Close on the heels of the amendments brought about to the SEBI(Listing Obligations and Disclosure Requirements) (LODR) Regulations, 2015 by SEBI on May, 5, 2021, it has come out with another notification on august 3, 2021, christened as the SEBI (LODR) (Third Amendment) Rules, 2021. While the former notification encapsulated changes almost to the entire gamut of the above Regulations, the latter notification has a distinctive sector specific pitch with the focus being on heralding a more rigorous regime in relation to the criteria for determining the independence of independent directors , putting an end to the existing practice of the Independent directors(IDs) being appointed by the Board subject to subsequent ratification of the members, providing that related party transactions shall be subject to approval only by the IDs.
Before we make a deep dive on the implications of the changes brought about, it is pertinent to note that the amendments have been notified for application as on the date of their publication in the Official Gazette i.e. August 3, 2021. However, in the press release issued by SEBI to announce the changes, it has been stated that the amendments made shall be prospective and therefore come into force from January 1, 2022. A faux pas of sorts appears to have been committed in the matter of the effective date of the notification and SEBI is expected to issue a corrigendum to clarify that the changes would be prospective only and will apply from January,1, 2022. It would only be fair that the changes are operative prospectively as making them operative with immediate effect would have literally set the cat amongst the pigeons and India Inc. would have been deprived of an opportunity to assimilate the import of the significant changes made in the regulations.
This exposition is therefore written on the premise that the amendments are applicable effective from January,1, 2022 as stated in the SEBI Press communiqué.
Criteria for determination of status of Independent directors (IDs) stiffened
Important changes have been announced to Regulation 16(1) in the definition of an 'Independent director'. The independent director shall not have any material pecuniary relationship other than by way of his remuneration as director of the independent director, with the company, its holding , subsidiary or associate company during the two immediately preceding financial years or during the current financial year. This provision is being modified to provide that such relationship shall not exist in the immediately three preceding financial years.
Further in substitution with the existing clause(v)in Regulation 16(1)(b) it is provided that neither the ID nor any of his relatives shall hold any securities or interest in the listed company , its holding, subsidiary company during the three immediately preceding financial years or during the current financial year of a face value which is in excess of rupees fifty lacs or two percent of the paid up share capital of the company or its associated companies of the genre stated above or such higher amount as maybe prescribed.
In addition, the ID shall not have any indebtedness with the listed company or its associates as above in excess of such amount as maybe prescribed during the preceding three financial years or during the current financial year.
The ID shall not also provide any guarantee or provide any security in connection with the indebtedness of any third person to the listed company, its holding, subsidiary or associate company or their promoters or directors for such amount as may be specified during the three immediately preceding financial years or during the current financial year.
He shall not have any other pecuniary transaction or relationship with the listed company or its affiliates as above which accounts for two percent or more of its gross turnover or total income.
Pecuniary relationship or transactions with the listed company or its affiliates as described above shall not exceed two percent of its gross turnover or total income or fifty lacs or such higher amount as maybe prescribed.
In Regulation 16(1)(vi), the present requirement is that neither the ID nor his relatives shall hold or has held the position of a Key Managerial personnel (KMPs)or is or has been an employee of the company or its affiliate companies .It is now being provided that such employment shall not be in any company which belongs to the promoter group of the listed company.
It is also now provided that in case the relative of the ID is an employee in the listed company or its affiliates as mentioned above, other than in the capacity of a KMP, this will not vitiate the independence of the ID.
Appointment of directors to be approved at the next General meeting or within three months from the date of appointment whichever is earlier
Regulation 17(1C) is being inserted to provide that where the Board has appointed any person as a director, it shall be ensured that approval of the shareholders is obtained at the next general meeting or within a period of three months from the date of appointment whichever is earlier.
The above insert will run contrary to the provisions of Section 161 of the Companies Act, 2013(hereinafter 'The Act') in terms of which the Board is empowered to appoint an additional director whose appointment has to be regularized at the next AGM and not at any General meeting .Further where a director is appointed in a casual vacancy, the appointee survives the term of the original director .
The listed company cannot have the luxury of availing of the benefit of Section 161 post January,1, 2022 and will have to regularize the appointments made by the Board by holding a general meeting within three months from the date of appointment. The listing Regulations being a special provision for listed entities shall prevail over the Act which would be in the nature of a general provision and the provisions contained in Section 161 will have to yield place at the altar of Regulation 17(1C).
The other aspect which needs articulation in this area is that although Regulation 17(1C) prima facie contemplates appointment of any director including an independent director, considering the fact that the amendments introduced by SEBI consider appointment of Independent directors only through a special resolution under new sub-regulation (2A) under Regulation 25 which shall discuss subsequently, we are of the considered view that Regulation 17(1C) applies to the appointment of directors other than IDs only.
The immediate fall out of the above insert is that appointments of directors by the Board shall be short lived with the need to have the ratification of such appointments by members at General meetings latest within three months from the date of such appointment. The tried and trusted procedure set out in Section 161 of the Act will have to be given a go by in the face of Regulation 17(1C).
Nomination and Remuneration committee to have two thirds as Independent directors
The present requirement is that the NRC shall have IDs to the extent of fifty percent. This requirement is being increased to two thirds representation by IDs under Regulation 19.
Audit Committee to have at least two thirds representation by way of IDs-Regulation 23(2)
The existing stipulation is that the Audit committee shall comprise of two thirds by way of IDs and in the case of a company which has issued SR Equity shares all the members shall be IDs.
The insert of the words 'at least' in the above Regulation makes it obvious that the composition of the Audit committee shall be such that it shall have at least two thirds as IDs. There is of course no objection to the company having more than two thirds of the IDs in the Committee voluntarily.
