SEBI's nudge for better corporate board evaluation
Published: Feb 23, 2017
THE Securities and Exchange Board of India (SEBI) is definitely one of the most pro-active regulatory bodies of India which not only keeps a strong vigil on the capital market but also knows how to keep its subjects on their toes. SEBI has played a crucial role in bringing landmark transformation in corporate governance norms in India and its implementation is visible to some extent atleast in disclosure practice of some entities. However, corporate governance is an evolving concept and if the companies are not willing to raise their benchmark, the regulator would.
Pursuant to this constant endeavour, SEBI issued the Guidance Note on January 5, 2017 for the evaluation of the board of directors of a listed company. The Guidance Note aims to provide guidance to listed entities in relation to the various aspects involved in an evaluation process of the board of directors and in improving the effectiveness of the board of directors while enhancing corporate governance standards. The history of corporate board evaluation in India is quite new. Countries like UK, USA have evolved a very matured board evaluation mechanism.
SEBI Committee on Corporate Governance in 2003 recommended it as a non-mandatory provision for listed companies. But it was only in 2013, Companies Act, 2013 made it mandatory. SEBI stepped into the picture only in 2015, it came out with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR).
The essence of Section 178 of Companies Act and Regulation 19 of LODR1 is that it requires listed companies to (a) formulate a criteria for evaluation of performance of independent directors and the board of directors; (b) carry out an evaluation of the performance of every director; and (c) determine whether to extend or continue the term of appointment of the independent director based on each of their evaluation reports. Evaluation of an independent director must be done by the board of directors of the listed entity excluding the director being evaluated. Additionally, independent directors are required to (a) review the performance of non-independent directors and the board of directors as a whole; (b) review the performance of the chairperson of the listed entity (while accounting the views of the executive and non-executive directors); and (c) assess the quality, quantity and timelines of flow of information between the management and the board of directors necessary for the performance of duties of the board of directors.
Unfortunately, Indian companies resort to compliance of the letter of the law and tactfully avoids the spirit. Similar is the case with the corporate board evaluation. While the companies have complied with the law, yet there has not been qualitative board evaluation undertaken in the past. Cimply Five Corporate Secretarial Services ("CimplyFive) and InGovern Research Services conducted a unique research where it attempted to identify new trends, practices and lessons emerging out of the board evaluation practices in India. They conducted a research on 100 listed companies in India to understand the ground realities of corporate board evaluation. The research outlined a 5 star rating system for board evaluation, but interestingly even the highest ranked company could gain only 3 star rating in the final result.
The Guidance Note classifies the evaluation process into several stages.
1. pre-evaluation process;
2. evaluation process; and
3. post-evaluation process.
Pre-Evaluation
In the first stage, the board needs to first identify the objective of evaluation, both standard and specific based on issues of concern, recent events etc. The criteria for evaluation needs to be developed at every level within the board of directors depending on the functions, responsibilities, competencies required, nature of business etc. SEBI has also prescribed the specific issues that would require focus in terms of evaluation under each criteria. SEBI has provided three specifications in terms of evaluation of individual directors. Firstly, SEBI specifies that the evaluation of individual directors must be done on a general basis while taking into consideration the qualifications, experience, knowledge and competency, fulfillment of functions assigned to or prescribed under law, ability to function as a team, initiatives taken by individual directors, availability, commitment, contribution and integrity. SEBI has also prescribed additional criteria for independent directors and chairpersons.
However, the aforementioned criteria is not exhaustive and SEBI has provided that different criteria may be assigned depending on the requirements of the listed entity, circumstance, outcomes of previous assessments and maturity of the board.
Evaluation process
The Guidance Note prescribes two methods of evaluation of the board of directors: (a) internal assessment; and (b) external assessment.
Internal assessment: Assessment may be undertaken either through a detailed questionnaire to be circulated to individual directors, committees, board of directors etc., or through oral assessments provided by the person on interviews. If required, the questionnaire may enable written answers to be provided on confidential basis. Views of the members may also be taken on a confidential basis by the chairperson if the members are not willing to disclose their inputs in writing.
Assessment by external experts: SEBI has suggested the use of external experts with the view that independence is imparted to the evaluation process. SEBI further specifies that the external assessment may be done based on questionnaires/interviews or a combination of the two on a regular basis. Moreover, SEBI has provided that caution should be exercised to ensure that the external assessor is not a related party or conflicted due to closeness of the board of directors so as to ensure impartiality.
Post Evaluation
Post the evaluation processes undertaken, SEBI specifies that feedback must be accorded in one or more of the following ways:
1. Orally given by chairman/external assessor or any other suitable person to each member, committees and board of directors; or
2. Written assessment to every member, board of directors and committees.
SEBI has laid down that an active role is required of the chairperson in providing feedback. If the individual members are not comfortable to open individual assessments, provision for confidentiality may be made where possible. SEBI has provided that feedback must be provided honestly and without bias. SEBI has also suggested a periodical review to be undertaken for improvement of the effectiveness of the board of directors considering that the evaluation of the board of directors is not a static process. Such responsibility lies with the board of directors and should be done based on feedback from the concerned parties.
Conclusion
Corporate board evaluation is an instrument of self-criticism but if done constructively, it is helpful in identifying areas for improvement and defining action plans to remedy the deficiencies. Episodes like Satyam, Mallya, Tata and the ongoing rift between the founders and board of Infosys have compelled SEBI to revisit board evaluation regime. Recently, the SEBI passed an order2 against Vijay Mallya that diversion of substantial funds of United Spirits Limited to its group companies and Kingfisher Airlines at the instructions of board members headed by Vijay Mallya and other Key Managerial Personnel amounts to fraud on the public shareholders. SEBI in the interest of capital market and investors prohibited Vijay Mallya from accessing the capital market and from holding the position of directorship in any listed company. While it is true that the SEBI Guidance Note is not compulsory, it is one more step towards a meaningful corporate governance. It would not be wrong to expect that this Guidance Note reflects the intention of SEBI and its possible future interpretation of corporate governance as an adjudicator. In other words, the Guidance Note can exert indirect pressure on the Indian boards to up their level of corporate governance. In short, there is a dire need for transforming the culture of opaqueness which the Indian boards have got used to. It must be understood that the process of corporate board evaluation is an ongoing process. Unfortunately, this is being looked as an end (merely for compliance purpose) and not as means to attain a transparent and efficiently functioning board.
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1The listed entity which has listed securities shall make disclosures and abide by its obligations under these regulations, in accordance with principles set out in the LODR Regulations.
2In the Securities and Exchange Board Of India Mumbai, WTM/SR/CFD–CMD/6/01/2017, In respect of - Dr. Vijay Mallya and Ors, 2017-TIOLCORP-02-SEBI.
