Corporate Governance: SEBI is Focused on Bureaucratic Compliances
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| 21/01/2013 02:16 PM | 
Mandating mindless reporting and training rules to ensure good governance is not a substitute for effective enforcement
The new consultative paper from the Securities and Exchange Board of India (SEBI) seeking to review corporate governance norms, issued on 4th January, would normally have evoked nothing more than a yawn; but maybe this one needs some attention. There is now a pattern to discussions on governance. Every report produced over the past 15 years had several excellent recommendations—the CII report of the 1990s, the Kumar Mangalam Birla report in 1999 and the NR Narayana Murthy report in 2003 and even those by the ministry of corporate affairs (MCA). In each case, powerful industry bodies ensured that some sensitive changes are never implemented. I had a ringside view of how this works as a member of the Narayana Murthy committee. Mr Murthy followed a strict policy of deciding each issue by a majority concurrence. So, the sudden aggressive participation by industry associations ensured that the recommendations on limiting the term of independent directors and rotation of auditors were shelved, postponed or later showed up on a non-mandatory code put out by the MCA. In any case, recent examples like the UB-Kingfisher saga and the collapse of Deccan Chronicle, are glaring examples of how no checks & balances work on companies run by politically powerful owner-managers. They represent a failure of good governance codes as well as prudent lending practices by banks which are listed entities.
So what is new about the latest set of good governance recommendations? Two things. First, it tries to co-opt the MCA by claiming that many of the changes are meant to align prescriptions in the listing agreement of stock exchanges with the Companies Bill 2012. Secondly, this is probably the first consultative paper on governance produced without involving corporate India and its consultants, lawyers, investment bankers, auditors or friendly academics. Instead, the paper reflects the views of India's newest breed of market intermediaries—the three new 'proxy advisory firms' whose long-term survival depends on the regulator creating a market for their services. One of them, Stakeholders Empowerment Services Pvt Ltd (SES), has been set up by SEBI's former executive director, JN Gupta and his son, and has MS Sahoo, a former SEBI whole-time director as its advisor. Curiously, neither of them showed the same aggressive activism that is evident in their advisory reports, while at full-time jobs with the regulator.
In the US, proxy advisors have increased their power and influence from the Dodd-Frank Law which mandates certain voting regulations. In fact, they have turned more powerful than institutional investors and it has led to a backlash and a demand for regulation and scrutiny of the advisors themselves. In India, too, these firms were set up only when SEBI quietly created a role for them at the time when Mr Gupta and Mr Sahoo were about to complete their terms at SEBI. In 2010, it issued a directive to mutual funds mandating the disclosure of their proxy voting policies and decisions on their website. But, according to the SEBI report, while fund houses have complied, there is no discernable change in voting and some institutional investors do not even attend general body meetings.
The current set of recommendations clearly intends to tighten the rules. It refers to the need for 'regular intervention' by 'institutional' investors, but this will clearly not apply to large insurance companies, especially those in the public sector, which dance to the finance ministry's tune. In fact, SEBI is under pressure to allow these institutions to breach the 10% ceiling on holding of individual stocks and also to dilute the norms for listing of public sector companies. Is it then fair to tighten the rules only for those who comply? I am sure, we will hear on this issue from corporate India.
The recommendations indicate that SEBI plans to ensure good corporate behaviour through penalties for failure to comply with governance norms including de-listing (in extreme cases), debarment of directors and, maybe, even prosecution. Other proposals include: formal induction, training, examinations and annual performance evaluation of independent directors (IDs); appointment of a lead ID with separate meetings mandated for them; more board committees and the appointment of at least one ID by 'small shareholders'.
All of these sound very uplifting, but will make it irksome to be an ID. Many of the proposals are a serious encroachment on the company's primary responsibility of running a legal and profitable business that earns a decent return for investors and provides fair treatment and compensation to its employees. Good governance norms are important, but cannot become the centrepiece of a company's existence or occupy unreasonable time and attention of management. Investors are likely to ditch stocks of an unprofitable company much faster than those of a profitable one whose major governance lapse is to designate the chairman's brother-in-law as ID.
The proposal for an independent director representing the 'small shareholder' is another old chestnut that has been discarded as unworkable several times. When three consecutive SEBI chairmen have not been able to enforce the 25% public shareholding norm, and the retail investor population has shrunk and is ignored, what is the purpose of this pointless suggestion?
