Newsletter Category: 2018

The story is apocryphal, but the messaging is clear. A person who approached a bookseller for an updated copy of the Companies Act, 2013 was told that no such thing can exist for long, because there are always amendments in the pipeline.

Enacted in 2013, after several versions had been considered and perhaps discarded along the way, the Companies Act, 2013 (the Act) was expected to be a statute that would not need revisiting for a reasonable time. Even before the ink was dry, the clamour commenced for making significant and substantive changes in several provisions of the Act. Since then, committees have come up with several suggestions, some of which have found their way to the statute books, introducing, in the process, a sense of discontinuity. This exercise goes on. On 2nd November, 2018, some provisions of the Act were amended, through an ordinance, based on recommendations of yet another committee. Some other recommendations have been put out in the public domain for consultation. How much of such feedback finds its way into the statute is a story for another day.

The practice of legislating in haste and repenting (amending) at leisure is best illustrated by the change proposed in Section 8 of the Act. Comparing the proposed amendment with the original provision of the Act will show no changes. What is now proposed is to undo the effect of a change made through a notification and to restore the original provision.

One of the major changes suggested is the proposal to cap the compensation of Independent Directors (IDs) by tweaking the definition of ‘independence’. This proposed amendment is premised on the understanding that if a significant portion of a person’s income from all sources is attributable to one company, her/his independence should be deemed to have been sacrificed. The folly of defining independence in terms of pecuniary compensation is being persisted with. That such a provision will deny companies the services of experienced persons with smaller annual incomes seems to have been lost sight of. Equally, the opportunity to reward or compensate Directors based on their contribution to the company has been lost, striking at the root of Board contribution to the company’s prospects. Legislating for independence of mind is clearly a laughable idea.

The accompanying clause provides for an assessment by “such body or institute” to determine the suitability of persons for appointment to Board positions. The use of the word “institute” is a clear giveaway, since it does not take too much effort to see this as providing a revenue stream to an institute that has failed to take off. It is reasonable to presume that any formal assessment by an institute would be on the basis of a person’s understanding of the provisions of law and regulation and would have hardly any input by way of boardroom behaviour and other non-statutory attributes which a person should bring to the Board. Clearly, this is a solution out of sync with the reality of the boardroom.

On the specious assumption that IDs do not have enough work to do, they have been given the responsibility of filing copies of resignation along with detailed reasons therefor to the Registrar of Companies (ROC). It is not clear why the present arrangement of the resignation letter, with reasons therefor, being given to the company, and by the company to the exchange, is considered inadequate. The responsibility for filing a copy of the letter with the ROC could very well have been given to the company, rather than to the ID.

More serious is the proposed proviso that the resignation of the ID shall take effect from the 30th day from the date of receipt of notice by the company. If the intention is to ensure that the ID remains accountable, this provision is unnecessary, since accountability for acts and omissions during the period of directorship will survive the directorship of the individual. Earlier, prior to the coming into force of the Act, an ID was at the mercy of the company which had to accept his/her resignation, for it to take effect. The change to give it immediate effect from the date of receipt of communication by the company, was a salutary provision, which is now sought to be taken away for unknown reasons. This seems even more strange when the law continues to provide that the resignation of non-IDs shall take immediate effect.

Legislation as a response to, or an outcome of, a single episode in the corporate arena, is a kneejerk reaction that is best avoided. It is no secret that Schedule IV of the Act owes its existence to the Satyam debacle. The present consultation paper contains a proposed amendment which is clearly a response to the IL&FS imbroglio. Section 241 of the Act is proposed to be amended to provide for action against “persons concerned in the conduct and management of the affairs of a company.” Action will be triggered if there are reasons to believe that the person is guilty of fraud, misfeasance, persistent negligence or default in carrying out his obligations and functions under the law, or breach of trust. A prima facie conclusion of the existence of guilt is a condition precedent to action to be taken. The next sub-clause provides that the Central Government may make an application to the tribunal if in the opinion of the Central Government there are circumstances suggesting “that the business of a company is not or has not been conducted and managed by such person in accordance with sound business principles or prudent commercial practices.” In effect, this hinges on the forming of the opinion that there are circumstances suggesting imprudent practices or unsound business principles. It is always possible to conclude with the benefit of hindsight, that commercial decisions that have gone wrong are unsound or imprudent decisions. Adequate safeguards need to be provided before such a sweeping provision is given effect to. It is fairly easy to accuse the managements of a large number of companies, of taking decisions that are unsound or imprudent. The mindless application of such a provision in a trigger-happy environment can be destabilising.

The draft put out for consultation also has an excellent example of terrible draftsmanship. The proposed Section 241(4) reads as follows: “The person against whom a case is referred to a tribunal under sub-section (3), such person shall be joined as a respondent to the application.” The words “such person” are clearly superfluous.

Perhaps anticipating the stricter provisions that are on the anvil, IDs are exiting Boards at the pace at which middle order batters in the Indian women’s cricket team have been exiting the crease. The stated reasons are mostly the inability to commit quality time to the affairs of the company. One wonders whether so much time was needed to come to the conclusion of the inability to commit quality time. That it should happen, at least in one known case, within a year of joining the Board, is disturbing.

As the bard said “Mischief thou art afoot. Take what course thou wilt.”

 

READERSPEAK – BOARDROOMS OF THE FUTURE

“Sabyasachi Hajara, Former Chairman Shipping Corporation of India”
“All the directors, executive, non-executive and independent, are meant to work in good faith for the benefit of the company and all its stakeholders and there should never be a divide or ‘ opposition ‘ in the boardroom.”

“Pradeep Dinodia, presently ID on listed entities and Managing Partner, SR Dinodia & Co. LLP”
“As for your concluding paragraph, I think the brashness of youth cannot supplant the wisdom of grey hair; a judicious mix will probably give the best results.”

 

READERSPEAK – DISCLOSURES OR CLOSURES?

“BS Raghavan, IAS (Retd.)”
“This is just to assure you that I read avidly all your writings and every time am lost in admiration for the clarity, elegance, language, style and content, all laced with a light touch or gentle punch here and there. The latest one DISCLOSURES OR CLOSURES is no exception.”

“General (Retd.) Ved Prakash Malik, Former Chief of Army Staff”
“Educative piece! There is a lot of gossip; and more and more questions like the ones that you have raised.”

