Two agencies regulate companies in India: the Ministry of Corporate Affairs (MCA) through The Companies Act, and the Securities and Exchange Board of India (SEBI), whose writ covers all listed entities. Until January 2009, SEBI was the clear winner. The companies that really mattered were listed and, therefore, in SEBI’s jurisdiction; the key clauses of the Listing Agreement clearly defined the norms for financial disclosure and corporate governance; most importantly, SEBI was considered a more transparent and professional body compared to the MCA.

Satyam changed all that in January 2009. As a stunned corporate world was figuring out how half a dozen felons led by Ramalinga Raju stole monstrous amounts of company money with neither the statutory auditors nor the non-executive directors having a clue, the MCA assumed charge. It played the lead role with the investigators, the new Satyam Board, the press and the politicians. In the process, it consigned SEBI to purgatory. Since then, the MCA has been determined to define a new control raj and hold the aces.

The Companies Bill, 2009, is a particularly gross example of the MCA calling the shots. The original bill has been significantly modified by the MCA and the Parliamentary Standing Committee (PSC) chaired by Yashwant Sinha. The PSC report — including the altered bill — was presented to the Lok Sabha on 31 August 2010. It will be debated in the winter session of Parliament. Given how little parliamentary debate occurs in matters such as competition and corporate law, it will be almost certainly passed during the session.

This article critiques certain terrible provisions of the bill which relate to corporate governance, boards and auditors. I certainly believe that The Companies Act, 1956, needed changing to the 21st century. But in doing so, the MCA has displayed some terrible aspects of licence-control dirigisme and excessive over-reach of law. Here is a small sample.

Board size. Clause 132(1) of the bill states that every public limited company must have a minimum of three and a maximum of 15 directors, excluding nominees from lending institutions. A company wishing to appoint more directors can only do so after obtaining prior approval of Central Government and passing a special resolution. Every sensible country’s corporate law prescribes the minimum, as it should. But why should it impose a maximum? Isn’t that a matter for the company’s shareholders to decide? And if the shareholders agree to such a special resolution, why does a company need “prior approval of Central Government” to increase its Board size beyond 15?

An independent director’s term. According to a new clause 132(7) introduced by the MCA and approved by the PSC, (i) no independent director shall have a tenure exceeding, in the aggregate, a period of six consecutive years on the Board of a company; (ii) three years must elapse before such a person is inducted in the same company in any capacity, and (iii) no individual shall have more than two tenures as independent director in any company in the manner provided in this clause.

Clause 132(7) has appeared thanks to a clever ploy by the MCA. It wasn’t in the original bill. In December 2009, the MCA released a document called Corporate Governance: Voluntary Guidelines, where it stated:

“a) An individual may not remain as an independent director in a company for more than six years.

b) A period of three years should elapse before such an individual is inducted in the same company in any capacity.

c) No individual may be allowed more than three tenures as an independent director in the manner suggested in (a) and (b) above.”

Impossible to tell apart, right? When various organisations and bodies seriously critiqued this provision, MCA responded that it is ‘voluntary’ — and no different in spirit to the voluntary recommendation in SEBI’s Clause 49 that an independent director ought not to serve for more than nine consecutive years.

In subsequent discussions with the PSC, the ministry successfully introduced it as a new sub-clause. The PSC has not only agreed, but has also stated that it “would like the Government to formulate a code of Independent Directors [to]… include their mode of appointment, role and responsibilities… their remuneration and extent of their liability”. With the MCA convincing the PSC that various elements of its ‘voluntary’ code should be incorporated in the Bill, it has made ‘voluntariness’ absolutely mandatory!

No corporate law in any country worth the name legislates the maximum number of years that a director can serve on a Board. Not in the USA; in the UK; in Australia; in Canada; in Singapore; in Hong Kong; and many more. Such a ceiling, if it exists at all, is in the Memorandum and Articles of Association of a company, or as a Board practice. Legislation does not prescribe a ceiling.
 

