INDEPENDENT DIRECTORS – NOT JUST COMPLIANCE BUT A REQUIREMENT

Introduction

With India emerging as a prominent player in the global economy, there is an urgent need in the Indian Corporate Sector to upgrade the Corporate Governance System on par with the international norms. It has been widely observed that the Indian MNCs are way ahead than the PSUs in terms of quality of management; the PSUs, however, have an edge in terms of transparency of management.

Foreign Institutional Investors are investing heavily in India and it is for sure that the Corporate Sector in India has to inculcate a lot of professionalism in their functioning methodology. The Corporate Governance in the Indian Corporate Sector has to change rapidly in order to remain a strong force in the global economy.

Barring a few exceptions, the Indian Corporate Houses continue to function in the same conventional manner as they used to over a couple of decades ago. The quarterly Board Meetings have become a mandatory ritual, where trivial issues are discussed. It has also been observed that the Promoters prefer to appoint their acquaintances to the Board of Directors, in order to restrict the external interference in the management. Law is enforced to bring about a change and that very same Law is usually tweaked to ensure compliance as well as preference. Voluntary compliance to the regulations in strict sense is the only option to ensure a good Corporate Governance system.

Independent Director

The term "Independent Directors" became a part of the Indian Corporate dictionary after the publication of the Kumar Mangalam Birla Committee Report, which led to the introduction of Clause 49 in Listing Agreements.

The appointment of an Independent Director (Non-executive Directors) in the Indian Corporate Sector has become a matter of mere legal compliance. It is very common to have a retired bureaucrat, a celebrity like a film artist, a retired major general from the army, a retired judge from the High Court or the Supreme Court, etc. as the Independent Director on the Board. There is nothing wrong in this approach per se but more often than not these Independent Directors end up as a decoration on the Christmas tree.

Even today, in most of the companies, Independent Directors have no say in management issues. Over the years, “Manpower” played a key role in making or breaking a Corporate Structure. The Independent Director needs to have a prominent role in the management affairs of the Company and should be able to devote considerable amount of time to do the same rather than just remain a Namesake.

The rationale for requiring an Independent Director on the Board is to ensure a special check on the finances and functioning of the company particularly through the Audit Committee. The appointment of an Independent Director just to comply with the law defeats the complete rationale behind enforcing such a law.

The Legal Provisions do not define the required qualifications for a person to be appointed as an Independent Director, but rather specify grounds on which a person could be disqualified from being an Independent Director. The Law requires the Independent Directors to have discretion to think and act independently in the management affairs. The Law also mandates that the shareholders should elect an Independent Director.

In practice, however, the Promoters nominate or rather choose the candidates to be elected as an Independent Director. This transforms the “election” of an Independent Director to just “selection” of an Independent Director for the Shareholders point of view.

The ideal methodology to be employed in appointing an Independent Director should be based on certain values encompassing a proper mix of specialization in the areas of accounting and finance, technology relevant to the Company, Corporate Management, marketing and industry knowledge, etc. Perhaps, a skill matrix, which lists desirable competency versus those presently available on the Board, is useful in determining the gaps, which could be filled in by appointing a person with the required competencies.

It would be more appropriate that the Code of Conduct for Corporate Governance of a Company should specifically include the qualifications and attributes that the Company seeks of an Independent Director. A critical element for a person to be an Independent Director is being independent of the pressures exerted by the Management, in true sense and also as perceived by the general public.

Independent Director’s independence should include the will and ability in terms of knowledge and experience to ask the hard questions required to provide effective foresight in general, and especially in dealing with potential Conflict of Interests.

Conclusion

The appointment of truly Independent Director to the Board of Directors is not a panacea for all the evils. An Independent Director, however, if truly independent, can bring about transparency in management and can help avoid situations like the not so old Enron scandal on a global level and Global Trust Bank scandal back at home.

The Corporate Sector in India today, is largely governed with people’s money. A common man is also a shareholder in an Indian MNC today and most of the Equity Capital comes from the pockets of a common man in the society. In such a situation, the Indian economy cannot afford to witness another scandal of bankruptcy, where the root cause is corrupt management. This would affect the Indian society at a ground level, bringing the complete economy to its knees both in terms of finances as well as credibility in terms of global exposure.

The writing on the wall is very clear: unless Ethics are as important as Economics, unless Fair Play is crucial as Financial Success, unless Morals are as vital as Market Share, we cannot emerge as the global Corporate Leaders.

LAW FOR MERGER AND ACQUISITION- A CRITICAL REVIEW

Introduction

The recent years has seen a considerable increase in the Merger and Acquisition (M&A) activity across the Indian Corporate Sector. India Inc., has emerged as the most strategic market for M&A for foreign players at the same when Indian Corporate bigwigs are eyeing major players on a global level. At the end of the day India, Inc., stands to be the largest gainer.

The M&A activity in India is governed by numerous cumbersome laws and regulations that it leaves ample space for misinterpretation. Even the largest of the Investment Banks lives in the fear of that it might overlook one of the basic rules of compliance and attract negative coverage in the media.