Targeted reform and disclosure is better than introducing mindless red-tape. For instance, SEBI did well to mandate disclosure of pledged shares and dematerialisation of promoter holding after the Satyam scandal. But it still didn't prevent the Deccan Chronicle debacle. Also, Ramalinga Raju was able to fudge the books because of the active collusion by auditor PricewaterhouseCoopers (PWC). Why is there no significant action against PWC in India, when it has paid $25.5 million to settle US shareholder claims and $17.5 million in settlements with the US Securities and Exchange Commission and Public Company Accounting Oversight Board in the Satyam case? Importantly, in early January, a US court dismissed shareholder claims against Satyam's IDs on the grounds that they had asked the right questions and were misled. India needs to study the judgement carefully and evaluate how far we can stretch the responsibility of IDs if they were deliberately misled or not in charge of certain actions. In fact, the SEBI recommendations ought to have reviewed the gross miscarriage of law in the Nagarjuna Finance case where Nimesh Kampani, Minu Shroff and other IDs were on the run for almost a year.
Secondly, collusion with auditors and lawyers to ensure a better deal for owner-managers usually happens during mergers, acquisitions, restructuring and amalgamation of entities inside or outside a corporate empire. SEBI has limited powers to regulate auditors who are accountable to self-regulatory bodies under the MCA. Even if SEBI manages to mandate the rotation of auditors, which has been discussed and discarded by every corporate governance committee until now, it will be a big achievement. Some of SEBI's recommendations, especially those regarding training of independent directors are only creating business opportunities for trainers, including its own National Institute of Securities Management. Mindless rules will only push the better-managed companies to follow the trend of well-managed multinational companies to de-list their shares. This will end up hurting investors. It is time for the government to call a halt to mindless regulation and focus on quick enforcement and action which will serve as a deterrent to mismanagement. We need to review how SEBI has performed in terms of its twin mandate of investor protection and market development and insist that it cleans up its own act before needless tinkering with rules to shift the focus from pathetic enforcement.
Sucheta Dalal is the managing editor of Moneylife. Subscribers get free help in resolving their problems with select providers of financial services.
The new consultative paper from the Securities and Exchange Board of India (SEBI) seeking to review corporate governance norms, issued on 4th January, would normally have evoked nothing more than a yawn; but maybe this one needs some attention. There is now a pattern to discussions on governance. Every report produced over the past 15 years had several excellent recommendations—the CII report of the 1990s, the Kumar Mangalam Birla report in 1999 and the NR Narayana Murthy report in 2003 and even those by the ministry of corporate affairs (MCA). In each case, powerful industry bodies ensured that some sensitive changes are never implemented. I had a ringside view of how this works as a member of the Narayana Murthy committee. Mr Murthy followed a strict policy of deciding each issue by a majority concurrence. So, the sudden aggressive participation by industry associations ensured that the recommendations on limiting the term of independent directors and rotation of auditors were shelved, postponed or later showed up on a non-mandatory code put out by the MCA. In any case, recent examples like the UB-Kingfisher saga and the collapse of Deccan Chronicle, are glaring examples of how no checks & balances work on companies run by politically powerful owner-managers. They represent a failure of good governance codes as well as prudent lending practices by banks which are listed entities.
So what is new about the latest set of good governance recommendations? Two things. First, it tries to co-opt the MCA by claiming that many of the changes are meant to align prescriptions in the listing agreement of stock exchanges with the Companies Bill 2012. Secondly, this is probably the first consultative paper on governance produced without involving corporate India and its consultants, lawyers, investment bankers, auditors or friendly academics. Instead, the paper reflects the views of India's newest breed of market intermediaries—the three new 'proxy advisory firms' whose long-term survival depends on the regulator creating a market for their services. One of them, Stakeholders Empowerment Services Pvt Ltd (SES), has been set up by SEBI's former executive director, JN Gupta and his son, and has MS Sahoo, a former SEBI whole-time director as its advisor. Curiously, neither of them showed the same aggressive activism that is evident in their advisory reports, while at full-time jobs with the regulator.
