INDEPENDENT DIRECTORS

The origins of the concept of independent

directors can be traced to the United

Kingdom and United States of America. In

the United States of America, in the second

half of the 20th century, listed companies

were encouraged to have at least two 'outside directors'

on their boards. This was primarily to introduce

objectivity to the decision-making process, provide

a solution to management-shareholder conflicts,

and improve performance of the company. However,

corporate scandals like Enron and Worldcom, featuring

management transgressions like poor reporting

standards, ignorance of high risk issues, unsanctioned

loans and guarantees, accounting loopholes, etc.

prompted amendments to the listing rules of key stock

exchanges like NYSE and NASDAQ.¹ These changes also

found legislative backing with the enactment of the

Sarbanes Oxley Act of 2002, which provided for listed

company audit committee independence requirements

and responsibilities.

Similarly, following a series of corporate scandals in the

United Kingdom, the Cadbury Committee was established

in May 1991 by the London Stock Exchange, the Financial

Reporting Council and the accountancy profession. The

reason for its creation was the significant fall in investor

confidence in the accountability of listed companies, which

had been triggered, in part, by the Maxwell scandal and

the collapse of the Polly Peck consortium and the Bank of

Credit.² The central elements of the Cadbury Report code

provided for (i) a clear division of responsibilities, i.e.

a separation of the chairman of the board from the chief

executive, or a strong independent voice on the board;

(ii) the board comprising of a majority of outside directors;

(iii) remuneration committees comprising of a majority of

non-executive directors; and (iv) the appointment of an

audit committee by the board, including at least three nonexecutive

directors. These provisions were given statutory

authority by amendments to the London Stock Exchange,

whereby listed companies had to "comply or explain", i.e.

elucidate the extent of their compliance to the code and

explain any deviance from its provisions.³

Developments in India

In India, the origin of independent directors can be traced

to recommendations made by the Kumara Mangalam Birla

Committee (1999), Naresh Chandra Committee (2002), and

Narayana Murthy Committee (2003). Pursuant to these

recommendations, the concept of independent director

was introduced for the first time by the Securities and

Exchange Board of India ("SEBI") in Clause 49 of the listing

agreement, requiring listed entities to appoint independent

directors on their board.

With the advent of time, however, the Indian corporate

world was shocked by the Satyam scandal, which involved

the manipulation of the company's accounts, amongst

other malpractices. Pricewaterhouse Coopers, the

independent auditor of Satyam, was fined for not following

the code of conduct and accounting standards in the

performance of its duties. Immediately after the Satyam

scandal in 2009, more than 500 independent directors

across various Indian companies resigned due to issues

relating to transparency in corporate governance and their

consequent liabilities due to fraudulent activities of the

companies appointing them.

Subsequently, an order of SEBI in 2011 may have added

to the fear in the minds of independent directors. In the

said order, three independent directors of Pyramid Saimara

Theater Limited were restrained from discharging their duties as directors in any listed company for three years

because they had erred in preventing false and misleading

accounting disclosures by the company. SEBI, while

reiterating the 'duty of care' test, refused to accept that

directors could not be held responsible for the day-to-day

affairs of the company. However, the Ministry of Corporate

Affairs ("Ministry") in a circular in 2011 clarified that

penal actions against non-executive directors could only

be maintained if the Registrar of Companies ("Registrar")

concluded that the directors had failed to act diligently, and

were 'officers in default' under the erstwhile Companies Act,

1956. A prosecution against them could not succeed if the

violation had occurred without their knowledge or consent.

The said circular conferred discretion on the Registrar to

confirm and verify the aforesaid factors before issuing a

notice to non-executive directors.

The committee constituted by the Ministry to revamp

the Companies Act, 1956, was of the view that given the

responsibility of the board to balance various interests,

the presence of independent directors on the board of a

company was critical for improving corporate governance.