Consider this. Is there a law that states the maximum number of terms for a Lok Sabha MP? If political representatives have no ceilings on the number of terms that they can be elected, why is it imposed on corporate fiduciaries? How can law decide the maximum tenure of an elected appointee of the shareholders? It is for a company’s shareholders to choose, not the State.

Such a clause seriously impairs the working of Boards and corporate governance. Consider multi-product, multi-location, multi-service companies, or businesses with substantial regulatory interface such as banks, mutual funds and insurance companies. Even with serious training, it normally takes a new independent director a year and a half to properly understand nuances of the businesses. Hence, what is proposed is that the effective tenure of being an informed and sensible fiduciary be four and a half years. After that the Nomination Committee of the Board will have to hunt for a replacement.

What great corporate governance is this? Where is it to be found in law? Where is the hard evidence that independence in judgment ends after serving six years on a Board? None whatsoever. How then did it come to pass? Because the MCA found it ‘worthy’ for legislative over-reach.

Number of directorships. A new clause 146 inserted by the MCA states that no person can be a director of more than 15 public companies, and within these, in no more than seven listed companies. That is probably fair. But the PSC has tightened it further. The maximum number of public companies has been reduced to 10; and for listed companies, it has reduced to five. To reduce the number of listed companies where a person can serve as a director to five is extreme. A person can, with full diligence, serve on seven to nine listed Boards, especially if these are not as meeting-intensive as those of banks. I’m willing to bet that limiting it to five won’t improve governance, while it will certainly increase the stress of finding new directors. And if this clause is about getting directorships for those who don’t normally make the cut, it still won’t. Let me state an honest truth. Today, there aren’t even 250 people who are genuinely competent to be independent directors of major corporations. The law won’t suddenly increase this to 500 or 1,000.

Ban on stock options. A new clause 132 (6) states: “Subject to the provisions of section 176, an independent director shall not be entitled to any remuneration, other than sitting fee, reimbursement of expenses for participation in the Board and other meetings and profit-related commission as may be approved by the members.”

Thus, stock options have been omitted in law “to allow independent directors to remain independent in decision making” (PSC). Here are four questions:

· Which significant nation’s (USA’s, UK’s, Canada’s, Australia’s, Singapore’s, Hong Kong’s to name some) corporate law bans stock options for independent director? Answer: none.

· Where is the irrefutable evidence that stock options given to independent directors systematically encourage corporate mis-governance and self-seeking behaviour at the cost of long term shareholder value? Answer: none.

· How can one expect to attract best-in-class independent directors on Boards of start-ups without getting stock options? Answer: can’t.

· How can one attract good independent directors to sit on Boards of financially distressed but sound companies without getting stock options? Answer: can’t.
 

One can impose constraints. For example, listing norms can state that stock options, even if converted to shares by an independent director, cannot be sold until six months after the director exiting from the Board. Such constraints are worth debating. But to ban stock options is seriously counter-productive.

Statutory Auditors. The big firms have had it! Clause 123 (1A) states that no company shall appoint/re-appoint an individual or a firm as auditor for more than five consecutive years. Moreover, such a firm or individual auditor shall not be, respectively, eligible for re-appointment as auditor in the same company for five or three years thereafter. In addition, where a firm is appointed as an auditor, the auditing partner of the firm must be rotated after three consecutive years and shall not be eligible to be re-appointed as auditing partner of the same company for the next three years.

These are absurd. Only Italy has compulsory rotation of auditors by law — and Italy is hardly the model for corporate governance! No sensible common law or civil law country has these provisions.

This clause is due to pressure from the Institute of Chartered Accountants of India (ICAI). The large mass of ICAI members want to audit large corporations, even if they don’t have the requisite skill sets. They have now changed the law to get entry. Have no doubt that such short period rotation will harm the quality of audit. And even the small firms will lose their few marquee clients!

I can state many more. But here’s the piece de resistance. The PSC has recommended that the maximum percentage for political contributions per year be raised from 5% to 7.5% of average net profits during the three immediately preceding financial years! That’s brilliant corporate governance, isn’t it?