundaries of governance within which companies can operate.

PROPOSED AMENDMENTS TO CLAUSE 49 OF LISTING AGREEMENT

Let’s look at some of the issues that SEBI’s consultative paper raises:

Term of Independent Director (ID)

The maximum period for a director to serve as an ID should be 10 years, irrespective of the number of terms served. However, a transition plan, with a definite timeframe, may be needed to ensure compliance.

Separation of offices of Chairman and Chief Executive Officer

The offices of Chairman and MD/CEO should be separate in companies above a particular size (net worth or market capitalisation). The Chairman should be an ID for such companies.

Constitution of Audit Committee

All members of the audit committee should be independent directors. The committee should also be responsible for reporting any misconduct of auditors to NFRA.

Nomination and Remuneration Committee

The proposed Nomination and Remuneration Committee and its roles and responsibilities are important steps to ensure a more objective and transparent manner of selecting and rewarding directors. There should be a relationship and cap between the pay of the CEO / MD/ Executive Directors and the median employee’s remuneration besides a disclosure.

Formal Letter of Appointment to Director

The total compensation, in particular – perquisites, given to all directors should be quantified and stated in the letter of appointment.

Requiring Independent Directors to Disclose Reasons of Their Resignation

SEBI’s recommendation is that if personal reasons are stated for resignation, then the director must be required to state in his letter of resignation whether he is also resigning from all other directorships or not. And if he is not resigning from one or more of other directorships, he should explain the specific personal details applicable in the case of the company. The letter of resignation containing detailed reasons submitted to the Registrar should be available for public inspection and posted on the website.

Mandatory Rotation of Audit Partners

The Companies Bill proposes that an auditor cannot be appointed for more than one term of 5 consecutive years, and an audit firm for more than 2 consecutive terms of 5 years. On completion of the term as above, there should be a cooling period of 5 years before they are reappointed.

Approval of Major RPTs by “Majority of the Minority”

The term “major RPTs” needs to be clarified. Also, Clause 188 in the Companies Bill seeks to exclude “arm’s length transaction”, which is defined as not leading to conflict of interest. The possibility of a self serving interpretation of arm’s length as well as conflict of interest needs to be considered. For major RPTs, approval of resolutions should be by “majority of the minority” members.

PROPOSALS FOR DISCUSSION

SEBI has also put out many proposals for discussion. Some of these are:

Appointment of Independent Directors by minority shareholders
Cumulative voting for appointment of Independent Director
Mandate minimum and maximum age for Independent Directors
Lead Independent Director
Separate meetings of Independent Directors
Succession Planning
Mandating e-voting for all resolutions of a listed company
Abusive RPTs

Requiring approval by shareholders for divestment of major subsidiaries
Immediate and continuous disclosures of material RPTs
Prohibiting/ regulating grant of affirmative rights to certain investors
Approval of managerial remuneration by disinterested shareholders
Expanding the scope of Related Party Transactions(RPTs)

Fiduciary responsibility of controlling shareholder
Enforcement for non-compliance of corporate governance norms: As per SEBI, at present, monitoring of the compliance of the same is done only through disclosures in the annual report of the company and periodic disclosures of the various clauses of Clause 49 of the Listing Agreement on the stock exchange website. In order to improve the monitoring, the following is proposed by SEBI:

Carrying out of corporate governance rating by the Credit Rating Agencies.
Inspection by Stock Exchanges/ SEBI or any other agency for verifying the compliance made by the companies
Imposing penalties on the Company/its Board of Directors/Compliance
Officer / Key Managerial Persons for non-compliance either in sprit or letter
In order to strengthen the monitoring of the compliance, inputs from other market participants like investor associations, lenders, proxy advisory firms, etc. should also be considered.

Role of Institutional Investors: SEBI has identified the following as the key issues concerning the role of institutional investors from a corporate governance standpoint:

Issues relating to disclosure by institutional investors of their corporate governance and voting policies and voting records.
Issues relating to the disclosure of material conflicts of interests which may affect the exercise of key ownership rights.
InGovern is of the view that: Institutional investors should behave more responsibly and should become signatories to UNPRI – United Nations Principles for Responsible Investment. Voting policy and vote reporting should be extended to all institutional investors, not just mutual funds. Vote reporting should be done within 15 days of an end of a quarter. SEBI should deal strictly with institutional investors on non-compliance with disclosure requirements.

CONCLUSION

The proposed changes and the issues put out by SEBI for discussion are far reaching and should effect a marked change in the corporate governance practices in India. Companies, independent directors, institutional investors, auditors and other market participants should welcome the changes and usher in a new era of corporate governance in India.

About Author

Shriram Subramanian

Shriram is the Founder and Managing Director of InGovern Research Services, India’s first proxy advisory and corporate governance research firm.