It also maintained that independent directors would bring

an element of objectivity to the board process, working to

the benefit of general interests of the company and those

of the minority and smaller shareholders. Accordingly,

the requirement of independent directors was proposed

by means of the Companies Bill, 2009 ("Bill"). The Bill provided for independent directors to be appointed on the

boards of companies along with attributes determining

independence.⁴

Independent directors under the

Companies Act, 2013 ("Act") and

SEBI regime

These proposals were incorporated in the Act, which

mandates the appointment of independent directors by all

public listed entities and certain prescribed classes of public

companies. A concomitant obligation on listed entities is

captured under the SEBI (Listing Obligations and Disclosure

Requirements) Regulations, 2015 ("Listing Regulations").

The number of independent directors mandated thereunder

ranges from a minimum of 1/3rd to 1/2 of the board, based

on the board constitution. The Act (along with the Listing

Regulations) prescribes the pre-requisites of being an

independent director.

An independent director is a director other than a managing

director, a whole time director or nominee director who,

amongst others, is a person of integrity and possesses

relevant expertise and experience; is not or was not a

promoter of the listed entity, or its holding, subsidiary

or associate company; is not related to the promoters

or directors of the company, its holding, subsidiary or

associate company; and has had no pecuniary relationship

with the company or its promoters or directors during the

immediately preceding two financial years. An independent

director must possess appropriate skills, experience and

knowledge in fields like finance, law, management, corporate

governance, etc., related to the company's business. An

independent director is also required to be a part of various

committees of the board, such as the nomination and

remuneration committee, audit committee and corporate social responsibility committee. Independent director must

comply with the code of conduct for independent directors

provided in Schedule IV of the Act, which lays down

guidelines for their professional conduct. These revolve

largely around protecting the interests of the company,

its shareholders and employees, reporting concerns about

any violations, etc., maintaining their own 'independence'

and objectivity at all times, and assisting the company in

implementing the best corporate governance practices.

In today's context, independent directors are involved in

the review of, among others, the performance of the (i)

management; (ii) board; (iii) non-independent directors;

and (iv) chairperson of the company (taking into account the

views of executive and non-executive directors). Importantly,

the Act limits the liability of an independent director to such

acts of omission or commission by a company which had

occurred with his knowledge, attributable through board

processes, and with his consent and connivance or where

he had not acted diligently.

Conclusion

The aforementioned developments have made it evident that

the role of the independent director is considered pivotal to

the company's growth and effective management. While the

legislature has indeed taken steps in a positive direction,

the determining factors in making this exercise a successful

one will be (i) the company's role in satisfying itself of the

capabilities and independence of its independent directors;

(ii) the role of the independent directors in scrutinizing the

affairs of the company with a keen eye, and continually

ensuring their own independence; and finally (iii) functions

of the board being guided by honesty, frequent introspection

and integrity. Only when these steps are implemented in

congruence with each other can high standards of corporate

governance be truly achieved.

Footnote:
1. Seil Kim and April Klein, "Did the 1999 NYSE and NASDAQ Listing Standard Changes on Audit Committee Composition Benefit Investors?" (January 2017), available

at

NASDAQ Listing Standard Changes on Audit COmpositi....pdf>, last viewed on May 12, 2017.

2. Anonymous, "The Cadbury Report", the

University of Cambridge (Judge Business School), available at, last viewed on May 12, 2017; see also Ranjan R., "Role

of Independent Directors in Corporate Governance", Indian Academy of Law and Management, available at

governance/>, last viewed on May 12, 2017; see also Donald C. Clarke, "Three Concepts of the Independent Director", George Washington University

School of Law, 32 Del. J. Corp. L. 73 (2007), available at , last

viewed on May 12, 2017.

3. Anonymous, "The Cadbury Report",the University of Cambridge (Judge Business School), available at

report>, last viewed on May 12, 2017.

4. The Companies Bill, 2009, available at p. 68, last viewed on May 12, 2017

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.