“Nawshir Mirza, Former Senior Partner of M/s S. R. Batliboi & Co”
“As usual, well written and brilliant. In the November conference you might want to have a session on “Dealing with Difficult News”. Boards and managements have no clue how to do this.”

“Sanjeev Aga, presently ID on listed entities and former MD and CEO of Idea Cellular”
“Piercing analysis. Lucid expression. Perfect title. And a great finish.”

“Pradeep Dinodia, presently ID on listed entities and Managing Partner, SR Dinodia & Co. LLP”
“I think, if the AGMs get out of the farce of either aggression to get freebies or praise the promoters to the sky, then we can have a constructive dialogue for the better governance of the companies.”

“Sabyasachi Hajara, Former Chairman Shipping Corporation of India”
“Minority shareholders are also owners of the company and are entitled to proper disclosures particularly in the interest of transparency.”

“Sanjay Sinha, Founder, Citrus Advisors and former CEO of L&T Mutual Fund”
“Hard hitting points put forward in such an engaging matter. Made my day with sufficient food for thought.”

In the days gone by, trapeze artists and conservancy workers had a higher premium attached to their insurance policies because of the perception of higher risks in their chosen occupations. Unconfirmed reports are now emerging that insurance companies are likely to significantly increase the premium on the policies of Independent Directors (IDs), the reason being that such Directors are often required to do the tightrope walk as well as to clean the mess in the boardrooms.

In any business decision, the risk-reward trade-off is one of the material determinants. An application of this approach to the boardrooms of the future will provide interesting insights.

In an inversion of the natural order, let us look at the rewards first. Till the Companies Act, 2013 (the Act) was given effect to, IDs could receive stock options, based on the philosophy and the business outlook of the company, on whose Board they were members. Proceeding on the assumption that stock options would lead to short-termism in the approach of IDs, this time-honoured method of compensation was discontinued.

The next element of compensation is the profit-linked commission, subject to statutory limits, payable to IDs. Companies that made significant profits saw no problem in suitably compensating IDs with handsome commissions, subject of course to statutory limits. Overwhelmed by the seemingly high numbers being bandied about, and with no thought for the contribution that such Directors might have made, and continue to make, in boardrooms and outside, proposals are now being mooted for significantly reducing commission payments. What compounds the error is that the limits proposed are a function of the total income of such Directors from all sources. This would lead, for example, to a person with deep pockets becoming eligible for higher compensation than, say, a retired university professor.

The third element of compensation is the sitting fee. Paid at a uniform rate to all Directors, whether performing or non-performing, this by itself is unlikely to incentivise active involvement and contribution in boardrooms.

There is of course, the view expressed by one of the governance gurus that the media swears by, that IDs do not have any contribution to make in boardrooms, and exist only to “open doors” for Chairpersons and Managing Directors.

It merits comment that all these measures have been conceived at a time when the cap on the salary payable, without government permission, to the Chief Executive has been removed. Contextually, with an increasingly important role being envisaged for IDs, it is their compensation alone which is targeted to move southwards.

It is now time to look at the risks. To begin with, there was, and still remains, the long laundry list in Schedule IV of the Act. Significant risk resides in many of those functions and responsibilities, with interpretation by external agencies likely to be the critical factor. Statutory responsibilities have assumed ominous proportions, with the fig leaf of protection under Section 149(12) of the Act being treated with disdain. What is worse, the assets and bank accounts of family members are being frozen with no determination of how much of it might be self-acquired. In addition, there is now the reported proposal for the Government to step in and identify the non-performing members of the Board. Thereafter, applications would be moved to the National Company Law Tribunal (NCLT) to remove those Directors, and consequent thereon, bar them from any Board position for 5 years. Among the determinants that the Government will use will be efficiency and credibility. It is not clear how a Government, sitting outside the boardroom, will arrive at conclusions regarding the efficiency of Board members. Further, it would seem odd for the NCLT, which is a quasi-judicial body, to pronounce on efficiency, without an objective evaluation. The only evaluation now available, and with statutory backing, is the evaluation contemplated in Schedule IV of the Act and the SEBI (LODR) Regulations, 2015, as well as the guidelines issued by SEBI. As annual reports of listed entities reveal, the prescribed evaluation has been undertaken, and in no case has a Director been found wanting. With that evaluation report in place, it is difficult to foresee how the NCLT or any other similar body can come to a conclusion that some Directors are, or have been, inefficient in the discharge of their duties.

It is difficult to resist the conclusion that IDs are being collectively looked upon as the opposition party in the boardroom. Should that perception prevail among the Directors, it would be reasonable to presume that every management proposal would be opposed or would face significant resistance in the boardroom. Whether this will contribute to the ease of doing business is something that deserves serious attention.

Boardrooms of the future will have younger persons, with diversity factored in, and trained in the letter of law and regulation. With the bold and the beautiful replacing the bald and the not-so-beautiful, will dissent crowd out decisions in Board minutes? Will Boards miss the wisdom of those who have seen the movie before?

“What is truth” asked Pontius Pilate. He left without waiting for an answer. Shareholders at the Annual General Meeting (AGM) of a large private sector bank also sought to know the truth. They waited in vain and when the proceedings ended, they left with more questions than answers.

This was an AGM with a difference. The iconic leader, whose role was central to the doubts and concerns, was not on the stage. Hamlet without the Prince of Denmark, one might have legitimately observed.

This was an AGM with a difference. The iconic leader, whose role was central to the doubts and concerns, was not on the stage. Hamlet without the Prince of Denmark, one might have legitimately observed.

It takes all types to constitute the population at any AGM. Apart from the versifiers, the cheerleaders and the critics, there are also some chess players contemplating the moves ahead. What if the report finds some, if not all, of the allegations to be true? Can a Board, which, in all of 15 minutes, found nothing wrong, eat humble pie and ensure that the CEO stays at home? If that happens, will a legal challenge be far behind? The Board then gets into a safety zone. Any question will entail the time-honoured answer – “The matter is subjudice”. AGMs will come and go, the questions will remain.

AGMs were always meant to be constructive conversations between the Board and the management on the one side, and the shareholders on the other. Over time, this annual family reunion has become ritualistic, and the conversation almost adversarial. Evasiveness, equivocation and the art of speaking much but saying little are the order of the day. And all the light that is shed is on the wise worthies seated on the stage, and not by them.

