Recent failures have given enough reason to believe that directors need to have greater awareness of their fiduciary responsibilities. Of the recent failures — several on account of corporate governance lapses — had boards with well-established directors that failed in executing their fiduciary responsibilities. The IL&FS and CG Power are cases that come quick to mind. Leave aside abject failures, but governance practices in well-established companies also raise questions on the role of independent directors.
That shareholders have to vote against remuneration resolutions or stock option schemes raises questions on whether the nomination and remuneration committee (NRC) has used objective benchmarks to decide executive compensation. Whistle-blower letters that go directly to the regulator rather than through the company’s own policy and process are, to some extent, a reflection of the trust commanded by the company’s board and leadership. Related party transactions that are defeated centrally question the role of the audit committee and the overall board in exercising independence when approving these transactions.
Will the proficiency test for independent directors, instituted by the Ministry of Corporate Affairs in October (Exhibit 1), address any of these issues? We think not. The test is designed to familiarise independent directors with securities and corporate law, basics of accounting, and “and other such areas relevant to the functioning of an individual acting as an independent director”. It does not attempt to make independent directors think about what is beyond the scope of legal provisions.
The target audience is narrow — limited to independent directors with less than 10 years of board or KMP experience. Directors with less than 10 years of aggregate work experience — typically those born in the promoter family and have reached drinking age — do not have to take this test, since they are not independent directors.
The proficiency test is an overlap with the familiarisation programmes already being conducted by companies. The Companies Act 2013 mandated companies to hold trainings for directors, which was subsequently rechristened to director familiarisation programmes. The idea of this was akin to continuing professional education for directors. The discretion of what trainings to undertake has been left to companies, and companies tend to mix programmes from business-related topics, to regulatory updates. Over and above this, directors will now have to take the test. Perhaps, it may have been easier to ask companies to ensure at least one session annually covers regulation and regulatory updates — that may have a better outcome.
The implementation of the mandatory test is likely to follow a script we have all seen in the past. While the test has been mandatory, it is a decision that seems to have been made in a hurry: the October 22 notification essentially requires the test to be made available from December 1. To get a panel together and create an online test in less than two months is challenging. There is a high probability of the test being postponed, or a hurried implementation with execution difficulties.
Once implemented, the exceptions will begin. Listed public sector companies have been the exception to almost every rule — there is little reason to believe that they will comply with this requirement. Reduction of passing thresholds (currently set at 60 per cent), exempting bureaucrats above a certain rank, creating optional questions or sections, et al will likely follow.
In the manner that the proficient test has been designed, it seems to become more eligibility criteria than training. It is one-time; directors take it, pass and they are done. This is not continuing professional education, where directors are kept abreast of changing regulations or changing market expectations. The Ministry of Corporate Affairs will do well to roll-back this entire idea, since its impact on board quality will be nothing more than a check-the-box.
There is no denying that independent directors need training. However, the training needs to focus on taking the right decision for all stakeholders — not on ensuring compliance (companies have legal teams for that). Boards need to straddle between taking the right decision and what is legally right; they need to find their own .Exhibit 1: The proficiency test for independent directors
· All independent directors must register themselves with the directors’ data bank that is being maintained by the Indian Institute of Corporate Affairs (IICA). The registration can be for one-year, five-year period or for the lifetime of the director. For existing independent directors, the registration must be completed within three months of the regulation coming into effect (December 1, 2019), while individuals going to be appointed for the first time must register before their appointment.
· For directors with less than 10 years of board or KMP experience (in a listed company or an unlisted company with an at least Rs 10 crore share capital), an online proficiency test is mandatory. These directors need to score at least 60 per cent marks to pass. There is no cap on the number of attempts and the test needs to be taken within one year of registering with IICA’s directors’ data bank.
· The IICA will be responsible for conducting the online proficiency test and for preparation of the course work. The test will cover corporate law, securities law, basic accountancy, “and other such areas relevant to the functioning of an individual acting as an independent director”. The test will also allow individuals to take advanced test in specific areas, for which the IICA will remain responsible for providing course work and administering such advanced tests.
· The course outline and study material will be approved by a panel of 10 members, all of which will be nominated by the central government. The 10-member panel will comprise of the following individuals:
1. Secretary, Ministry of Corporate Affairs, or her nominee
2. Director General and Chief Executive Officer of IICA, or her nominee
3. Department of Economic Affairs nominee
4. Department of Public Enterprises nominee
5. SEBI nominee
6. At least one representative of the stock exchanges, who will be nominated by the central government
7. At least one nominee from the industry, who will be nominated by the central government8. At least one member from the academia, who will be nominated by the central government