Taking a position that is at variance with that of the Securities and Exchange Board of India (Sebi), the JJ Irani Committee on company law has recommended that one-third of the board of a listed company should comprise of independent directors.

Sebi had in the revised Clause 49 of the listing agreement mandated that at least 50 per cent of the board of a listed company comprise independent directors. The capital market regulator had made it clear that corporate India should comply with revised Clause 49 by March 31,2006.

What is Clause 49 of Sebi's listing agreement?
Sebi monitors and regulates corporate governance of listed companies in India through Clause 49. This clause is incorporated in the listing agreement of stock exchanges with companies and it is compulsory for them to comply with its provisions.

The new Clause 49 lays down tighter qualification criteria for independent directors. The new clause disqualifies material suppliers and customers from being independent directors.

It disallows a shareholder with more than 2 per cent stake in the company from being an independent director as well as a former executive who left the company less than three years ago. Partners of current legal, audit and consulting firms, as well as partners of such firms that had worked in the company in the preceding three years, too, can't be independent directors.

A relative of a promoter, or an executive director or a senior executive one level below an executive director, too, cannot be an independent director.

Another important difference is that while the original clause gave the board the freedom to decide whether a materially significant relationship between director and the company affected his independence, the new clause takes this discretionary power away from the board.

In the original clause, the maximum time gap between two board meetings could be four months. The new clause has reduced this time gap to three months.

The original clause had stipulated that the audit committee must meet at least three times a year and at least once every six months. The new clause makes it mandatory for the audit committee to meet a minimum of four times in a year with a maximum time gap of four months.

Moreover, unlike the original clause which was silent on the qualifications of audit committee members, the new clause states that all members should be financially literate and at least one should have financial or accounting management expertise.

The new clause also gives a definition of "financially literate" and "accounting or related financial management expertise". The new clause also strengthens and widens the role and responsibility of audit committees.

Who is an independent director?
The Indian definition of independent directors as given in the recently amended clause 49 of listing agreement is an inclusive definition, which says who could be independent directors.

Clause 49 of the listing agreements defines independent directors as follows: "For the purpose of this clause the expression 'independent directors' means directors who apart from receiving director's remuneration, do not have any other material pecuniary relationship or transactions with the company, its promoters, its management or its subsidiaries, which in judgment of the board may affect independence of judgment of the directors."

The definition of the term 'independent directors' has been amended to mean a non- executive director who:

- Does not have a pecuniary relationship with the company, its promoters, senior management or affiliate companies.

- Is not related to promoters or the senior management.

- Has not been an executive with the company in the immediately three preceding financial years.

- Is not a partner or executive of the auditors/lawyers/consultants of the company;

- Is not a supplier, service provider or customer of the company.

- Does not hold 2 per cent or more of the shares of the company.

Further, there is certain minimum information that is required to be made available to the members of the board prior to the board meeting which ranges from annual operating plans and budgets to labour problems. In addition, a company is also required to lay down a code of conduct for members of its board as well as the senior management.

The British definition, interestingly, as given in the Higgs report is an exclusive definition which provides for who cannot be an independent director.

The latter appears to be more appropriate as it provides who is not acceptable as an independent director. An inclusive definition for independent directors is too restrictive. It is only human that the management of company would choose an "acquiescent independent" on board. The really independent may never be taken on board the board.

It is also a matter of open debate as to what would happen to the decisions taken by the board, if subsequently it is found that an independent director is not actually independent.

What is the difference between an independent director and non-executive director?
The key difference between a non-executive and non-executive independent director is that the latter is forbidden to have any pecuniary relationship with the company apart from receiving a sitting fee which at the time of writing that clause was Rs 5,000 and has since been raised to Rs 20,000. Can we truly justify a fee of $450 for a few hours work in a country where the average wage is less than $3 a day?

Why do we need independent directors?
Independent directors are the cornerstones of good corporate governance. And effective corporate governance is the pillar of the country's economy. Independent directors' duty is to provide an unbiased, independent, varied and experienced perspective to the board. Corporate scandals such as those that affected Enron and Worldcom have revealed how this independence has been compromised by a cozy relationship between the CEO and the so-called independent directors.

With the legacy of English legal system, India has one of the best corporate governance laws but poor in implementation. Since liberalisation, however, serious efforts have been directed at overhauling the system with Sebi instituting the Clause 49 of the listing agreement dealing with corporate governance. This clause is incorporated in the listing agreement of stock exchanges with companies and it is compulsory for them to comply with its provisions.

However, in March 2005, Sebi extended the date set for compliance with these new provisions to December 31, 2005 , since a large number of companies were unprepared to fully implement the changes.

"Sebi, as a market regulator, expects total compliance of corporate governance norms. We have given enough time for those who have to meet the requirement of Clause 49," said Sebi chairman M Damodaran.

Major changes in the clause include amendments/additions to provisions relating to definition of independent directors, strengthening the responsibilities of audit committees, and requiring Boards to adopt a formal code of conduct.

Do these conditions apply to all the companies?
The committee says that these conditions shall apply only to a listed/unlisted company with paid-up capital and free reserves of Rs 10 crore, or a company having a turnover of Rs 50 crore and above for the financial year beginning 2003. The number of independent directors who are to be on the board shall not be less than 50 per cent of its total strength for these companies.

However, this norm will not apply to an unlisted public company having less than 50 shareholders and not having any debt from the public, banks or financial institution and to any unlisted subsidiary of a listed company.

In any case, nominee directors are to be excluded while computing the percentage of the independent director. The minimum number of directors for a listed company, and to the categories to whom these rules are applicable, shall not be less than seven, of which, four shall be independent directors.

As regards the three categories of companies to which the various recommendations apply, it has been specifically stated that the audit committee would only constitute independent directors. However, it is not mandatory for unlisted companies having 50 or less shareholders, companies not having debts from institution, banks, and so on, and unlisted subsidiaries of listed companies.

Does Sebi recognise government directors as 'independent' directors?
In March 2005, the petroleum ministry inducted VK Sibal, director general of hydrocarbons, on ONGC board, in addition to two officials from the ministry and one from department of economic affairs, taking the total number of government directors on ONGC board to four.

With seven functional directors, the number of executive directors went up to 11 in a board of 14 - a clear violation of Sebi's guideline that prescribes at least 50 per cent of the board being made up of non-executive directors (independent directors).

However a Sebi official said, "The present composition of the ONGC board does not conform to the requirements of the listing agreement. Sebi does not recognise government directors as 'independent' directors".

Sources said the nomination of a fourth government director also violated the policy of having a maximum of two government directors on a PSU board.

"According to the definition of independent directors, ex-officio government nominee directors and the nominee of IOC cannot be treated as independent directors. Only the three non-official part-time directors qualify the definition of independent directors."

What is the penalty for violating this condition?
Failure to comply with clause 49 (corporate governance) of Sebi's listing agreement is punishable with imprisonment of up to 10 years or a fine of up to Rs 25 crore or both. Besides, stock exchanges can suspend the dealing/trading of securities.