Last week, the Securities and Exchange Board of India (Sebi) came up with a slew of proposals to tighten Clause 49 of the Listing Agreement of stock exchanges. At one level the move is ironical because it comes so soon after Deepak Parekh, chairman of Sebi’s Primary Market Advisory Committee (PMAC), had publicly pointed out that not a single company has been fined for violating Clause 49 in over a year after the compliance deadline expired. He also pointed out that nearly half of all listed companies were in breach of the stringent regulations that are India’s version of the dreaded Sarbannes Oxley legislation in the US.
Sebi has still to respond to Deepak Parekh’s challenge and initiate punitive action. But look closely at the changes proposed by Sebi and they reveal that non-compliance is probably far more than the 50 per cent mentioned by Parekh. In fact, even compliant companies have figured out several ways to beat the listing rules and make them meaningless; these tricks and loopholes may now be plugged.
The change that made it to the headlines is that government-nominated directors on corporate boards would not be treated as independent directors. This was proposed by the Narayana Murthy committee, but had been rejected by the Sebi board. Does it stand a better chance of being accepted after this round of public debate?
The issue applies largely to listed public sector companies, where almost all the directors, directly or indirectly are appointed by the government or after an informal approval by bureaucrats and ministers. This would suggest that the proposed change, even if approved by Sebi’s board, might be largely cosmetic.
Consider how companies have been making a mockery of the rules. Clause 49 places an enormous fiduciary responsibility on independent directors — some might even call it onerous. They have to be part of key committees such as the audit and remuneration committee and need a degree of financial literacy. They also enrich the management by bringing their vast personal experience to the board; that is why they are paid fairly hefty sitting fees these days. So, when the regulator is compelled to prescribe that independent directors must be at least 21 years old, it is based on specific instances where companies have dared to ‘decorate’ their board with youngsters below that age. Sebi certainly needs to amend its rules, but wouldn’t its action have had more impact if the Sebi chairman had shamed the company by naming it during a public discussion? After all, investors need to know how seriously companies treat disclosure rules.
Another proposed change is that companies must make a disclosure if independent directors are related to each other, as well as to other directors. This too is based on specific examples where companies appointed brothers or a husband-wife couple to the board as independent directors. Technically, there is no bar on such appointments since they are not related to the management. While it is an open secret that most companies invite only confidantes, friends and benign academics to their board of directors, appointing siblings or couples is to really stretch the crony culture.
Another trick to reduce the number of truly independent directors is consider a non-executive chairperson as an independent director although he/she is a parent or relative of the owner-manager. Sebi’s rules signal that filial love and respect is acceptable in the boardroom so long as these beloved appointees are not passed off as ‘independent’ directors; in fact, nobody can be less independent. Such companies may now have to find more independent directors to comply with rules.
One set of companies came up with another neat trick. Since chairman M.Damodaran had threatened non-compliant companies with delisting, they made sure they had the right number of independent directors. But whenever a director resigned, no attempt was made to find a replacement. Sebi plans to mandate that when an independent director resigns or is removed, the vacancy must be filled in 90 days.
Every one of the changes proposed by Sebi are indeed necessary but if the amendment proposal was accompanied by examples of how the provisions of Clause 49 are vitiated, it would have ensured a better response from the investing public.
The reason for Sebi’s sudden burst of activity to amend and tighten Clause 49 is unclear. Shouldn’t the regulator worry about ensuring greater compliance with the existing provisions before seeking to tighten them? A clue may lie in another development, which is a Cabinet decision that all public sector companies will comply with Clause 49 provisions. In fact, it may be safe to bet that Sebi could not have acted against private sector companies when non-compliance was more rampant among public sector entities.
Unfortunately, Sebi’s failure to follow-up on its threat of punitive action has dented its credibility. This time around, there will be no rush to comply unless the regulator demonstrates that it means business. While Sebi waits for public feedback and then for its board of directors to approve of the proposed changes, I believe it can regain at least some of its credibility by creating a watch-list of companies that have not complied with Clause 49 and publish their names on its website along with the nature of lapse. After all, Sebi needs to prove that it can do a lot more than tinkering with the rules and manufacturing red tape.