Independent directors: how the Sebi rule will impact the appointment of independent directors
Independent directors are often seen as the vanguard of shareholders, especially minority shareholders on the board. They occupy a fiduciary position, which is essential to corporate governance. Proxy advisers (PAs), on the other hand, stand guard for their clients who are typically institutional investors and provide voting recommendations, for and against the resolution, after considering the purpose of shareholders’ resolutions. a company.
Given the important role played by independent directors, resolutions relating to their appointment and reappointment are subject to further scrutiny by proxy advisers, who provide voting recommendations.
This article analyzes how the recent Securities and Exchange Board of India (Sebi) consultation paper titled “Independent Director Regulatory Review Consultation Paper” released on March 1, 2021 to seek public opinion of here April 1, 2021 (SEBI consultation document) is likely to impact proxy advisor recommendations as India Inc prepares for the next quarter’s annual general meeting season.
The Sebi consultation document
The SEBI consultation paper focuses on almost all aspects of ID and in a way suggests a 360-degree overhaul of all aspects of the role an ID plays in a business, from l ‘eligibility for appointment / renewal, including revocation, resignation and remuneration for the participation of IDs in the committees of the board of directors. Sebi’s consultation paper is indicative of the regulator’s proactive role in streamlining the legal regime vis-à-vis independent directors in India. The main takeaways are listed below:
Definition of independent directors
Restriction of key management personnel or employees of promoter group companies, and their relatives from being named IDs in the company, unless there has been a 3-year cooling-off period.
The process for appointing and renewing independent directors
The appointment and renewal, respectively by ordinary and special resolution, are based on the double approval of the shareholders as well as the “majority of minority shareholders” (simple majority) less the shareholders of the promoter and the group of promoters, in a process single vote and Meeting.
In the event that such a resolution is not adopted, either the same person is proposed after a period of reflection and within 90 to 120 days, or a brand new candidate is proposed.
Removal of independent directors
There is a dual approval mechanism for revocation, and in the event that such a resolution is not passed, re-filing the proposal after a cool-down period, both processes are similar to the suggested process for appointment and removal. renewal of independent directors.
Discuss and provide more transparency on the role of the nomination and remuneration committee
The nomination and remuneration committee will be made up of 2/3 independent directors.
Candidate pre-selection process, identification and recommendations
The disclosure in the notice of appointment of independent directors is sent to shareholders to include the skills and abilities of the nominee proposed for nomination as an ID as well as explanations of how the nominee is suited to the requirements of the company, as well as the channel used to search for candidates.
Prior approval of shareholders for the appointment of independent directors
The appointment of independent directors by the board follows the prior approval of shareholders at a general meeting. In the event of an appointment to fill a fortuitous vacancy, shareholder approval is required within three months.
If an independent director resigns, the resignation letter must be disclosed along with a list of their current terms of office and membership. If the independent director resigns for reasons such as concerns, other commitments or personal reasons, a mandatory cooling off period of 1 year is required before the person can join the board of directors of any other company.
Composition of the audit committee
The audit committee will be composed of 2/3 independent directors and 1/3 non-executive directors, who are not linked to the promoter, including an appointed director, if applicable.
Open suggestion to explore the granting of stock option plans to employees (“ESOP”) with a long vesting period of 5 years to independent directors and a possible maximum limit of remuneration via ESOPs, at instead of a commission related to profits
What impact does this have on the recommendations of proxy advisors?
A proxy advisor would sometimes apply more stringent standards than the bare minimum required by law. This is why the Sebi circular entitled “Procedural Guidelines for Proxy Advisors” dated August 3, 2020, requires proxy advisors to disclose in their recommendations the legal requirement vis-à-vis the higher standard which has been applied and the rationale for recommending higher standards.
In terms of existing higher standards adopted by PAs operating in India
The media have shown that in the past, whenever a proxy advisor has asked shareholders to vote against the resolution proposing the appointment of a family member of a previously independent director as an independent director of the society. The rationale for such a recommendation was not based on the merit of the recommended candidate, but related to the affinity of family members and relatives with the company and, among other things, the possibility of gratification.
Similarly, with regard to the internal charter policy, namely the proxy voting guidelines (referral policy recommendations), one of the proxy advisers is responsible for initiating an independent advisor with no significant connection (which may be financial or personal or otherwise than a reasonable person to conclude that there is a potential influence on objectivity to impede the individual ability of the director to meet required fiduciary standards), directly or indirectly, to the company (other than a seat on the board of directors) or the dissident significant shareholder.
Another PA based on its self-adopted “Advisory Guidelines for Proxies”, examines the proposed candidate’s relationship / association with the company, promoters, other directors, senior management or holding company, subsidiaries and partners. associates, to verify the independence and assess the independent decision-making ability based on the conflict of interest of the proposed candidate. Flags are also raised in the event that there are pecuniary relationships other than the remuneration of the directors in question. The PA is not in favor of appointing a partner / owner of a consultancy / law firm as an independent director, when the company uses the services of such an entity.
Another higher standard generally adopted is to recommend against a candidate who has been on two or more board failures, as repetitive board crises are indicative of unsuitability.
The presence of an independent director at board and committee meetings is also a higher standard adopted in the voting recommendation by proxy advisors, reflecting the director’s degree of proactivity and the level of involvement and involvement. engagement with society.
Other factors to be taken into consideration are, among others, links between boards of directors / cross links between several boards of directors, old and / or prolonged association with the company / promoter / group of promoters, representative of large shareholders / lenders, reputational risk and inexperienced family members / relatives proposed for appointment.
Aspects discussed in the Sebi consultation document, which are most relevant to proxy advisers when compiling voting recommendations are the suggestions relating to eligibility, appointment and renewal as well as disclosure relating to the candidacy. in the notice of meeting, in particular the statement of motivation of the company the suitability of the candidates proposed to be independent directors. In line with the existing higher standards, proxy advisors can now, among other things, advise against the appointment of a candidate, who has ties to the promoter or group of promoters, as an independent director, with more force.
The other relevant aspect would be the proposed reconstitution of the nomination and remuneration committee as well as the audit committee. Typically, proxy advisors note legal compliance for the constitution of board committees. The suggestions contained in the Sebi consultation document provide a basis for PAs to suggest that investors engage in a conversation with the company to strengthen its corporate governance by imbibing the suggestions contained in the Sebi consultation document.
While the suggestions in Sebi’s consultation paper have not yet taken the form of law and are subject to public scrutiny, the fact that such suggestions have been recommended by the regulator market is sufficient to be adopted as higher standards by proxy advisers. and institutionalized as a factor in arriving at the vote recommendation. In particular, this should streamline the appointment of independent directors, given the rigorous level of scrutiny to which a candidate must now undergo by the proxy advisers reviewing the nomination resolution. This should hopefully result in truly “independent” independent directors and not directors with just a semblance of independence.
(Rabindra Jhunjhunwala is a partner and Saranya Mishra a partner at Khaitan & Co. The opinions are theirs)