The Concept of independent director was introduced in the year 1999 on the recommendations of Kumar Mangalam Birla Committee.
In the year 2004 Clause 49 of the Listing Agreement was further amended and it was made mandatory for every listed company to have an optimum combination of Executive and Non Executive Directors on the Board. It was provided that if the Chairman is the executive director, half of the Board must comprise independent director. If the chairman is non executive director, 1/3rd of the Board must be independent directors as under:-
Composition of Board
(i) The Board of directors of the company shall have an optimum combination of executive and non-executive directors with not less than fifty percent of the board of directors comprising of non-executive directors.
(ii) Where the Chairman of the Board is a non-executive director, at least one-third of the
Board should comprise of independent directors and in case he is an executive director, at least half of the Board should comprise of independent directors.
Provided that where the non-executive Chairman is a promoter of the company or is related to any promoter or person occupying management positions at the Board level or at one level below the Board, at least one-half of the Board of the company shall consist of independent directors.
Under Companies Act, 1956 the term Independent Director has not been defined, it is defined in Listing Agreement only as under :-
The expression ‘Independent Director’ shall mean a Non Executive Director of the Company who:
a. apart from receiving Director’s remuneration, does not have any material pecuniary relationships or transactions with the company, its promoters, its directors, its senior management or its holding company, its subsidiaries and associates which may affect independence of the director;
b. is not related to promoters or persons occupying management positions at the board level or at one level below the board;
c. has not been an executive of the company in the immediately preceding three financial years;
d. is not a partner or an executive or was not partner or an executive during the preceding three years, of any of the following:
i) the statutory audit firm or the internal audit firm that is associated with the company, and
ii) the legal firm(s) and consulting firm(s) that have a material association with the company.
e. is not a material supplier, service provider or customer or a lessor or lessee of the company, which may affect independence of the director.
f. is not a substantial shareholder of the company i.e. owning two percent or more of the block of voting shares.
g. Is not less than 21 years of age.
a. 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.
b. “Senior management” shall 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.
c. “Relative” shall mean “relative” as defined in section 2(41) and section 6 read with Schedule IA of the Companies Act, 1956.
Nominee directors appointed by an institution, which has invested in or lent to the Company shall be deemed to be Independent Directors.
“Institution’ for this purpose means a public financial institution as defined in Section 4A of the Companies Act, 1956 or a “corresponding new bank” as defined in section 2(d) of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 or the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 [both Acts].”
Independent directors are put in the Board to act as supervisory body of every activity of the company and to enhance the Good Corporate Governance Practice of the Company. Independent Directors are the very vital part of the Board. They must serve as an agent of Shareholders, Government and Company as well, they must protect the benefits of minority shareholders, they must provide valuable advice and check on the operations and activities of the Company.
However, after the scam of Satyam the reliability of Independent Director has came under question. There is lack of commitment, professionalism and clearity of liabilities of Independent Director. They are serving the role of friends of promoters.
The scam of Satyam was really an eye opener for the Government of India. If the concept of Independent Director is to be succeeded, the Government must move forward to break the nexus between the Independent Director and Promoters for that rules should be made and the Independent Director should be appointed by the Central Government of SEBI.