Impact Of The Budgets On Startups

In 1993, Vinod Dham redefined the way people looked at semiconductors that powered computers by leading a group of engineers at Intel to develop the ‘Pentium’. He subsequently came to be known as ‘Father of the Pentium Chip’. Overtime, he became a mentor, philanthropist and a popular guy in the finance world.

Never in a million years, he would have thought that his image would be tarnished. But in 2018, the Hyderabad High Court imposed a fine of Rs 20,000 on Dham for conflict of interest in providing professional services to Satyam and remaining on the board of Satyam as an independent director and for failing to get the government’s nod for providing professional services. But he was only fined miniscule in comparison to Krishna G Palepu. A former professor at Harvard Business School, Palepu had received Rs 87 lakh as fees from Satyam without Govt’s approval. He was fined the highest among 6 others at Rs 2.66 crore. This was all in connection to the Satyam Scam that sent shockwaves to the entire country in 2008.

In this article shall look at the role of Independent Directors of a company and how the role becomes even more crucial when the company goes bankrupt for some reason.

A Brief History of the Satyam Saga
Satyam Computer Services Ltd was a Hyderabad-based software Company set up in 1987. It catered to the IT needs of various sectors like Healthcare, Bio-Tec., Telecommunication and Media, Automotive Banking & Finance, etc.

On January 7, 2009, the Chairman of Satyam Software Services Ltd, Ramalinga Raju, confessed to a Rs 7,136 crore fraud committed by him and a few others at the company by admitting that his company had been falsifying its accounts for years, overstating revenues and inflating profits.

He took sole responsibility for those acts and further stated in a letter to SEBI that “it was like riding a tiger, not knowing how to get off without being eaten.” The scam highlighted several loopholes in the Indian corporate governance structure – unethical conduct, fraudulent accounting, insider trading, oversight by auditors, ineffectiveness of Board, failure of independent directors and non-disclosure of material facts to the stakeholders.

The mayhem that Satyam Scam brought to the Dalal Street forced heads to roll in the corporate governance space. There was a call to fix accountability and protect shareholders’ interests by fixing more responsibility on the promoters and the directors- including the independent ones.

The changes post the Satyam Episode.
The new Companies Act 2013 increased compliances by the companies. It required at least one-third of the Board as Independent Directors (as opposed to Clause 49 of Listing Agreement that called for more) with tenure of initial 5 years and who receive only fee and not stock options. Thanks to Satyam again (which wanted to buy the two Maytas firms owned by promoters’ kin), the new Act introduced stricter norms on related party deals and also empowered shareholders through the class action suit provision. The SEBI made it mandatory to rotate individual auditors after five years and audit firms after 10 years to improve the quality of financial reporting, detect any oversight and ensure independence of auditors in the true sense.

But the notable difference came about to be the role of independent directors.

What prompted the change in Role of Independent Directors ?
The erstwhile Companies Act 1956 did not provide a specific definition of an Independent Director. In the Satyam case, a panel of independent directors which included a Harvard Professor, former IIT director, a cabinet secretary and even the dean of Indian School of Business and others, couldn’t stop the Maytas deal which ultimately resulted in the admission of Raju to a scam. Even prior to that, the independent directors had failed in discharging their duties professionally by signing off on every important matter of the company without much deliberation. Shareholders lost Rs 13,600 crore in Satyam shares in less than a month and the scam had international ramifications as well.

The Role of Independent Directors: Post the Companies Act 2013
Section 149(6) clearly defined the meaning of independent directors as follows:

“An independent director in relation to a company, means a director other than a managing director or a whole-time director or a nominee director,— [(a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience;

(b) (i) who is or was not a promoter of the company or its holding, subsidiary or associate company;
(ii) who is not related to promoters or directors in the company, its holding, subsidiary or associate company”

The Companies Act, 2013 requires the CSR Committee to consist of at least three directors, including at least one independent director, by companies that trigger the conditions of the Corporate Social Responsibility (CSR) Committee of the Board to formulate and monitor the CSR policy of a Company. It clearly states that the Independent director’s appointment process must be independent of the company’s management and that databank may be used to appoint an independent director