In the US, proxy advisors have increased their power and influence from the Dodd-Frank Law which mandates certain voting regulations. In fact, they have turned more powerful than institutional investors and it has led to a backlash and a demand for regulation and scrutiny of the advisors themselves. In India, too, these firms were set up only when SEBI quietly created a role for them at the time when Mr Gupta and Mr Sahoo were about to complete their terms at SEBI. In 2010, it issued a directive to mutual funds mandating the disclosure of their proxy voting policies and decisions on their website. But, according to the SEBI report, while fund houses have complied, there is no discernable change in voting and some institutional investors do not even attend general body meetings.
The current set of recommendations clearly intends to tighten the rules. It refers to the need for 'regular intervention' by 'institutional' investors, but this will clearly not apply to large insurance companies, especially those in the public sector, which dance to the finance ministry's tune. In fact, SEBI is under pressure to allow these institutions to breach the 10% ceiling on holding of individual stocks and also to dilute the norms for listing of public sector companies. Is it then fair to tighten the rules only for those who comply? I am sure, we will hear on this issue from corporate India.
The recommendations indicate that SEBI plans to ensure good corporate behaviour through penalties for failure to comply with governance norms including de-listing (in extreme cases), debarment of directors and, maybe, even prosecution. Other proposals include: formal induction, training, examinations and annual performance evaluation of independent directors (IDs); appointment of a lead ID with separate meetings mandated for them; more board committees and the appointment of at least one ID by 'small shareholders'.
All of these sound very uplifting, but will make it irksome to be an ID. Many of the proposals are a serious encroachment on the company's primary responsibility of running a legal and profitable business that earns a decent return for investors and provides fair treatment and compensation to its employees. Good governance norms are important, but cannot become the centrepiece of a company's existence or occupy unreasonable time and attention of management. Investors are likely to ditch stocks of an unprofitable company much faster than those of a profitable one whose major governance lapse is to designate the chairman's brother-in-law as ID.
The proposal for an independent director representing the 'small shareholder' is another old chestnut that has been discarded as unworkable several times. When three consecutive SEBI chairmen have not been able to enforce the 25% public shareholding norm, and the retail investor population has shrunk and is ignored, what is the purpose of this pointless suggestion?
Targeted reform and disclosure is better than introducing mindless red-tape. For instance, SEBI did well to mandate disclosure of pledged shares and dematerialisation of promoter holding after the Satyam scandal. But it still didn't prevent the Deccan Chronicle debacle. Also, Ramalinga Raju was able to fudge the books because of the active collusion by auditor PricewaterhouseCoopers (PWC). Why is there no significant action against PWC in India, when it has paid $25.5 million to settle US shareholder claims and $17.5 million in settlements with the US Securities and Exchange Commission and Public Company Accounting Oversight Board in the Satyam case? Importantly, in early January, a US court dismissed shareholder claims against Satyam's IDs on the grounds that they had asked the right questions and were misled. India needs to study the judgement carefully and evaluate how far we can stretch the responsibility of IDs if they were deliberately misled or not in charge of certain actions. In fact, the SEBI recommendations ought to have reviewed the gross miscarriage of law in the Nagarjuna Finance case where Nimesh Kampani, Minu Shroff and other IDs were on the run for almost a year.
Secondly, collusion with auditors and lawyers to ensure a better deal for owner-managers usually happens during mergers, acquisitions, restructuring and amalgamation of entities inside or outside a corporate empire. SEBI has limited powers to regulate auditors who are accountable to self-regulatory bodies under the MCA. Even if SEBI manages to mandate the rotation of auditors, which has been discussed and discarded by every corporate governance committee until now, it will be a big achievement. Some of SEBI's recommendations, especially those regarding training of independent directors are only creating business opportunities for trainers, including its own National Institute of Securities Management. Mindless rules will only push the better-managed companies to follow the trend of well-managed multinational companies to de-list their shares. This will end up hurting investors. It is time for the government to call a halt to mindless regulation and focus on quick enforcement and action which will serve as a deterrent to mismanagement. We need to review how SEBI has performed in terms of its twin mandate of investor protection and market development and insist that it cleans up its own act before needless tinkering with rules to shift the focus from pathetic enforcement.
Sucheta Dalal is the managing editor of Moneylife. Subscribers get free help in resolving their problems with select providers of financial services.
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