The searchlight has been turned on the divine right of the promoters to stay on the Boards indefinitely, and to compensate themselves as they please. One of India’s top chieftains, a third generation leader to boot, has had retail and institutional investors questioning the disproportionate share of commission that has accrued to him, being recommended by a Nomination and Remuneration Committee of which he is a member. Elsewhere, minority shareholders have turned down a proposal to enhance the compensation of the Managing Director, a member of the promoter family, when the company had underperformed in relation to the preceding year. There is almost deafening silence following the AGM of a large healthcare company. What transpired therein? Don’t stakeholders, other than shareholders, also have a right to know? More importantly, since nature abhors a vacuum, falsehoods and misconceptions will occupy the space that fact and truth have left vacant. Mercifully, those that attended the AGM of a beleaguered financial entity have chosen to air their views, albeit with utmost circumspection.

The message from the shareholder community is loud and clear. Do not take us for granted. We will raise questions, and if the answers are not forthcoming, we are prepared to rock the boat. Are we witnessing the first signs of shareholder democracy?
Disruption, fashionable as the concept has become, is not something that shareholders desire. What else explains their unquestioning endorsement of a management proposal to certify that five of the Independent Directors on the Board, all aged 75 years or more, are physically and mentally fit to carry out their duties? It is a moot question whether the age prescription was intended to address the negative impact on independence of mind, that long years of being on a Board might cause, and not physical or mental fitness.

This leads one to ponder over the question – “What is fit and proper?” If a plethora of prima facie believable allegations are made against a CEO and these are interesting enough to excite the professional curiosity of more than one investigative agency, does that CEO remain fit and proper for a Board position in a subsidiary? The Chairperson of the parent company is forthcoming enough to say that since nothing has been proved, the person was considered worthy of support for a Board position. By the same logic, why should that CEO have been “persuaded” to take a break from responsibilities at the parent company? Clearly the balance of convenience lay in the parent company not taking a position one way or the other in the election of that CEO to a subsidiary Board. Wags are a dime and dozen, and one of them was heard asking whether the presence of at least four Directors with insurance background on the Board of the parent company was insurance enough for taking a bold position in extending support to the beleaguered CEO for a Board position of an insurance subsidiary.

Companies that are seen as the best and the brightest are having the chinks in their armour exposed. Reputations are taking knocks like never before. Reverence of promoters is a thing of the past, and respect is being given grudgingly. The reasons are not far to seek. Transparency is being paid lip service, as evidenced by the ground rule laid down that questions of an uncomfortable nature should not be asked. If the odd one slips through, it will be greeted with righteous indignation. The world outside will never know because the media has no rights of admission to the theatre. Meanwhile, trust will become a trait of the past.

In good times, when things are going swimmingly well, it is useful to remember Thomas Gray’s immortal lines – “The boast of heraldry, the pomp of pow’r, And all that beauty, all that wealth e’er gave, Awaits alike th’ inevitable hour. The paths of glory lead but to the grave.”

 

READERSPEAK – Shooting the messenger?

“Bharat Doshi, Member (Non-Official Director), Central Board of Directors, RBI and Former Group CFO, Mahindra and Mahindra”
“Your piece “Shooting the Messenger?”, received this morning, was brilliant.  Well said! Loved the line “—-omniscience of God, Government and Google —-“.”

“Kiran Mazumdar Shaw, Chairperson and Managing Director, Biocon”
“Very relevant and rational point of view.”

“Michael Pinto, Former Secretary, Government of India”
“It’s true that Indian firms must seek greater interaction with proxy firms to correct their somewhat ritualistic approach to this question.  And it’s also true that it’s unfair to blame Proxy Firms alone for the sub-optimal decisions taken by foreign investors.”

“Milind Kulkarni, Senior Advisor and Former CFO, Tech Mahindra”
“I entirely agree with a very apt issue raised – “whether outsourcing of thinking, and decision making, is healthy for the corporate sector.” ”

“Nawshir Mirza, Former Senior Partner of M/s S. R. Batliboi & Co”
“There is one very good reason that proxy firms do not interact with managements as institutional investors do. It is that they form their views using the same knowledge that the average, diligent shareholder can possess, without privileged access to managements…If managements have their reasons to do what they do, they should explicitly set them out.”

“S Sandilya, Chairman, Eicher Motors”
“I agree with your observations that there is less application of mind and less appreciation for the local country specific situation or company specific information and invariably mechanical formula based ticking the box approach.”

“Santrupt Misra, CEO, Carbon Black Business and Director, Group Human Resources, Aditya Birla Group”
“Excellent article – one of the best I have read!”

“Shankkar Aiyar, Political Economy Analyst and Visiting Fellow at IDFC Institute”
“Gets to the nub….”Recommendations are often the outcome of a mechanical application of predetermined criteria.””

The trinity of age, attendance and tenure has begun to haunt corporate Boardrooms. Resolutions for reappointment, of Directors, which used to be passed by shareholders without discussion or debate, have become conversation pieces within and outside of Annual General Meetings. The credit, if one might call it that, goes entirely to a relatively latter-day phenomenon in the governance space – Proxy Advisory Firms. While their recommendations cover a whole gamut of issues, the focus herein, courtesy a recent episode, is on the resolutions relating to reappointment.

The role of proxy advisory firms, as also the manner in which they go about their business of making recommendations, has been the subject of considerable debate in the last few weeks. At one end of the spectrum are allegedly detached observers, welcoming shareholder activism, riding on the advice of proxy advisory firms. At the other end are insiders, wondering aloud, whether outsourcing of thinking, and decision making, is healthy for the corporate sector.

The facts first. Foreign institutional investors with investments in corporate entities across several jurisdictions, often find it a challenge to keep abreast of every relevant development in the investee companies. Resultantly, they fall back on the advice given to them by proxy advisory firms in regard to whether they should, or should not, support a resolution being brought by the management to the shareholders for approval. It is no one’s case that the recommendation of the proxy advisory firms is not preceded by adequate indepth research. Regrettably, however, recommendations are often the outcome of a mechanical application of predetermined criteria, without taking into account the specifics of the company that has been thoroughly researched.

