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March 8, 2021

SEBI proposes new Rules for Independent Directors

by CA Jessica Nagaonkar in SEBI

SEBI proposes new Rules for Independent Directors

The Securities and Exchange Board of India was established in accordance with the provisions of the Securities and Exchange Board of India Act, 1992. It is the duty of the Board to protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit. SEBI has over the years, strengthened the institution of independent directors (IDs) through the recommendations of various committees as also through stakeholder consultations.

However, concerns around the efficacy of independent directors as a part of corporate governance framework continue. There was therefore a need to further strengthen the independence of IDs and enhance their effectiveness in the protection of interests of minority shareholders and performing other functions. In view of the same, SEBI proposed a slew of changes in the regulations dealing with appointment, removal and remuneration of independent directors and their role in the audit committees of a listed entity. Let us learn more about what is being proposed by SEBI in this article.

Introduction of Cooling Period of 3 years for KMP

  • Key management personnel (KMP) are those persons having authority and responsibility for planning, directing, and controlling the activities of the entity, directly or indirectly, including any directors (whether executive or otherwise) of the entity.
  • At present there are restrictions on those who have been KMP’s in a company, or those who have had a material pecuniary relationship with a company, its subsidiaries or promoters.
  • The cooling-off period for the each was three and two years, respectively.
  • Now, SEBI has proposed to introduce a single cooling-off period of three years.
  • That means, a KMP or his relative, and anyone that has had a material pecuniary relationship with the company, its subsidiaries or promoters, can be appointed as an independent director in a listed entity only three years from the date when he ceases to have a pecuniary or employment relation with the listed company

Dual Approval Process for Appointment, Reappointment and Removal of Independent Directors

  • Independent Directors are non-executive Directors who do not have any material or pecuniary relationship with the Company.
  • Under existing company law and SEBI regulations, independent directors are nominated and appointed by the company’s board subject to the subsequent approval by shareholders through an ordinary resolution (simple majority must vote in favour).
  • In case of a re-appointment the approval must be via a special resolution (at least 75% of those voting must be in favour).
  • The same process of ordinary and special resolutions (second term) applies in case of removal of a director.
  • In the case of promoter-led companies, the shareholder vote outcome would be swayed by the majority.
  • In order to give non-promoter or public shareholders a stronger voice, SEBI has proposed a dual approval process for appointment, re-appointment or removal of independent directors from the board of a listed entity.

What will be the features of this Dual Approval?

  • Appointment, reappointment or removal of independent director would require approval of both – the shareholders and also majority of minority shareholders.
  • The shareholder vote would be via ordinary or special resolution as is the existing case for appointments and reappointments.
  • The majority of minority vote would be via simple majority.
  • Both votes would be done through a single process and meeting.

What would happen if candidate fails to get dual approval?

  • Any candidate failing to get dual approval can be proposed again for independent directorship via a second vote after a period of 90 days.
  • The vote in such a case would be via a special resolution put to all shareholders.
  • The same process would apply for removal of independent directors.

Remuneration of Independent Directors

  • SEBI has also, once again raised the issue of remuneration for independent directors. SEBI has also sought public feedback on the remuneration of independent directors, particularly on the debate of linking their pay-outs to profits
  • The regulator has noted that skin-in-the-game is important but profit-linked commissions may encourage short-termism. A better option may be to allow long-vesting ESOPs. Incidentally, when the new company law was legislated in 2013, ESOPs were disallowed on the same concerns of short-termism.

Resignation by Independent Director

Noting the need to strengthen disclosures around resignation of independent directors, SEBI has proposed that:

  • Entire resignation letter must be disclosed to the shareholders along with a list of his membership in committees of the board.
  • An independent director who resigns from a board citing pre-occupation, personal commitments etc will be subject to a cooling period of 1 year before joining any other board.

Detailed disclosures by the Nomination and Remuneration Committee

  • The task of the Nomination and Remuneration Committee is to assist the Board of Directors in matters related to the appointment and compensation of the Company’s CEO and Management Group.
  • In addition, the Committee prepares for the Annual General Meeting a proposal on the number of Board members, Board composition and Board member compensation.
  • The Committee also recommends, prepares and proposes to the Board the CEO’s and the deputy CEO’s nomination, salary and compensation, and further evaluates and provides the Board and the CEO with recommendations concerning management and employees rewards and compensation systems.
  • In addition, the Nomination and Remuneration Committee prepares the remuneration policy and remuneration report for the Company’s governing bodies.
  • SEBI has proposed more detailed disclosures by the Nomination and Remuneration Committee regarding selection of candidates for post of independent director.
  • The NRC will be tasked with evaluating the skills, knowledge and experience for shortlisting candidates.
  • Also, the appointment of key managerial personnel (KMP) and employees of promoter group companies as independent directors would require more checks and balances.
  • And, in the case of vacancy in an independent director post, the new candidate appointed by the board must be subject to shareholder approval within 3 months.

Independence of Audit Committee

  • Audit Committee plays a critical role by ensuring the independence of an audit process.
  • Audit Committee is formed to act as a conduit of information supplied by the management to the auditors and to insulate an auditor from the pressures of the management.
  • Therefore, such committees are to be independent of management and has the responsibilities of deciding the work or scope, including the fixation of audit fees and the determination of the extent of non-audit services.
  • Currently, two thirds of a board’s audit committee must comprise independent directors.
  • Given the import of the decisions made by audit committees, ranging from finalisation of accounts to related party transactions, SEBI has proposed that: 2/3rds of the total strength of an audit committee must comprise of independent directors, while the remaining must be non-executive directors who are not related to the promoter

SEBI’s efforts come a year after the corporate affairs ministry mandated a test to determine eligibility of an individual to be appointed independent director and include their names in a data bank last year. SEBI said the proposals were prompted by continuing concerns around efficacy of independent directors and the need to strengthen their independence and effectiveness in order to protect minority investors.

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