Proficiency Test for Independent Directors:A retrograde step for governance

There is a need for India Inc. to represent to the MCA to reconsider the suitability of such a proficiency self-assessment test...

Background:

A recent notification issued by the Ministry of Corporate affairs (MCA) has amended/enacted the applicable Rules to make it mandatory for existing independent directors of Indian companies to get registered with a central database, and to qualify an online proficiency self-assessment test ( 'proficiency test). A person who is looking forward to appointment as an Independent Director in a company shall also procure the said registration and pass the said proficiency test. An individual who has obtained a score of not less than 60% in aggregate in the online proficiency self-assessment test shall be deemed to have passed such a test. There shall be no limit on the number of attempts an individual may take for passing the said test .The Rules in this regard have come into force with effect from 1st December 2019. The registration with central data base had to be done by 28th February 2020 and the proficiency test has to be passed within 1 year of the said registration. The Indian Institute of Corporate Affairs (IICA) in Manesar, Haryana, will conduct this exam. It will also create and maintain a data bank with names, addresses and qualifications of people who are willing and eligible to be appointed as independent directors for companies. Boards of companieswill have to disclose the results of these tests in their annual reports. This proficiency self-assessment test shall cover companies law, securities law, basic accountancy and such other areas relevant to the functioning of an Individual acting as an Independent Director. The IICA shall prepare basic study material, online lessons including audio-visuals for easy reference of individuals taking the online proficiency self-assessment test.

However, an exemption from the requirement of passing the said test is available to an individual who has served for a period of not less than 10 years on the date of inclusion in the data bank as a Director or as Key Managerial personnel (KMP) in a listed public company or in an unlisted public company having a paid up share capital of Rs. 10 crore or more.

Underlying Rationale

The role and responsibilities of Independent Directors on the boards of listed entities in the backdrop of recent corporate scams has been an area of concern for regulators and common investors. Recent corporate scams have turned the heat on company directors, who, the government feels, failed to detect any signs of trouble. Independent directors perform functions that are critical to good corporate governance and having qualified and upright independent directors on company boards is crucial for the development of capital markets. The intent of the MCA was to demolish the myth that directors do not have fiduciary duty and to propagate corporate literacy to make them aware of their duties, roles and responsibilities.

A retrograde step needing a serious re-visit

A serious but basic question is being raised as to how such a requirement can foster better corporate governance and why should the Government attempt to legislate human calibre and behaviour. While business education is formally a social science and process that covers learning specific knowledge, it must end at a stage where practical experience and innate skills should start governing. Some basic questions arise here,"Can we infuse ethics by way of a mere proficiency test?Can we aim to get better governed corporates by compelling Independent Directors to pass an exam?"

Some inherent flaws and avoidable regressive repercussions in this regard are analysed hereunder:

(i) This could further shrink the pool of available directors. Highly qualified and experienced persons (not Directors or KMPs on listed entities) who are or have been highly placed in corporates or in Ministries or other Institutions may take this requirement negatively since their back ground and experience itself reveal the gruelling practical situations and roles they performed in the practical realm. Do they really need to pass an elementary test to prove their credentials?;

(ii) Inclusion of a statement regarding the opinion of the Board (in the Directors' Report) with regard to proficiency of the Independent Director is equivalent to writing a "passed" or "failed" report card 'of Independent Director. But how can this be considered as an opinion on proficiency? What happens where the Board has a high opinion about an Independent Director's integrity, expertise and experience but where he has failed to pass the 'proficiency test'?

(iii) Skills needed for an Independent Director vary significantly and hence the test may not serve any purpose;

(iv) It also gives rise to an impression that all current Independent Directors are closely linked to the management, which is not always the case;

(v) Independent Directors need different skills depending on the business the company is into, for e.g. Independent Directors of an FMCG company may need to have different skills as compared to Finance and banking Industries. Thus, making them subject to pass a common exam may not really serve the purpose;

(vi) While the Government aims to have an accountable board with diverse skills, sets the corporate literacy test will not help in addressing the accountability issue in any case;

(vii) Assuming there are directors who have passed such proficiency test, and those who have failed, will it be easy to say that the latter, despite their professional erudition, specialist skills or capabilities, are not less appropriate to be on corporate boards than the former;

(viii) Corporate boards need to have diverse skills – technical, behavioural, industrial, and so on. How does a common proficiency test assess the capability, for example, of a person, who has technical competence on the line of business that the company is engaged in?

Instead of passing an exam , Independence of directors can be better fostered by exposing them to special training programs on fiduciary duties, risks specific to the business which the company is into, better awareness on securities regulations, basic knowledge of consequences of violations, case studies and the danger marks in the specific area of business which the company is into, the concern areas and lapses based on recent live examples of scams, and building capability to anticipate and highlight serious issues;

There is certainly a need for India Inc. to represent to the MCA to reconsider the suitability of such a proficiency self-assessment test.