In the Indian context, decisions on whether or not to support resolutions, are based almost entirely on the recommendations of one or more of the 2 proxy advisory firms in the US, and/or one or more of the 3 proxy advisory firms in India. These firms are, more often than not, the providers of resolution-specific advice to institutional investors from outside of India. The reported disconnect in the manner in which advice is given stems from the fact that whereas fund managers are the persons likely to interact with company managements, the advice of proxy advisory firms is received, and acted on, by compliance officers who instruct custodians to exercise their votes. Since agreeing with the recommendations of the proxy advisory firms is much the easier option, it is fair to presume that application of mind is minimal. This also manifests herd mentality among institutional investors. That a mechanical application of guidelines could be disruptive and could go against the interest of the shareholders, institutional or retail, does not seem to merit adequate attention.

It is time to revisit the trinity. Age is a good starting point. Internal guidelines of some of the proxy advisory firms are to the effect that persons above the age of 70 should be “persuaded” not to remain on Boards. The fact that the Regulator, having applied its mind, has indicated that the election of persons above the age of 75 would need a special resolution does not seem to have persuaded these firms to revise their criteria. There is increasingly a clamour for younger Boards. Considering that the Board of Directors is the seat of wisdom, which among other things is a function of age, it is incomprehensible why the considered decision of the Regulator should be second-guessed by prescribing a lower age limit.

Attendance, or the lack thereof, is the second stick with which to beat a Director coming up for re-election. There too, there is a mechanical approach leading to persons having less than 75% attendance being treated as not serious enough to merit a Board position. The possibility that there could be emergent last minute reasons for a Director to miss out on a Board meeting does not seem to concern the advisors. Further, in some companies, which are in the process of acquisitions or dealing with contentious court matters, there is often the requirement of holding Board meetings with very little notice, making it next to impossible for many Directors to participate, even through video conferencing. With a few such meetings taking place, without the attendance of the entire Board, there could be a situation where an individual Director falls short of the stipulated minimum of attending 75% of the Board meetings. It does not need extraordinary powers to conclude that a Director who missed out on a few meetings convened at very short notice should not be considered as a non-serious Director.

The third element which stands in the way of many Independent Directors continuing as such is tenure. For reasons that one can quarrel with, the lawmakers decided that tenure before the commencement of the Companies Act, 2013, which came into effect in 2014, would not be relevant, and that only tenure post the appointment to the Board in terms of the Companies Act, 2013 would be taken cognisance of. The negative fallout of this prospective application of restriction of tenure meant that many persons who had been on the Board for decades, got a fresh start in 2014. As a result, the term of appointment of an overwhelmingly large number of Directors will come to an end in 2019. Some of these Directors may not seek re-election, for personal reasons, including the fear of increasingly strict penal provisions and the laundry list of liabilities.

Focussing on the attendance details for only the previous year is unlikely to give a clear indication of the time devoted by the Director concerned throughout the term of his/her appointment. It is also imperative for persons acting on such mechanical advice to consider that in some cases, the whole Board will be exiting at the same time. That such an event could be destabilizing and disruptive is as plain as daylight.

In their defence, some proxy advisory firms have argued that they attach the highest importance to the contribution made by Directors. It is difficult to comprehend how persons sitting far away from the Boardroom, and without the omniscience of God, Government and Google, are in a position to assess or appreciate the contribution of individual members of the Board, unless they explain contribution only in terms of attendance records. It is useful to remember that in many Boards, there are value-adding serious professionals, who, for good reasons, are unable to attend all meetings. Yet, as insiders know and appreciate, the contribution of such Directors, within and outside Boardrooms, is often critical. A mechanical application of the minimum attendance requirements would remove such value-adding Directors from corporate Boardrooms.
A continuing constructive conversation between the proxy advisory firms and management will help the former understand and contextualise the resolutions that they are required to examine, with a view to formalising their recommendations. The demand that proxy advisory firms, advising on Indian companies, should be regulated in India, is at best a sub-optimal solution. Engaging with the companies is what the situation requires.

There is reasonable evidence to conclude that foreign proxy advisory firms do not factor in Indian realities while making their recommendations. The disconnect perhaps owes itself to a fundamental flaw in the Corporate Governance framework in India, which is that the shareholding pattern, and the existence of promoters, are not in sync with western Corporate Governance models and conclusions based thereon.

Blaming proxy advisory firms for sub-optimal decisions by investors is understandably unfair. Shooting the messenger is an avoidable pastime. However, to escape blame, the messengers need to be dispassionate in their recommendations and address any possible conflicts of interests arising from ownership or additional revenue streams. In the ultimate analysis, the recommendations of the proxy advisory firms are meant to result in informed investing. The moot question is when they inform, should investors mechanically conform?

 

READERSPEAK – Referees in the Regulatory Space

“S. Sandilya, Chairman, Eicher Motors”
“I agree with you that the regulatory organizations must be financially self-sufficient and not have any linkage with the powers that be for their day-to-day operations.”

“Sabyasachi Hajara, Former Chairman Shipping Corporation of India”
“Total independence in every sense and full autonomy of the Regulators distinctly improves the level of comfort for the investors.”

Decades ago, when intellectual discourse yielded place to ideology-derived belligerence, and worse, in Indian universities, Professor V.V. John, an eminent Vice Chancellor, made a profound observation. He stated that outside the gates of heaven, there was one long queue and one short queue. The persons in the longer queue were required to first serve a term in purgatory or hell, before they gained admission to heaven. The second queue was meant for Vice Chancellors who had already served in Indian universities.

Unconfirmed reports emanating from above would seem to suggest that persons who have served in regulatory organisations would also be entitled to join the shorter queue. Clearly, the price that is required to be paid while on earth is that of steering the ship, through stormy seas, to safe shores, in an effort to promote orderly conduct in the regulated universe.

The life of a Regulator, especially in the emerging markets, is as exciting as it is challenging. One securities market Regulator of a relatively small jurisdiction once mentioned that when the stock market indices were going up, no one knew of his existence; but when they came down, everyone knew his telephone number and residential address.

A Regulator’s role is a combination of the roles of FIFA and of the football match referee. The Regulator lays down the rules, and also enforces them on the field of play. What lends credibility to this role is an attempt to make the rules and regulations clear, and to give them reasonable continuity of existence, so that the players are aware of what is fair, and what is not, on the playground. Domain familiarity is clearly a necessary requirement. What is more critical is equanimity and poise and a sense of justice and fair play, treating all regulated entities alike. In the process, those that need to be rapped on their knuckles should be dealt with in a manner significantly different from those that need to be hanged for material system-destroying offences.

