Independence of Members of Board Committees19/10/2022 0 By indiafreenotes
King III recommends that the delegation of powers to a committee be made official, in order for the members to have formal terms of reference to determine the scope of their powers, and the responsibilities they bear. The terms of reference should include detail pertaining to:
- The composition of the committee
- The objectives, purpose and activities
- The powers that have been delegated
- Any mandate to make recommendations to the board
- The lifespan of the committee, and
- How the committee reports to the board.
The Act requires public companies and state owned companies to appoint an audit committee comprising three independent non-executive directors. King III proposes that all other companies provide for the appointment of an audit committee (the composition, purpose and duties to be set out in the company’s Memorandum of Incorporation).
In addition, King III proposes that the board should appoint the audit, risk, remuneration and nomination committees as standing committees. The board may also consider establishing governance, IT steering and sustainability committees.
King III suggests that the committee should only comprise members of the board. The majority of the members should be non-executive, of which the majority should be independent. The ideal situation is for the chairperson of the board to also chair the nomination committee, failing which an independent non-executive director should be the chairperson.
The chairman of the committee should be an independent, non-executive director. The chair of the board should not chair the remuneration committee, but may be a member.
Insiders as Independent Directors
- Position: Current and former executives and directors of an issuer should not be permitted to sit as an independent non-executive directors until five years after leaving the relevant positions, and then only under certain restrictions.
- Rationale: Insiders such as individuals from these groups can retain emotional, financial, professional, and personal ties to the issuer, its management, and its directors. This retained loyalty may compel the insider to decide on matters in a way that does not first serve the interests of shareowners.
Independent Director’s Connection to the Company
- Position: Independent non-executive directors should not have been connected to a director, chief executive, or substantial shareowner of the issuer within the preceding five years.
- Rationale: Individuals with such links to insiders are more likely to make decisions on the basis of those links than on what is best for shareowners. After five years, the allegiance may diminish to a point where the independent, non-executive director may make decisions that run counter to the interests of the insider.
Mode of Appointment of Independent Directors
The appointment of independent directors should be made by the company from amongst persons, who in the opinion of the company, are persons with integrity, possessing relevant expertise and experience and who satisfy the above criteria for independence.
The term material pecuniary relationship should also be clearly defined for the purpose of determining whether the director is independent or not. The concept of “Materiality’ is relevant from the recipient’s point of view and not from that of the company. The term ‘material’ needs to be defined in terms of percentage. In view of the Committee, 10% or more of recipient’s consolidated gross revenue / receipts for the preceding year should form a material condition affecting independence. For determining materiality of pecuniary relationship, transactions with an entity in which the director or his relatives hold more than 2% shareholding, should also be considered. An independent director should make a self-declaration in format prescribed to the Board that he satisfies the legal conditions for being an independent director. Such declaration should be given at the time of appointment of the independent director and at the time of change in status. Board should disclose in the Director’s Report that independent directors have given self-declaration and that also in the judgment of the Board they are independent. The Board should also disclose the basis for determination that a particular relationship is not material.
Director/ Attributes of Independent Directors
The Committee was of the view that definition of an Independent Director should be provided in law. The expression ‘independent director’ should mean a non-executive director of the company who:
a) Apart from receiving director’s remuneration, does not have, and none of his relatives or firms/companies controlled by him have, any material pecuniary relationships or transactions with the company, its promoters, its directors, its senior management or its holding company, its subsidiaries and associate companies which may affect independence of the director. For this purpose “control” should be defined in law.
b) is not, and none of his relatives is, related to promoters or persons occupying management positions at the board level or at one level below the board;
c) is not affiliated to any non-profit organization that receives significant funding from the company, its promoters, its directors, its senior management or its holding or subsidiary company;
d) has not been, and none of his relatives has been, employee of the company in the immediately preceding year;
e) is not, and none of his relatives is, a partner or part of senior management (or has not been a partner or part of senior management) during the preceding one year, of any of the following:
i] The statutory audit firm or the internal audit firm that is associated with the company, its holding and subsidiary companies;
ii) The legal firm(s) and consulting firm(s) that have a material association with the company, its holding and subsidiary companies;
f) is not, and none of his relatives is, a material supplier, service provider or customer or a lessor or lessee of the company, which may affect independence of the director; g) is not, and none of his relatives is, a substantial shareholder of the company i.e. owning two percent or more of voting power.
Explanation: For the above purposes:
(i) “Affiliate” should mean a promoter, director or employee of the non-profit organization.
(ii) “Relative” should mean the husband, the wife, brother or sister or one immediate lineal ascendant and all lineal descendents of that individual whether by blood, marriage or adoption.
(iii) “Senior management” should mean personnel of the company who are members of its core management team excluding Board of Directors. Normally, this would comprise all members of management one level below the executive directors, including all functional heads.
(iv) “Significant Funding” Should mean 25% or more of funding of the Non Profit Organization.
(v) “Associate Company” Associate shall mean a company which is an “associate” as defined in Accounting Standard (AS) 23, “Accounting for Investments in Associates in Consolidated Financial Statements”, issued by the Institute of Chartered Accountants of India.
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