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Thursday, August 18, 2022

SEBI’s backtrack on independent directors

Umakanth Varottil writes: The securities regulator decided to forego the opportunity to revamp the system. It has deprived minority shareholders of the say it had extended earlier.

While the regulators have taken giant strides to enhance board independence in India, one significant conundrum persists.

In the high-profile Tata-Mistry corporate dispute, noted industrialist Nusli Wadia became collateral damage. The shareholders of several Tata group companies passed a resolution to remove Wadia as an independent director from their boards. Wadia’s so-called transgression was that he spoke out in favour of the minority shareholders of the Tata group, thereby inviting the wrath of the promoters. This episode warns of ominous consequences for the institution of independent directors in India: Toe the promoter line or confront an ouster from the company.

While the regulators have taken giant strides to enhance board independence in India, one significant conundrum persists. Even though concentration of shareholding is the norm in Indian companies, independent directors are appointed just like other directors through shareholder voting by a simple majority, thereby conferring significant power in the hands of significant shareholders to handpick the independents. In case of family-owned companies, it is not uncommon to appoint “friendly” independent directors. As for public sector undertakings, an investigation by this paper (‘How independent are Independent Directors of PSUs? Half from BJP’, IE, July 2) reveals a demonstrable affiliation between independent directors and the ruling political dispensation of the day. These trends suggest that unless independent directors owe their allegiance to the shareholder body as a whole, and not merely to the promoters, independence is likely to remain largely in form and not function.

The process for appointment and removal of independent directors is by far the most important determinant of allegiance. If they are to serve at the pleasure of all shareholders, rather than just promoters, independent directors must be hired and fired accordingly. Taking a step in this direction, the Securities and Exchange Board of India (SEBI) in March this year made a laudatory proposal. In its consultation paper, the market regulator appeared to concede that even though an independent nomination and remuneration committee of the board screened candidates for independent directorships, the appointment was ultimately dominated by the promoters during shareholder voting.

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Hence, SEBI proposed a “dual approval” system whereby the appointment of an independent director required the satisfaction of two conditions: First, the approval by a majority of all shareholders and, second, the approval of a “majority of the minority”, namely the approval of shareholders other than the promoters. In case of a failure to satisfy the two-step test, the company would be free to propose the same candidate after a 90-day cooling off period for approval by a special resolution (75 per cent majority) of all shareholders voting. SEBI recommended the same “dual approval” system for the removal of independent directors as well. In establishing such a minority shareholder-friendly mechanism, SEBI drew inspiration from Israel and the premium-listed segment of the United Kingdom, which confers greater power to minority shareholders in installing or dethroning independent directors.

However, what began with a bang ended with a whimper. In a press release on June 29, SEBI announced that the appointment and removal of independent directors would be by way of a special resolution rather than a simple majority and made no mention of the dual voting system. By this, SEBI has clearly backtracked from its proposal in the consultation paper and deprived the minority shareholders of the level of say it had extended earlier. Regrettably, SEBI has neither published the feedback received during its consultation, nor articulated the reasons behind its change of heart. But it is entirely reasonable to assume there was a significant resistance from the industry and, in particular, the promoter groups. In substantially downgrading the say of minority shareholders in determining independent directors, India has failed to take a place among elite jurisdictions adopting the dual approval system.

Opponents of the dual approval voting mechanism have generally raised a number of objections, none of which hold water. The first protestation is philosophical in that it militates against the majority rule principle that is intrinsic in a corporate democracy. While understandable, that is hardly an immutable rule as corporate law does make exceptions in cases involving oppression of minority shareholders.

The second concern is that placing too much power in the hands of minority shareholders would be counterproductive, as it could result in a tyranny of the minority, and impinge upon the required collegiality in the boardroom. However, the dual approval system instead represents the best of both worlds. It does not negate the promoter’s involvement in the process of appointing or removing independent directors. The first limb requires the approval of all shareholders, where promoters would have a significant influence. At the same time, minority shareholders have a say as well, through the second limb that requires a “majority of the minority” vote. Hence, the appointment or removal of independent directors would need the approval of both constituencies, the promoters as well as outside shareholders. Only consensus candidates would end up becoming independent directors.


The third issue is one of shareholder apathy: Will minority shareholders be motivated to exercise an informed and meaningful choice? Minority shareholders tend to be passive when they are unable to influence the outcome of shareholding voting. However, where they do have a significant say, like in the “majority of the minority” process, they are likely to be more active in exercising their franchise. Rising shareholder activism in India, stewardship obligations of institutional shareholders and a vibrant proxy advisory industry create an efficient support system for minority shareholders to act.

In all, the appointment and removal system continues to undermine the independence and efficacy of corporate boards. The securities regulator decided to forego the opportunity to revamp the system. One hopes that the current outcome does not signal the death knell to the proposal of the “majority of the minority” voting for the election and removal of independent directors, and that it will return to the Indian corporate governance discourse before too long.

This column first appeared in the print edition on July 14, 2021 under the title ‘Letting the board down’. Varottil is associate professor of law at National University of Singapore

First published on: 14-07-2021 at 02:47:02 am
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