The need for regulatory organisations arises when it is recognised that smaller entities, with a disadvantage of limitation of size and scale, are unable to stand up and be counted on their own strength. This is best illustrated in the preamble to the SEBI Act which states that the objective of the statute is to protect the interest of investors and to provide for the development and the regulation of markets. It follows that a Regulator’s role is not only that of a policeman pulling up persons for real or perceived offences, but also one that creates a large universe in which more and more persons can take part in the process of wealth creation. (One regulator who years ago made a statement that regulation was his only objective, may be forgiven for not reading the Preamble!).

How is this role discharged? Rules and regulation can at best provide the enabling framework. What is essential is that all contending parties involved in any transaction are given a fair hearing, and thereafter, a reasoned order is passed in order to do justice to the party that has been adversely affected. “Audi alteram partem” is a pillar of natural justice, not a comment on an automobile of choice.

The requirements of impartiality and fairness are often explained in terms of the demand for “independence” of Regulators. Regulatory independence is a misconceived notion. What is required is functional autonomy to operate within an ecosystem in which there are multiple participants.

Functional autonomy, without any accountability, would be the perfect recipe for disaster. Accountability however should not mean being responsive on a continuing basis to the demands that government functionaries or the political executive might make in regard to individual transactions. Further, in a country as vast as India, with a significant public sector presence, it is not unusual for Regulators to be requested to grant exemptions, with extension of time being the fallback option. Responding positively to such requests weakens the regulatory system since exemptions and carve-outs based on ownership can be disruptive to discipline in the regulatory environment.

As far as accountability is concerned, the best option is to provide for every Regulator to appear before an appropriate Committee of Parliament once a year to explain what that regulatory body set out to do in the year gone by, what thereof was accomplished, and the reasons for falling short of the identified objectives. It is equally important for the Regulator to explain to a Parliamentary Committee what the state of the regulated universe is, and what major issues are proposed to be addressed in the forthcoming year. The necessity for giving evidence annually to a Parliamentary Committee derives from the clear understanding that regulation is subordinate legislation, and that Parliament, as the supreme lawmaker in the country, is entitled to know how subordinate legislation is being conceived and implemented. To see such rendering of evidence as interference by Parliament is to close one’s eyes to the representative form of government that we have chosen for India.

The functioning of Regulators in recent times has often raised eyebrows. As corporate skeletons tumbled out of cupboards in rapid succession, the inadequacy of the regulatory organisations in the US manifested itself. The position was no better in other developed jurisdictions. Nearer home, we have an example of the banking Regulator stating that it is not adequately empowered to deal with public sector banks, and that it has powers to discipline only private sector banks. The question whether such powers are being exercised with respect to private sector banks need not detain us here. What is more significant is the admission of absence of powers over public sector banks, when everyone, including the Government, believed that the Regulator was adequately empowered. Statements of this kind are destabilising for the credibility of the organisation. Recently, we have seen the insurance Regulator clear a proposal by a government owned insurance company for investment in a bank to the extent of 51% of the share capital, when the statutory limit is 15%. It is not unlikely that the larger public interest, which the Regulator perceived, merited such a decision. It would have however helped the optics, if the decision was not seen as taken immediately on receipt of the application by the insurance company. The related question whether the Board of the insurance company was fully in the picture, or was cajoled or coerced into taking this decision is a tale which will be told another day. Suffice it to say that the announcement of the decision of the Board to the public was made by a senior government official, and not by any executive of the insurance company. It remains to be seen whether the regulatory system looks into these aspects, and investigates them to decide whether the Board has done what it needs to do as the custodian of Corporate Governance.

Reports seem to indicate that in-principle approval was obtained from the banking Regulator before application was made to the insurance Regulator. Other regulated entities are entitled to ask when the informal in-principle approval system came into being.

Strengthening of regulatory organisations is clearly a high priority. Unless this is done, ownership-derived preferential treatment, for the mere asking, is likely to be the order of the day. Regulatory organisations must also be financially self-sufficient, so that their existence does not owe itself to handouts from the government. Handouts, as is well known, come with strings attached, and regulatory organisations cannot afford to pay that price.

Debates and discussions on the structure of regulatory organisations are meaningless, unless the business of regulation is taken seriously by the creators of regulatory organisations and by the leaders of those organisations. Failing this, one will have to fall back on Alexander Pope’s contextually amended observation –

For forms of regulation, let the fools contest.
Whatever is best regulated is best.

 

READERSPEAK – Auditors’ Dilemma – To Sign or To Resign?

“TV Mohandas Pai, Chairman, Manipal Global Education Services”
“Agree with you fully, running away is not an option!”

“Pradeep Dinodia, presently ID on listed entities and Managing Partner, SR Dinodia & Co. LLP”
“An excellent piece of incisive writing….. They are doing risk management of their auditing practice rather than that of the Auditee. The suggestion that their concerns be shared with the Audit committee is one of the best I have seen in a long time. The Auditing firms should also appoint ombudsman in their own firms to deal with unreasonable audit partner demands on the Auditee.”

“Nawshir Mirza, presently ID on listed entities and former Partner, S.R. Batliboi & Co.”
“From my four decades as an auditor and near two decades as an independent director, I would say that the auditors that resigned have failed to fulfil their part of their contract of appointment. A quiet resignation is nothing but connivance between the auditor and the stewards of the business to allow the latter an easier escape. Action should also be brought against the directors on the audit committees of the concerned companies for not only failing in their responsibilities for ensuring full information to auditors but for failing to inform the shareholders of the reasons for their auditors’ resignations, the auditors having failed to do so.”

“Siddharth Shriram, former CMD, Mawana Sugars”
“There is a further dilemma that auditors face and that is their own conflict of interest. Also, their own qualifying note that they always write ‘we have relied on the information provided ….’ is a cop out because they must delve deep into the audit. They take on too many audits and then cannot do a thorough job; consulting practices are often the rich fruit of audit practices.”

“Suresh Talwar, Founder Partner, Talwar Thakore & Associates (TTA)”
“Brilliant. Brief yet very comprehensive.  It covers every aspect of the subject.”

