Issues with SEBI’s Dual Approval System

Background:

  • Independent directors are appointed just like other directors through shareholder voting by a simple majority. This confers a significant power in the hands of significant shareholders to handpick the independents.
  • In case of family-owned companies, it is not uncommon to appoint “friendly” independent directors.
  • As for public sector undertakings, there is a demonstrable affiliation between independent directors and the ruling political parties.

Dual Approval System:

  • The above trends suggest that unless independent directors owe their allegiance to the shareholder body as a whole, independence is likely to remain largely in form and not function. In its consultation paper, SEBI proposed a “dual approval” system.
  • Under this system, the appointment of an independent director required the satisfaction of two conditions:
    • First, the approval by a majority of all shareholders.
    • Second, the approval of a “majority of the minority”, namely the approval of shareholders other than the promoters.
  • SEBI recommended the same “dual approval” system for the removal of independent directors as well.
  • SEBI drew inspiration from Israel and the premium-listed segment of the United Kingdom, which confers greater power to minority shareholders in installing or dethroning independent directors.
  • SEBI has not yet made any mention of implementing the dual approval system.

Issues:

  • The first issue is that it militates against the majority rule principle that is intrinsic in a corporate democracy.
  • While understandable, that is hardly an immutable rule as corporate law does make exceptions in cases involving oppression of minority shareholders.
  • The second concern is that placing too much power in the hands of minority shareholders would be counterproductive, as it could result in a tyranny of the minority.
  • However, the dual approval system instead represents the best of both worlds. It does not negate the promoter’s involvement in the process of appointing or removing independent directors.
  • Only consensus candidates would end up becoming independent directors.
  • The third issue is one of shareholder apathy: Will minority shareholders be motivated to exercise an informed and meaningful choice?
  • Minority shareholders tend to be passive when they are unable to influence the outcome of shareholding voting. However, where they do have a significant say, like in the “majority of the minority” process, they are likely to be more active in exercising their franchise.