Amendments in rules on appointment, removal of independent directors is significant reform; will bring more transparency, improve corporate governance

SEBI-Stock- Market - India

Changes undertaken by Sebi were much needed and timely and will bring paradigm shift in the ways companies conduct their affairs; decision on InvITs, REITs to usher new opportunities for companies, retail investors      

Securities and Exchange Board of India (Sebi) has undertaken some major reforms by amending rules related to appointment, reappointment, removal or resignation of Independent Directors on listed company’s board. It has also changed the criteria for InvITs and REITs and tightened screws with respect to insider trading. All these rules are expected to bring paradigm shift in the way listed companies, function. The new framework comes into effect from 1 January and would pave way for transparent and fluid market operations.

One of the key amendments is with respect to the Independent Directors (IDs). The market regulator approved amendments to the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations) pertaining to regulatory provisions related to Independent Directors. The decision was taken during a Board meeting of Sebi on June 29.

It has now made it mandatory that any appointment, reappointment, and removal of IDs shall be done only through a special resolution of shareholders for all listed entities. The new rules also call upon the company board to decide matters of remuneration also through the special resolution process.

This is a significant departure from the previous practice and intends to tighten the rules around the above processes. It is expected to somewhat dilute the say of promoters in the company on these very crucial matters and make it more structured and transparent.

The changes have been made based on the discussion paper floated by Sebi in March 2021.

The new rules say that the appointment, reappointment or removal of an independent director from company’s boards shall be through a special resolution where at least 75 per cent of the votes should be cast in support of a decision and its implementation. Earlier, this could be done through ordinary resolution where if 51 per cent of the votes are cast in favour of a decision, it used to sail through.

Moreover, the Nomination and Remuneration Committee (NRC), which selects candidates for appointment as an independent director must have two-third independent directors. Till now the requirement was only of majority independent directors.

The rules around their appointments have been made further stringent as the NRC must now disclose and justify the appointment of any new independent director on the board. They must also mention definite skill sets that the IDs are bringing to the table.

There should also be a cooling-off period of at least three years for an independent director who is to be appointed on the board if – he has served at key managerial levels in the company; or is a relative of somebody at top position in the company or any employee of the promoter group.

However, some relaxations have been given if the person being appointed as an independent director is a relative of employee/s of the company, its holding, subsidiary or associate company. This person is now permitted to become ID, without the requirement of a cooling-off period, in line with Companies Act, 2013.

The rules related to resignation of independent directors have also been tightened. The resignation letter of an ID shall be disclosed in full along with a list of her/his present directorships and membership in board committees, the new rules mandate.

Shareholder approval for appointment of all directors, including independent directors must be taken at the next general meeting, or within three months of the appointment on the Board, whichever is earlier. The say of public shareholders has now increased in major decision-making aspect while putting some checks on the promoter’s sway.

These are welcome steps to make the process more transparent and infuse higher confidence among the shareholders of the companies. It also intends to mitigate arbitrariness in the decision making in the company boards by increasing the number of independent voices. With the requirement of two-third independent directors, the structure has been made more robust.

The Sebi rules also require at least two-third of the members of the audit committee as independent directors. To ensure that the account books remain clean, it has made it mandatory that all related party transactions must be approved by them.

The rules also do away with limits on the number of times that a person can be appointed as an independent director.

Among other major reforms, the market regulator has made changes in the lot size and application value of Infrastructure Investment Trusts (InvITs) and Real Estate Investment Trusts (REITs). The changes have been made after demands to reduce the existing lot size and investment ticket size which is currently Rs 1 lakh and in multiple of one lakh. The Sebi Board approved the amendments to SEBI (Real Estate Investment Trusts) Regulations, 2014 and SEBI (Infrastructure Investment Trusts) Regulations, 2014. The revised minimum application value will be within the range of Rs 10,000-15,000 and the revised trading lot shall be of one unit.

The Board has also approved relaxation for unlisted REITs and InvITs in tapping the bond market. Under the current scenario, issuance of debt securities is made only on a private basis and the issue is open for subscription only to qualified institutional buyers (QIBs). The reduction in trading lot size to 1 is a very significant move that will likely usher new opportunities for InvITs. A lower threshold will also give opportunities to a wider retail investor base. This move will unlock the liquidity potential of these instruments, manifold.

Another important highlight of the amendments was the 10-fold increment in the reward amount for informants of insider trading practices from Rs 1 crore to Rs 10 crore. Insider trading has been a longstanding nemesis for the market regulator and raising the bounty could go a long way to curb it. A 10-fold increase is commensurate to the risk an informant takes while unearthing the market malpractice. It was a longstanding demand and could not have come at a better time.

There were expectations that the market regulator would also approve amendments to the Stock Exchange and Clearing Corporation regulations, which did not come through. Under this amendment, the regulator has plans to allow 100 percent anchor investment in the exchange and depositories segments.

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