“Debashish Mohanty, President and Country Head, UTI AMC”
“Can we think of a solution where a pool of funds will be created under a third party or under the supervision of the ministry of corporate affairs which will remunerate all the auditors of the registered companies? This will ensure neutrality and fairness of reporting.”

The spate of resignation by auditors has been perceived by some as the last nail in the coffin of Corporate Governance. The cynics who continuously look for evidence that Corporate Governance is dying, if not dead, are anxiously awaiting more resignations. Having long subscribed to the view that the biggest are necessarily the best governed, the apologists for the corporates that held themselves out as the shining examples of governance in India, are now feeling vindicated when auditors in smaller companies are opting out of their assignments.

An auditor in a corporate entity is one of the custodians of the faith and trust of the multitude of stakeholders. It is on account of the comfort, that an investor draws from the certification of the accounts as giving a fair and correct picture, that he/she stays invested in the company. When auditors throw up their hands or walk away, investor confidence suffers a mortal blow and share prices ordinarily experience a very steep fall.

Attributing the phenomena of increasing auditor resignations to any one reason would amount to oversimplification. There are those that believe that regulatory action, against the auditors in the case of a major corporate fraud, has induced a sense of fright in the auditing profession. There are others who subscribe to the view that the coming into being of National Financial Reporting Authority (NFRA), a statutory body with disciplinary powers, might have been the trigger for some resignations since the comfort of self-regulation by a membership body has got circumscribed by the higher powers vested in the NFRA. The fear of being arraigned in class action suits is yet another possible reason for the exit of auditors.
While the reasons may be many and varied, what ought to engage stakeholders as well as students of Corporate Governance is the question whether the auditors are doing the right thing by exiting either before the completion of the audit or immediately thereafter. Put differently, is exit the only option for an auditor unable to discharge his/her functions because of non-cooperation by the auditee or for other reasons? Is there an element of abdication of responsibility having regard to the fact that an auditor’s exit leaves a vacuum which cannot be immediately filled, and consequently causes considerable disquiet in the minds of stakeholders?

The more common reason cited by exiting auditors is that the information they have sought, in the course of audit, has not been made available to them. It is entirely possible that managements withhold information which, if taken into account by auditors, could lead to non-certification of accounts as presenting a true and fair picture. Should information be withheld or delayed, there are options other than exit available to the auditor. It is open to the auditor to approach the Audit Committee (AC) at any point of time, and not only when the quarterly meetings take place, to bring to the committee’s notice that complete and correct information is not being made available by the management. In fact, in most companies, that practice high standards of Corporate Governance, and where the auditor has interactions with the AC in the absence of management, one common question put by the committee to the auditors is whether the information flow is timely and comprehensive. For an auditor to not avail this opportunity is to act in a manner inconsistent with the expectations from that high office.

Auditors also have the unfettered right to qualify accounts if they believe that the position taken by the management in regard to some matters is inconsistent either with the facts or with the accounting policies that are followed. The purpose of the qualification is to put stakeholders on notice that the results indicated by the management should not be fully relied on to make investment decisions. Since qualifications in the accounts place the corporates at a severe disadvantage vis-à-vis the stakeholders and also the regulators, it is unlikely that managements will refuse to fall in line if the auditor signals the possibility of a disqualification.

Yet another option available to the auditors, especially when fraud is suspected, is to alert the Board and the Registrar of Companies (ROC). More often than not, it is fraudulent action on the part of the management that stands in the way of their sharing complete information with the auditors. In such a situation, it is incumbent on the auditors to assess whether a fraud has taken place or is suspected, and to alert the Board to such a possibility.

Notwithstanding every alternative that is available, it is possible that the circumstances are so adverse as to not to leave the auditor with any option but to quit. In such a situation, it must be made mandatory for the auditor to disclose, in sufficient detail, the reason for resignation and steps taken by the auditor to address the matters that finally precipitated his/her resignation. If for example, auditor has been denied information, the resignation letter should indicate, in sufficient detail, the efforts made by the auditor, including approaching the AC, and the auditor’s assessment as to why information is being withheld. In doing so, the auditor’s position would be considerably strengthened by the fact that Independent Directors (IDs) are also expected to ensure the timeliness and adequacy of information flowing to the Boards. Making common cause with IDs in pursuit of the objective of ensuring that the accounts reflect the correct position of the company is an approach that auditors should always embrace. A resignation letter by the auditor indicating detailed reasons for resignation should ordinarily trigger a regulatory enquiry to ferret out the truth. One possible safeguard against hasty resignations could be a requirement for the exiting auditor to appear before the shareholders at the next Annual General Meeting (AGM) and to personally indicate to them the reasons for resignation. Since they are appointees of shareholders, this alone can bring their assignment to a legitimate conclusion.

To sign or to resign seems to be the auditors’ dilemma. The way out is simple. When the going gets tough, the tough get going. They don’t leave.

Some of the above points emerged at our by-invitation roundtable on the topic.

 

READERSPEAK (in alphabetical order) – BRAKING VIEWS

“Anami Roy, Former Director General of Police, Maharashtra”
“Simply outstanding! So true and hilarious too. Love the cookies and nuts (the edible variety…) bit. But seriously an occasion for IDs to have a fresh hard look at things.”

“Anupam Puri, Formerly of Mc Kinsey & Co”
“Bravo! This is really, really good, and needless to say, very funny as well.”

“Apurva Purohit, President, Jagran Prakashan”
“What an excellent missive – Extremely valid points with dollops of wit and lashings of irony! My favourite type of communication!”

“PM Kumar, Former Business Chairman and Board Member, GMR Group”
“Hard-hitting and so real – the Emperor wears no clothes – PG Wodehouse plus plus!!”

“TV Mohandas Pai, Chairman, Manipal Global Education”
“Very nice, very relevant.”

“Vinita Bali, former Managing Director, Britannia Industries”
“Masterpiece!”

“V Sumantran, Former Vice-Chairman, Hinduja Automotive and Ashok Leyland”
“Thank you for this exquisite piece of prose. This one combining everything from Englebert Humperdinck to cricket to Sir Humphrey Appleby (?) is one more piece to treasure.”

