The Hindu Business Line : A Clause that must be enforced

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A Clause that must be enforced

Raghuvir Srinivasan

Will the government turn to SEBI yet again for another extension of the deadline, especially because its own companies are lagging behind in compliance? It would be a shame if that were to happen and more so because these companies had more than a year to fall in line.

WITH the deadline just a month away, things are hotting up on the Clause 49 front. Last week saw the SEBI Chairman, Mr M. Damodaran, talking tough on requests from companies for an extension of the deadline, which was already pushed back once from March 31 to December 31.

Mr Damodaran made it clear that another extension was not an option anymore and hinted at penalising companies that did not comply. Significantly, he did not rule out even a suspension of trading in the shares of the defaulting companies.

What is Clause 49?

The amended Clause 49 of the Listing Agreement sets out a number of measures to raise the standards of corporate governance in the listed companies. For instance, companies will have to submit a Compliance Report to the stock exchanges every quarter in a specified format.

This Report will have details on everything, from the composition of the board to the Audit Committee and its functioning and disclosures on related party transactions, subsidiaries and so on. Once the Clause comes into force, a separate section on corporate governance will become mandatory in the annual reports of listed companies and this will include a compliance report. This will enable investors/shareholders gauge the company's transparency and its corporate governance standards.

The one Clause 49 provision that is kicking up dust now is that on independent directors. At least half of the board of a listed company with an executive chairman should consist of independent directors and where the chairman's is a non-executive position, the number should be at least a third.

PSUs in a tight spot

The coming days will be interesting to watch not the least because some of the biggest public sector companies with a large following in the market are yet to comply with this norm on independent directors.

A study by Business Line last week of the compliance by the 50 companies that constitute the Nifty shows that just one of the nine PSU companies in the index — BHEL— complies with the requirement. The rest are still awaiting instructions from the government, as the appointment of directors has to be approved by it.

There are also some unique problems such as the board size becoming large and unwieldy if Clause 49 has to be complied with. PSU boards, as they are now composed, are large as they have to accommodate government nominees apart from the working directors.

In the case of ONGC, the board size of 22 directors, post-compliance, will be one more than what is permitted in the company's Articles of Association.

Not that these issues cannot be addressed, just that the government has yet to wake up to them. Meanwhile, a number of companies in the private sector, especially the medium- and small-size ones, could also find themselves on the wrong side if they do not act soon. So, will the government turn to SEBI yet again for another extension of the deadline, especially because its own companies are lagging in compliance? It would be a shame if that were to happen and more so because these companies had more than a year to fall in line — the original notification on Clause 49 was issued by SEBI in October 2004. Such a move would send out negative signals on the government's commitment to ongoing reforms.

Pertinent questions

Meanwhile, some interesting questions being raised on this whole issue of independent directors. Will having independent directors on the board be enough to guarantee transparency? Probably not. Have there not been instances where despite the presence of independent directors, companies have been opaque on corporate governance?

In fact, a lot would depend on the quality of the independent directors and also whether they are "independent" in every sense of the term. Given the demand for such people, projected at close to 15,000 now, it is doubtful if every company will be able to get the best man around for the job. And, again, what do these independent directors do when despite their objections a company acts against shareholder interests?

These are pertinent questions indeed but they certainly do not detract from the desirability of having independent monitors. They should also not be used as an excuse to stymie forward movement on the important issue of corporate governance; independent directors are but one step in the process of raising the bar on corporate governance standards.

SEBI needs to be backed fully by the government in this effort and the first step in this would be for the latter to ensure that its companies fall in line by the deadline. Granted that adherence to all the provisions of Clause 49 will entail a lot of effort by the companies, especially the compliance officer who is sure to come under pressure. But that is a small price to pay for a transparent and well-regulated stock market.

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