Sucheta Dalal :Clause 49: will or wonR17;t Sebi stick to its guns?
Sucheta Dalal

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Clause 49: will or won’t Sebi stick to its guns?  

Dec 26, 2005

With less than a week to the December 31 deadline for complying with the revised Clause 49 of the listing agreement of stock exchanges, why has the market watchdog turned more strident in its warnings that disobedience would attract strong punishment? Apparently, because some companies continue to believe that they will be able to force another relaxation to the already extended compliance deadline.


Their confidence stems from the fact that the ministry of company affairs (MCA) has officially written to the Securities and Exchange Board of India (Sebi) to extend the compliance deadline, because it soon intends to prescribe board composition through an amendment to the Companies Act. The amended Act clearly plans to go with the JJ Irani committee’s less onerous recommendation that only one-third of the board needs to comprise independent directors. Earlier, the Naresh Chandra committee (also set up by the MCA) had also advised Sebi not to tighten the regulation of listed companies through clause 49, instead of an amendment to the Companies Act.


Sebi has, however, refused to back down. Its confidence stems from the fact that the finance ministry has ignored the lobbyists. Sebi chairman M Damodaran is determined to ensure that companies have no excuse for non-compliance. He has repeatedly warned that disobedience will attract delisting, irrespective of whether companies are in the public sector or private sector. This was necessitated by the fact that although thousands of companies have complied with the most contentious provision of the amended clause 49—that half the board must comprise independent directors—hundreds of others continue to live in the hope of an extension. Many are also banking on Sebi balking at a drastic delisting of companies, since it would hurt investors the most.


But Sebi has been working to plan. Anticipating complaints about the difficulty in finding suitable candidates for the post of independent directors, it facilitated the creation of public lists of thousands of able and willing candidates. Next week, it will emulate the tax collection agencies by issuing an official advertisement exhorting listed companies to comply with the new listing rules and alerting investors to be vigilant.


• Hundreds of companies can’t believe Sebi will delist defaulters

• However, Sebi seems serious and believes its threat is credible

• The danger is that board composition will seem a panacea for   malpractices


Sebi’s warnings have already been effective. Several PSUs were scurrying around last week to clear director-level appointments in order to meet the December 31 deadline; most nationalised banks are already compliant. For those who still don’t get the message, Sebi intends to let its actions do the talking. In January, it will identify defaulters and warn investors about punitive action against specific companies. This will allow smart investors to exit before the shares are suspended. Sebi expects that the mere threat of action will send even the stragglers scurrying to comply with the rules.


Since the composition of the board itself has turned so contentious, a couple of equally touchy issues have gone on to the back-burner. The first is over the ban on independent directors having a ‘material pecuniary relationship’ with the company. Here, one group is engaged in a semantic debate over when a pecuniary benefit becomes ‘material’ enough to become objectionable. Some want specific ceilings and others believe they are mature enough to create their own definitions. Meanwhile another set of blue-chip companies have quietly started lobbying for independent directors to be allowed to keep their directorships (that come with fat sitting fees, a share in profits and stock options these days), while also earning some more as consultants or advisors to the company.


Ironically, the debate is so skewed that board composition alone is made to seem like the panacea for corporate malpractices. This is clearly incorrect and tends to mislead investors. Clause 49 itself raises other issues, such as mandatory risk assessment and certification of accounts by the CEO/CFO and a bigger role for independent directors on audit committees. These rules and conditions are necessary to ensure a degree of transparency in the operation of publicly listed companies and safeguard investor interest at a time when companies are busy cashing in on a powerful bull market to raise more funds than they need. But investors must remember that technical compliance with a fat rule book does not stop dubious managements from bending the rules.






-- Sucheta Dalal