Dear Chairman,

You might wonder why I have chosen to resign from the Board of Directors all of a sudden without any immediate provocation. For quite some time, I have been feeling that I do not contribute enough to the deliberations of the Board, leading me to ask myself whether I really belong here. The reasons for my wanting to leave are many and varied. The Companies Act, 2013 requires me to give detailed reasons for my resignation. Like many others who have left Boards in the recent past, I propose to state that the resignation is on account of “personal reasons”. Should I be asked, which is very unlikely, to expand on the term “personal reasons”, I will, without embarrassing you, me or the rest of the Board, state that the reasons are far too personal to be disclosed in public and have no bearing on public interest. I need to leave before 1st April, 2019. If I wait till then, and leave thereafter, I will be required to confirm, in terms of the amended SEBI LODR Regulations, that in addition to the stated reasons, “there is (sic) no other material reasons other than those provided.” In order to persuade you to immediately act on my resignation, which in any case takes effect from the date of receipt of the communication, I am sharing with you the text of the resignation letter that I would have to write after 1st April, 2019, if I stayed on till then.

“As mentioned to you earlier, I intend stepping down from the Board of Directors. In the name of the LODR, I am setting out hereinbelow all material reasons for my resignation.

1. When I joined the Board, I assumed that it was a cakewalk and that no effort would be required on my part to understand the agenda items and to contribute to boardroom deliberations. I have discovered that that was never the case.
2. As an ID, I have often watched, with the benefit of a courtside seat, serious exchanges between Board members, much in the manner of a spectator moving his head from side to side, while witnessing baseline rallies on the tennis court and wondering when the point will end.
3. You asked me to serve on Board Committees. After several years of serving on committees, pre-superannuation, I thought committees were diversionary tactics. How was I to know that committees even took decisions?
4. Recent events have brought home to me the shocking realisation that I can be held guilty of criminal conduct even if my only contribution in the boardroom was studied silence.
5. At the beginning of each year, I am required to sign several forms, some of which pertain to my close relatives, in order that they do not trade in shares of the company during the closed periods. I have often asked myself the question that Cain asked the Lord, “Am I my brother’s keeper?” I know by now that when it comes to brothers-in-law, I can perhaps hide under a technicality.
6. I have faithfully signed above my name on the quarterly and annual accounts without having the faintest notion of what I was endorsing, and drawing comfort from the several other signatories who I know will make excellent co-accused in a criminal trial.
7. Being on the Board severely impacts on my freedom of expression since I cannot share extremely important and topical information with friends outside the boardroom.
8. I am expected to be present at AGMs and smile knowledgeably when shareholders, who have invested in the company, ask difficult questions. Smiling knowledgeably and interminably is a tough task, and I can say this without checking with the airhostesses who do it throughout the day.
9. For all my pains, I am compensated with a sitting allowance, and my friends who are knowledgeable tell me that the risk-reward relationship is adverse to my interest.
10. During all the time that I have spent in the boardrooms, I could have pursued hobbies that I had to abandon till my superannuation. The Board assignment got in the way and I have no intention of echoing John Milton who said, “and that one talent which is death to hide, lodged with me useless.”
11. You mentioned that my evaluation results were unsatisfactory. But I never promised you that I would add value.
12. My dietician told me that cookies and nuts (the edible variety!) that cry for attention in boardrooms are bad for health. It is about time that I placed my health above that of the company.
13. As you and I know, I joined the Board to make up the numbers so that you have a quorum. Now that you have enough persons on the Board, I thought I should not overstay my welcome.”
14. And finally, I am comforted by the thought that neither you nor I intend to disparage each other. That said, I believe that we must enter into non-disparagement agreements. Before I am accused of adding to the company’s workload, let me mention that there is a recent specimen of such a letter, that you could choose to work on.

As Engelbert Humperdinck sang, “Please release me, let me go.”

 

Yours sincerely,

XYZ
Bored (Board) Director

 

READERSPEAK – WHERE ANGELS MUST NOT FEAR TO TREAD

“PM Kumar, Former Business Chairman and Board Member, GMR Group”
“Brilliant, well written, insightful, educative and compelling!”

In a move that was as rare as it was strange, the heads of some large Mutual Funds in India, as a group, chose to call on the Chairman of a beleaguered private sector bank. While there is no clarity on the matters that came up for discussions, it has been speculated in news reports that the meeting was intended to get some kind of an assurance that the share price of the bank would not travel rapidly southwards in the event of a change of the Chief Executive Officer. There is not even a hint, going by the newspaper reports, that these influential persons sought any assurance that there were no governance issues involved.

This meeting took place at a time when the television viewer, across channels, is being bombarded with the assurance “Mutual Funds sahi hai.” Did they ask the question – “Corporate Governance sahi hai?”

The incident in question raises the larger issue of the role of the institutional investors, especially in situations in which an investee company has come to adverse notice, not for its financials, but for practices and attitudes that, prima facie, do not seem to pass muster. In the case of financially weak entities, institutional investors, the world over, have been known to vote with their feet. On occasion, and especially in emerging markets, if a large institutional investor is in some sense a proxy for the government, the attempt has been to persuade the Board of Directors to take corrective measures rather than to exit the company and cut losses.

What sets apart institutional investors from retail investors is the leadership role, consequent on the size of the holdings, and the ability to influence good practices consistent with the highest standards of Corporate Governance. Institutions such as California Public Employees’ Retirement System (CalPERS) and Harvard Asset Management, to name only two, have for a long time been in the forefront of the efforts to pressurise companies to adopt the right practices while delivering consistent results. While the standards set by them may, at this point of time, be aspirational for Indian entities, nothing prevents Indian institutional investors from publicly taking aggressive positions vis-à-vis managements which are unresponsive and seemingly indifferent to the concerns of an average stakeholder.

There is no shortage of institutional investors in India. Mutual Funds, insurance companies, both public and private, foreign institutional investors and Private Equity funds that invest in public markets have to reflect on the kind of stance that they need to adopt when questions are being raised regarding governance practices, especially conflicts of interest. Mutual Funds have an especially important role to play. As the link between the small saver and the users of capital, it is not enough for them to provide the former with the benefits of research and risk diversification. At least as important is the responsibility of the Mutual Funds to stand up for what is right so that the faceless investor finds her voice heard in corporate Boardrooms and in the larger financial arena. Will benign neglect on their part, force SEBI to direct them to engage more effectively with managements, in public interest?