Recently, the Indian Income Tax Act, 1961 entered the Guinness book of world records for registering maximum number of amendments. The amendments to the Income Tax Act, 1961 is so cumbersome and unclear that it leads to many interpretations. In one of the high-profile cases a local tribunal erred in interpreting the judicial decision of a higher court and as a result the company had to file and re-file the tax applications. In the meantime, the permissions granted by other regulatory authorities lapsed and the company had to repeat the exercise resulting in enormous wastage of time and money.

Cases such as the above actually keep out the foreign players from being the strategic players in the M&A activity in India. In India, the M&A activity takes approximately six to seven months to reach completion. The reason being the long list of compliance requirements, which calls for liaising with various regulatory bodies to complete the M&A activity.

Overview of the Regulations

A broad overview of such compliance requirements includes the following:

The Ministry of Corporate Affairs: Regulates compliance under the Companies Act, 1956. The Ministry is governed and still dwells into law that was enacted five decades earlier and maintains a long list of documents for every small change in the nature of company and its management.

Rules of Taxation: Draws the power from the Indian Income Tax Act, 1961. The slabs for taxing the capital gains and treatment for accounting entries during M&A are very complicated. Ensuring compliance with all the listed provisions, sub-clauses, and amendments is a Herculean task.

SEBI: Regulates the Indian Stock Markets and draws power from the SEBI Act to ensure proper functioning of the Stock market. Ketan Parekh made a fortune by cheating the investors in a big way under the nose of the very watchful SEBI. During M&A activity, it becomes extremely necessary for the participating companies to comply with the SEBI rules with considerable time being devoted to be safe from “intelligent” people like Harshad Mehta and Ketan Parekh.

Competition Commission: Took over the ‘traditional’ MRTP Commission but Competition Commission is still in the budding stages and is always the target for carrying out trial and error process in a move to ensure healthy competition in the Indian Corporate Sector.

FEMA: Enactment that regulates Foreign Exchange in India with FIPB and the RBI being the regulatory Authorities. The regulated cap for foreign investment is highly volatile. In a recent case, a medical equipment company of US wanted to set up its base in India. Mid-way through the process the company realized that it missed out on the long list of reserved items in the SSI category. The company intended to make equipments made of stainless steel for use in the dental clinic, which is a reserved item for SSI. The company applied for exemption and the Ministry is yet to respond

Indian Stamps Act: Compliance with act is a difficult task for foreign investors as each State has its own set of enactment for Stamp duties. The Stamp-duty regulations change at regular intervals and the companies have to assess the deal regularly to be safe for mistaken under-valued registration of the deal. In certain cases, there are huge differences in stamp value between two states within Indian Territory.

Apart from the ones discussed above, there are several Labour Laws, Sales Tax, Custom Duties, etc. that require clearance at every stage. And compliance with sector specific regulators such as TRAI for Telecom industry and IRDA for Insurance sector, add up to the woes.

Each regulating body has its own set of enactment and regulating rules that makes compliances a real nightmare. Each Ministry issues a Press Note/ circular or notification, which are not in tune with those issued by their other relevant Ministry. This increases the chances of landing in a situation where compliance to the notification from one Ministry might end-up in non-compliance to the notification from another Ministry. Additionally, there exists clarification or corrigendum, which complicates the issue further. The requirement for approval from High Courts in addition to the approval of stakeholders, make the complete M&A activity in India a long-thought process.

Cause and Comparison

The governing laws in India today were drafted during the early days of Independence when India was not even an industrial nation lest being the emerging economic super power. All the laws and regulations were drafted in line with the prevailing conditions during late 1940s with a vision up to the early 1960s. India Inc., has come a long-way during these years and has gone on to become one of the leading players in the global corporate sector. The sad part is that the “good old” governing law prevailing today proves to be obsolete in many cases with the base matrix having evolved long ago.

This is not to say that there are no such laws and regulations in other countries. The laws and regulations may be many but the time take to complete the process is very easy in developed countries such as the US or the UK and even in emerging super powers such as China and Japan. Most of the countries follow a single-window concept to provide all the necessary clearances. Also, any amendments to the law are made only after assessing the total impact on all other related laws.

The Indian Law mandates a waiting period of 210 days after the Merger plan is reported to the government before completing the deal as against the 30 day waiting period in the US. The US law also provides for reducing the waiting period if there are no competitive problems and the parties request an early termination; such a provision is not available in the Indian law.

Required Initiatives

J J Irani Committee Report proposed upgrading the Companies Act three years ago; however it is yet to see the light. There have been many instances where the Company Law is in conflict with the Listing Agreement and there is an urgent need to address such overlapping issues.

A single window clearance system can resolve many issues related to clearances from various authorities and a dedicated body to provide such service to M&A activity can help improve the situation. Further liberalization of Indian economy is required to ensure smooth transitions during M&A activity. This can be achieved by abolishing sectoral caps and approval of FIPB for share swap.

The most important thing required in this chaotic scenario is regularizing Stamp Duty slabs. A single slab for Stamp duty must be introduced to ensure uniformity in M&A transactions across all the States in the Indian Republic. Simplifying the tax procedures and reducing the tax incidence would attract more foreign investment.

The new Competition Law is not yet properly in place and all the regulators discuss is that the new law is sure to pose a threat to commerce in the country. The regulators have failed to introduce strong governing laws to bring India's M&A control regime in line with prevailing global trends.