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Men in Suits

Independent Directors: Why They Are Important to Corporate Governance Today

Although independent directors have long been regarded as an important internal corporate governance mechanism, there is no universal definition of them. The concept of "Independent Directors" originated in the United States following a massive corporate collapse – that of the Penn Central Transportation Company – in which the Securities and Exchange Commission (SEC) chastised the Penn Central board for lacking independence, failing to oversee operations, and failing to identify the company's problems (Gordon, 2007). Since then, Independent Directors have grown in popularity in corporate governance and have played an important role in regulatory reform in the aftermath of several corporate scandals.

The most important characteristic of any successful company is an effective Board of Directors. Non-Executive Directors such as Independent Directors play an important role in putting effective corporate governance principles into action. Corporations' business activities cross national boundaries and involve shareholders and investors from all over the world. As a result, there is an urgent need for the appointment of Independent Directors at the company's highest levels. The need for Independent Directors has also arisen as a result of gradual changes in the investor and shareholder mindset.

Independent Directors have been known in the United States to bring a fresh perspective as well as to check the runaway business behaviour dictated by profits and personal gain. In many US companies, Independent Directors are the ones who frequently prevent management from making decisions that are motivated by personal gain rather than the best interests of the shareholders. Furthermore, because of their supposed objectivity, Independent Directors are tasked with investigating cases of corporate malfeasance and unethical behaviour. It is in a similar vein that Independent Directors operate in India as well.

The regime of Independent Directors in India has its formal origins in the year 2000, under Clause 49 of the SEBI, Listing Obligation and Disclosure Requirements. As a result, Section 149 of the Companies Act of 2013 provided statutory recognition to Independent Directors who are appointed and governed under the Act.The Act and its accompanying schedule, which details the roles and duties of Independent Directors, also seeks to protect them from frivolous prosecution by requiring allegations against them to be supported by proof of knowledge (attributable to board process), consent, connivance, or failure to exercise diligence. An Independent Director performs his responsibilities based on information provided by the company's key management personnel ("KMP") and executive directors. As a result, Independent Directors can only raise red flags on issues that come to their attention in the ordinary course of business and through board processes, and they cannot be expected to conduct roving investigations.

In October 2019, the Ministry directed the Indian Institute of Corporate Affairs (IICA) to keep an online database of all existing and eligible Independent Directors in order to ensure a standardised process and the integrity of Independent Directors appointed by companies. This notification mandated a proficiency qualification examination for Independent Directors, with a minimum score of 60% required for appointment. The Independent Directors' Institute aims to fill this void by establishing such a qualification.

Deloitte Touche Tohmatsu India LLP (DTTILP) conducted a survey in collaboration with the Institute of Directors (IOD) to better understand how Independent Directors perceive corporate fraud, their preparedness to address it, and the adoption of best practises to mitigate fraud and misconduct risks. Approximately 63 percent of Independent Directors believe that the current business disruption will increase fraud over the next two years. According to Deloitte India's most recent survey report, "Corporate Fraud and Misconduct: Role of Independent Directors," roughly 75% of Independent Directors agreed that they could play a significant role in preventing, detecting, and responding to fraud. This is quite encouraging, as the community is becoming more aware of the need to strengthen fraud risk management.

In a revised framework of the post-COVID market scenario, Independent Directors will, therefore, need to re-energize their role in order to protect their company from the anticipated economic distress and corporate fraud. An additional responsibility for these governance-guardians of the board is to ensure that their companies implement adequate guidelines and policies to protect the company's stakeholders.

Independent Directors can also help to balance out managerial flaws in a company. They oversee the company's legal and ethical behaviour. They are the source of the company's well-thought-out long-term decisions. They are expected to provide the required personal and technical expertise to prevent fraud and misappropriation by the company or its directors. Independent Directors are especially valuable because they play important roles in several mandatory board committees. CSR, Audit, and Nomination & Remuneration are three committees where their presence is critical.

Role of Independent Director in CSR Committee:

Independent Directors contribute to the board's recommendation of the CSR Policy. They also help to recommend CSR activities and programmes in accordance with Schedule VII. Independent Directors are also involved in determining CSR expenditure and monitoring and evaluating the Company's CSR Policy.

Role of Independent Director in Audit Committee:

The appointment, remuneration, and terms of appointment of the Company's auditors are recommended by the Company's independent Directors. They carefully examine and monitor the auditor's independence and performance, as well as the audit process's effectiveness. Independent Directors are important in the examination of financial statements and auditors' reports, as well as in reviewing annual financial statements taking into consideration the accounting policies and practices.

Role of Independent Director in Nomination and Remuneration Committee:

Independent Directors play a critical role in determining appropriate levels of remuneration for executive directors, key managerial personnel, and senior management, as well as in appointing and, if necessary, recommending the removal of executive directors, key managerial personnel, and senior management. They participate in the development of succession plans to ensure corporate governance, stability, and the long-term viability of the company. Independent Directors are also responsible for ensuring that appointments and succession planning are done on merit.

Independent Directors bring much-needed professional expertise because they are individuals with extensive experience in running businesses, as well as the fact that they sit on the boards of other companies, which means they are up to date on the latest developments. Many countries' regulators have moved to ensure that Independent Directors do not have conflicts of interest, and these have been codified into rules governing how many companies they can associate themselves with, as well as the sectors and industries that they represent.

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