In this context, developments in recent times raise interesting questions. Many Mutual Funds continue to buy shares of the beleaguered private sector bank at every dip. Research houses continue to have a ‘Buy’ recommendation on the stock. Clearly, both of these approaches are consistent with the short-term interests of the funds and their investors. The question that needs to be addressed is whether in extending support, through such action, to the listed entity, a signal is being sent that short term interests are paramount and that Corporate Governance, which is a necessary condition for sustainable performance, can be given the go-by.

The role of other institutional investors on the Boards of companies in difficulty is equally disquieting. There has been deafening silence from a large institutional investor with around 12% of shareholding in the bank presently in focus. It would have been legitimate for the nominee of that institution to assume a leadership role in the Boardroom and to satisfy himself and his organisation that the allegations being bandied about were without basis. To make matters worse, the website of the bank shows the Nominee Director as an Independent Director, even though Section 149(6) of the Companies Act, 2013 clearly states “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.” One fervently hopes that being categorised, for definitional purposes, along with a Managing Director and a Whole-Time Director, does not compel the Nominee Director to act strictly in accordance with the interest of the former. Whatever happened to IRDAI’s salutary provisions in the Stewardship Code relating to investee companies?

Institutional activism in India is not without precedent. The erstwhile undivided Unit Trust of India, even when battling its own problems, took principled stands on two occasions, once getting a proposal to be withdrawn, and on another occasion, forcing a vote which was narrowly lost. In recent times, promoters were pushed on the back-foot by institutional investors seeking clarity and probity.

If one may take liberties with an old saying, an occasional swallow does not make a Summer.

 

 

READERSPEAK – WHERE ANGELS MUST NOT FEAR TO TREAD

“General (Retd.) Ved Prakash Malik, Former Chief of Army Staff”
“Sound observation and advice, as always.”

“Shankkar Aiyar, Author and Columnist”
“Angels must tread but where are the angels…”

“Bahram Vakil, Founding Partner, AZB & Partners”
“If I may say, very well written and spot on.”

“G Mohan Gopal, Former Director, National Judicial Academy and National Law School of India University, Bangalore”
“I agree with your take about privatization of banks. Giving up on the mixed economy is a huge and very costly error.”

“Sabyasachi Hajara, Former CMD, Shipping Corporation of India”
“Completely concur with your views. PSBs have served our economy with great distinction since independence and must continue to be allowed to play their vital roles going forward.”

For years on end, the bureaucracy was the clear topper in the list of punching bags. Eyeball- seeking, agenda driven, media and the “on the one hand…on the other” economists, many of whom had not run even something as small as a teashop, competed to land more blows on officialdom, and in the process even managed to make “Babu” sound like yet another “four-letter word”.

The pecking order has changed. Public sector bankers are the flavour of the season, when it comes to identifying the root cause of India’s problems. As the criticism gets shriller, informed discussion and debate get drowned out. That these women and men are cut from the same cloth and do not become lesser mortals by serving in the public sector, is lost on the pundits, the prophets of doom and the rest that pontificate.

In the recent past, persons that have held high positions in the financial sector have jumped on the bandwagon, prompting the question as to how much of what they now preach, occurred to them when they held high office. To add to the excitement, the head honcho of a once venerated IT company has called for immediate privatisation of PSBs. Is it not fair to ask whether that company, with flagrant violations on the corporate governance front, ought to be nationalised in the public interest? After all, the cleaning up of Satyam was done by a government appointed Board of Directors.

Can PSBs be fixed? The short answer is ‘Yes’. Is privatization the solution? The short answer is ‘No’. What then needs to be done?

Let us start with the diagnosis. Asset quality has been identified as the major villain of the piece, forgetting that the low morale of the workforce, translating into indecision, is at least as worthy of attention. Admittedly, poor credit decisions have landed PSBs in a sorry mess. Those decisions did not come about because public sector bankers across the board were either clueless or collusive. Should they have been foresighted enough to anticipate that adverse court rulings would cripple the telecom and coal sectors? What impact did prolonged regulatory forbearance and the sudden shutting off of the tap, have on the present precarious condition of PSBs? If 11of the PSBs are under Prompt Corrective Action, what does it say about regulation and, also ownership? Has action been Prompt? Has it been, or is it going to be, Corrective? Finally, is there any Action? Problem banks, such as I0B, remained headless for months while sinking under the weight of bad assets. Even more disquieting is the vacancy, for months, in an important position of Deputy Governor in the RBI. Initial reports seemed to indicate that there was no engagement between the Bank Boards Bureau (BBB) and the administrative ministry. The recent clarification that both of them were on the same page does credit to neither, since it would appear that important decisions such as the removal of the Chief Executives were within the knowledge of the BBB and it was not felt necessary to keep the Boards informed. Treating Boards as a procedural nuisance or a substantive distraction can no longer be par for the course.

Looking on, with seeming unconcern, are the Boards of Directors. A thorough spring-cleaning is required in the boardrooms. After that is done, hopefully in double quick time, the reconstituted Boards should be given primacy in finding solutions to the problems of PSBs. The solutions must be bank- specific and time bound. The Chairpersons, with proven track records should address issues of motivation and morale by communicating with the rank and file. Simultaneously, they should identify and mentor the next generation leaders and ensure that they are optimally deployed.

As for asset quality related issues, two or three aspects cry out for action. The system must understand, and act on the understanding, that a wrong decision was not necessarily ab initio malafide. The non–legitimacy of the initial credit decision should not stand in the way of timely recovery efforts. Decision-makers should be incentivized, and shirkers held accountable for non- performance. Senior executives should not be transplanted in other banks to assume board level responsibilities.

Notwithstanding advances in technology, an inclusive India will need vibrant public sector banks, with continuity of Board and Management leadership, and a clear understanding of their role in economic development. Wishing them away a pipedream that is best abandoned.

“If Winter comes, can Spring be far behind?”

 

READERSPEAK – BANKING ON GOVERNANCE

“Vinita Bali, presently ID on listed entities and former MD, Britannia Industries”
“As always, very well articulated.”

“SK Roongta, Former Chairman, SAIL”
“An excellent and unbiased analysis.”

“Pradeep Dinodia, presently ID on listed entities and Managing Partner, SR Dinodia & Co. LLP”
“Your analysis of the problem is superb.”

“EA Kshirsagar, presently ID on listed entities and former Director in Charge, AF Ferguson”
“This is truly brilliant, incisive and lays wide open the farce being played out by all.”