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Needed, better direction on directors
June, 14th 2007
Clause 49 is a classic example of over-regulation in the era of de-regulation.

All stock exchanges come under the surveillance of the Securities and Exchange Board of India (SEBI). Using the Listing Agreement as a tool, SEBI took the initiative to introduce corporate governance through Clause 49. In spite of the best of intentions and efforts, Clause 49 has failed to click. Where is the flaw?

Crux of the problem

The crux of the problem is interference in the management of companies. In a corporate democracy, shareholders are supreme. They know what is in their best interest and the board is bound to act according to the wishes of the shareholders.

The legislature has to ensure that the interests of both minority shareholders and the public are protected. On the other hand, Clause 49 impinges upon the liberty and freedom of corporates and the rights of shareholders to manage their affairs. Clause 49 is a classic example of over-regulation in the era of de-regulation. It dictates how the board of a listed company should be constituted without considering whether the requirement is capable of being implemented.

Clause 49 commands that there shall be optimum combination of executive and non-executive directors on the board. Not less than 50 per cent of the strength of the board shall comprise non-executive directors. If the chairman of the board is an executive director, then not less than 50 per cent of the board shall comprise independent directors and if the chairman is non-executive, then such number shall not be less than one-third of the board's strength.

Any person who satisfies the conditionality for being appointed as an independent director must further satisfy the audit committee requirements. The clause refers the constitution of audit committee.

Further, it mandates the constitution of audit committee comprising a minimum of three directors and two-thirds of the members of audit committee shall be independent directors. All the audit committee members shall be financially literate and at least one member shall have accounting or related financial expertise.

Gauging compliance

Corporate managements find it extremely difficult, if not impossible, to find suitable candidates having the required attributes. There is lack of clarity in this proposal. All directors on appointment are non-executive. The term executive director is not defined. The managing director can, perhaps, be rightly called executive director.

The whole-time director who is in whole-time employment may fall in this category. Managing director is defined in Section 2 (26) of the Companies Act, 1956 as "a director who, by virtue of an agreement with the company or of a resolution passed by the company in general meeting or by its board of directors or, by virtue of its memorandum or articles of association, is entrusted with (substantial powers of management) which would not otherwise be exercisable by him, and includes a director occupying the position of a managing director, by whatever name called."

The whole-time director is not defined but is one who is appointed by the board from among them and discharges such executive function which he may be entrusted with. He is next only to the managing director and enjoys similar powers.

Executive powers

Both these directors are clubbed as managerial personnel for the purpose of Section 269 read with Schedule XIII of the Act. The cap `executive director' fits them well as they enjoy executive powers. These executive powers are conferred either by the board or under the articles of association of the company. A director discharging the duties and functions of company secretary cannot be styled as an executive director. It is a statutory appointment.

A director who is appointed chief accountant and financial officer and discharges duties as such does not enjoy any executive powers. Both these directors are directors simplicitor for enjoying the same powers as any other director.

All directors on appointment are non-executive; from among them the board appoints managing director, whole-time director, and so on.

To club a director who is a company secretary, chief accountant or CFO as an executive director is absurd.

As dependable and technically qualified people are hard to get, some companies have a system of promoting seniors into the board so as to retain talent.

Considering all these and many other pitfalls, it would be advisable to consider an alternative to the existing Clause 49.

Clause 49 in its present shape cannot be implemented.

N. R. Moorthy
(The author is a Pune-based company secretary.)

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