Apart from this every independent director is required to give a declaration that he meets the criteria of independence when :
He or she attends the first board meeting as a director.
In every financial year, at the first meeting of the board of directors.
When a situation arises which affects his or her status of independence being an independent director.
The Act states that the independent directors shall be appointed for a maximum term of 5 years and there shall not be more than 2 consecutive terms. Any vacancy in the office of independent director is required to be filled in the very next Board Meeting or within 3 months of such vacancy, whichever is later.

It also makes clear that a person can not be an independent director in more than seven listed companies at a time. The Act also empowered corporate governance by allowing a small shareholder to be an independent director provided he/she fulfills certain requirements.

If the Board meeting is called at a shorter notice so as to transact some urgent business, then the presence of at least one independent director is mandatory. In absence of any independent director, a decision should be circulated to all the directors and later approved by at least one independent director.

But All is *not*’ well
The MCA notified 18 March 2021 as the date on which, under Section 32 & 40 of the Companies (Amendment) Act, 2020 that public companies could now remunerate their non-executive directors, including independent directors, even if companies are loss making or have inadequate profits. The Ministry also specified the maximum yearly remuneration that could be paid to them by such companies, as defined in Schedule V.

This was prompted by the fact that there was a shortage of independent directors. The country has 6800 listed companies. India Inc has faced an exodus of independent directors in the past 2-3 years, amid the changing regulatory landscape. In the past 2 years, more than 2,000 independent directors have quit, spooked by high-profile corporate frauds, accounting discrepancies, and application of global anti-corruption laws. Once considered a dream position, the post of Independent Director has lost its sheen. It is not only the case of the private sector but even the public sector undertakings are not finding suitable candidates to fill the positions lying vacant for some time.

This prompted SEBI to say that independent directors resigning over governance concerns should come forward and state the same clearly to the public at large. However, that has not happened yet.

One such example was towards the end of 2018, when several independent directors of jailed businessman Rana Kapoor promoted Yes Bank Ltd. had quit the bank’s board through a series of resignations. But the actual letters of resignation were not revealed to the public by the bank, whose board was eventually taken over by an RBI administrator and subsequently replaced by a new board altogether after SBI picked up a majority stake in the bank to salvage it from a complete failure. Another notable example was K N Murali, former independent director of Dhanlaxmi Bank, who had resigned from the bank board citing personal reasons. In the infamous Nirav Modi case and also the Satyam case, the Enforcement Directorate had attached the assets of the independent directors and they were in trouble in view of piling up large cases against them.

The Tough Road Ahead
In April of this year, SEBI chief Ajay Tyagi remarked, “Yet another issue commonly raised is that however we may strengthen the processes related to independent directors, ones who are genuinely not independent will never be. It is true that human behaviour cannot be fully regulated by norms. However, it is our endeavour through improved processes and disclosures, to bring in greater balance, transparency and quality in the selection of independent directors and functioning of the corporate boards,”

Remember the resignation letter we talked about earlier ? SEBI has proposed in a consultation paper put out in March that while quitting a board, the entire letter of resignation by the independent director should be made public. Unlike the US and UK, in India the ownership in companies is mostly concentrated. And over time, SEBi has emphasized on the need to separate the roles of chairperson and managing director in Indian companies.

Indian companies were initially required to separate the roles of chairperson and managing director from 1 April, 2020 onwards. The deadline has been extended and this norm will be applicable to top 500 listed entities by market capitalization, with effect from 1 April, 2022. As at the end of December 2020, only 53% of the top 500 listed entities had complied with this provision.

There is a tremendous need to have independent directors that act as a watchdog overseeing the companies. When talking of effective corporate governance, Independent Directors quitting is a major worry and there lies a tough road ahead.

At Finsurety Advisors we provide the best in class consultancy services related to Companies Act & all it’s compliances.

– Finsurety Advisors LLP