Related party transactions (RPTs) shall be approved by IDs only-Regulation 23(2)
A proviso is being inserted under the above Regulation to stipulate that come January 1, 2022 all related party transactions shall be approved only by IDs.
This is a significant change as it has the effect of fragmenting the Audit committee into an exclusive club of IDs albeit, for the limited purpose of approving RPTs.
While the change is salutary from the stand point of ensuring that there will be independent decision making over RPTs , the flip side to it is that as IDs are not involved in day to day operations, they may not be aware of the commercial advantages sought to be drawn from such transactions. Moreover as the approval to such transactions shall become the exclusive preserve of the IDs , the IDs being conscious of their responsibilities, may be too cautious and conservative in granting approval to RPTs.
This is one example of Regulation dictating the manner in which business will be conducted and it will be left to posterity to decide on the merits associated with this reform.
Another question that remains unanswered is whether after the approval is granted by the IDs to the RPTs will it remain a decision of the Audit committee or a decision of the Independent directors considering that no change is being made to the settled position in the law that RPTs need to be approved only by the Audit committee.
Appointment, re-appointment and removal of IDs subject to approval by special resolution-Regulation 25(2A)
Sub-regulation (2A) is being introduced under Regulation 25 to provide that the appointment, re-appointment and removal of an ID shall necessitate the approval of shareholders by special resolution. This will mean that the board shall not have the freedom to appoint IDs as and when intermittent vacancies arise or where there arises a need to infuse fresh blood.
It will be necessary to seek the approval of the shareholders at general meeting by special resolution for such appointments or in cases of removal. The Board will have to take precipitator action by holding general meetings or by seeking approval through postal ballots for such appointments expeditiously.
Further considering the fact that in sub-regulation (6) of Regulation 25 the words 'the immediate next meeting of the Board of directors or 'appearing after the words 'later than the' and before the words 'three months' are being omitted clearly suggests that the Board shall take immediate action by convening a general meeting or by organizing a postal ballot soonest when a vacancy in the position of an ID arises.
The above changes mark the culmination of the objective of SEBI to take away the flexibility which is being now enjoyed by the Board in the matter of appointment of IDs albeit through a subsequent regularization process involving members' approval.
D&O insurance coverage for IDs of top 1000 companies
Regulation 25(10)provides that the top 500 companies in terms of market cap have to extend coverage to its IDs under a D&O policy. This requirement shall stand extended to the top 1000 companies with effect from January 1, 2022.
No ID shall be associated as Executive/Whole time director immediately upon resignation-Regulation 25(11)
Sub-Regulation (11) is being introduced which provides that where an ID resigns from his position, he shall not be appointed as an Executive /Whole time Director of the company or its holding company or subsidiary or associate or on the board of a company belonging to the promoter group unless he cools his heels for a period of one year from the date of his resignation.
This is a good step but with an obvious loophole. There is no bar to the ID being associated with the company as an Advisor or consultant of the company upon his resignation. Ideally the cool-off period of one year should have covered engagements of every genre.
In addition ,the clause does not restrain such appointment once the tenure of the ID gets over.
Disclosure requirements at the time of appointing new directors-Regulation 36(3)
While appointing a new director, apart from the existing disclosures that are to be made under the above Regulation, the company will have to state the details of the listed companies from which the proposed appointee has resigned in the last three years.
Further where it comes to appointment of IDs , a statement shall have to be made as to the skills, capabilities and the role which are expected in the said position and whether the proposed appointee fits the bill in terms of the above parameters.
Role of Nomination and Remuneration Committee(NRC) widens
Through changes being made to Schedule II under Part D , the NRC 's involvement in the selection of IDs is being widened by providing that the committee shall evaluate the balance of skills ,knowledge and experience expected of the candidate and on the basis of such evaluation, the Committee shall prepare the role and capabilities required of the ID .The person recommended for the appointment shall have the capabilities identified in that description. To facilitate the performance of this role, the NRC shall make use of an External Agency if need be and also consider candidates from a wide range of backgrounds with an eye on Board diversity , and also factor in the time commitments that can be made by the candidates.
Letter of resignation of the Independent director to be provided to the Stock Exchanges
Under the present dispensation it is good enough if the detailed reasons for the resignation of the ID are provided to the Stock Exchanges. As there was no need to attach the letter of resignation , to avoid embarrassment and reputational loss, companies could come out with diplomatic reasons to explain the resignation of the IDs.
The proposed amendments make it obligatory for the company to attach with the intimation of resignation, the letter of resignation which is expected to provide the detailed reasons behind the resignation. This will mean, in a manner of speaking, that skeletons could come out from the cupboards of the Board room in case the resignation of the ID is the culmination of any acrimonious relationship with the Management.
The above move obviously provides for greater degree of transparency in the matter .The flip side is that the outgoing ID ,in an act of pique, could also overreact in the given situation by providing reasons which may be exaggerated leading to the company providing a counter to the alarms . if any, raised by the ID.
Along with the letter of resignation, the company should also provide the details of listed companies with which the outgoing ID is associated indicating the category of directorship and Committee memberships.
Conclusion
The amendments made mark the culmination of the recommendations made by SEBI on the subject of Independent directors and it will undoubtedly have the effect of ensuring that the bar on corporate governance is not in any way lowered. The other aspect that comes out loud and clear is that the areas of divergence as between the Act and the Regulations already existing will widen further-an allusion to the adage that 'two straight lines shall never meet'. Corporate India should gear up to meet the requirements of the amended Regulations and rise up to the occasion and deliver governance in the true sense as opposed to the traditional 'ticking the box' approach which has thus far punctuated the compliance requirements under the Regulations.
CAclubindia
