Many top firms skirt rules on independent directors

Ingovern study says 21 of BSE 200 companies had financial dealings other than sitting fees and commission with those designated as such directors

Several top companies are found to be having a pecuniary relationship with their independent directors (IDs) or the legal/consultancy companies the latter are part of.

Corporate governance experts see these dealings, which are in addition to the payment of sitting fees and commission, as a worrying phenomenon.

The S&P BSE 200 Index, a collection of the top 200 companies on the bourse by market capitalisation, contains 21 companies that have had such a relationship with their 25 IDs, according to Bengaluru-based corporate governance firm Ingovern Research. Of these, six companies from the Nifty 50 Index and four from Nifty Next 50 Index have had such a relationship. The report also found such relationships in 34 smaller companies outside the BSE 200 index.

“(Such) relationships severely violate the independence of the ID concerned,” says an Ingovern report. Companies, it says, should enter into no professional relationship with either their IDs or the companies where the latter are owners or partners or employees.

Ingovern identified a Mumbai-based elderly lawyer as the ID with the highest number of such pecuniary relationships. This director’s law company acted as a solicitor to the companies. It has had pecuniary relationships with 14 companies where the person was an ID for all or part of FY15.

This included two companies of the Nifty 50, one of the Nifty Next 50 and five companies overall of the S&P BSE 200 Index.  

Some of the directors in this study did not have a direct pecuniary relationship with the company through their firms. However, they acted as a legal advisor to or have represented the promoters of the companies where they serve as an ID. Such a relationship also questions their independence on the said companies, Ingovern said.

UNDERMINING INDEPENDENCE

• Legal/consulting firm will draw a fee from the company and be working with the management
• Legal/consulting firm no longer acts as an independent party
• Advice given by it and any valuation done can be questioned, as the ID (being a partner in the firm) might influence the advice
• Companies often don’t disclose the fees paid to these legal/ consulting firms, saying it's not “material”

IN NUMBERS

• 21 Number of BSE 200 companies with pecuniary relationships
• 25 Number of independent directors (IDs) involved
• 15 Audit committee memberships of such IDs
• 4 Audit committee chairmanships of such IDs

The law sets monetary limits (Rs 50 lakh, a tenth of revenue of the legal firm, etc) for such relationships between companies and their IDs, on breaching which the latter may no more be classified as ‘independent’.

In many of the instances studied, the fees or transaction amounts might not exceed the limits set by the regulations but, said Ingovern, the fact of a pecuniary relationship between a company and its ID raises serious concern on the said independence.  It could adversely influence an ID’s objectivity on key decisions and also results in a conflict of interest.

In their book, Financial shenanigans: How to detect accounting gimmicks & fraud in financial reports, Howard M. Schilit and Jeremy Perler highlight pecuniary relationships of IDs with the companies whose board they're on as one of the important red flags that provide a breeding ground for shenanigans.  

They cite the example of Krishna Palepu, an ID on the board of the erstwhile Satyam, Computer while also providing professional services to the company. Being paid for providing professional services to a company would cloud an outside director’s objectivity and appearance of independence, they've said.

Often these IDs sit on the audit committee of the board or even chair it. This raises questions on the independence of this most important committee of the board.

If, says Ingovern, companies think it necessary to retain the professional services of the company concerned, in addition to the directors in question, the latter should be classified as non-independent ones. The regulations should also be changed to classify these relationships as related party transactions and with greater disclosures.