Ramesh S Arunachalam
Rural Finance Practitioner
The issue of independence of “independent directors” is a very critical one with regard to Corporate Governance and the same applies to MFIs as well. How to make this determination of a director’s independence? What criteria are used globally and what can be effectively used in micro-finance and especially in India.
Some suggestions are provided in this post and I also provide a comparative analysis of what top global corporate governance frameworks suggest with regard to director independence in a separate accompanying post. Read on…
For an MFI Director to be considered independent, it must affirmatively be determined that the Director has no material[i] relationship (whether financial, business, personal or otherwise) with the MFI or any of its sister concerns or subsidiaries or affiliates, either directly or as a partner, shareholder or officer or employee of an organization which in turn has a relationship with them. This is very critical.
In my opinion, in making the determination of independence, a Director’s relationships can be deemed immaterial as long as the following standards are met:
1. The Director is not, and has not been within the previous three years, an employee of the MFI or any of its subsidiaries or affiliates or sister concern.
2. No member of the Director’s immediate family[ii] is, or has been within the previous three years, an executive officer of MFI or any of its subsidiaries or affiliates or sister concerns
3. Neither the Director nor any member of his or her immediate family has received, during any twelve-month period within the previous three years, more than INR 1.2 Million[iii] in direct compensation from the MFI or any of its sister concerns or subsidiaries or affiliates (including, without limitation, any consulting, advisory or other compensatory fees) except (a) fees which the MFI pays to its Directors for their services as members of the Board and members or Chairs of Board Committees and (b) fixed amounts of deferred compensation for prior service, which is not contingent in any way on continued service; provided that compensation paid to an immediate family member for service as an employee other than an executive officer will not be considered in determining the Director’s independence so long as the compensation is comparable to the compensation paid to other similarly situated employees.
4. The Director is not a partner or an employee with a firm that is the internal or external auditor for MFI or any of its sister concerns or subsidiaries or affiliates; nor is any member of the Director’s immediate family a partner with such a firm or an employee who participates in the firm’s audit and/or tax compliance practice (as well as similar tasks); nor has the Director or any member of the Director’s immediate family within the previous three years been a partner or employee with such a firm who within that time has personally worked on the audit of MFI or any of its sister concerns or subsidiaries or affiliates.
5. Neither the Director nor any member of his or her immediate family is employed, or has been employed within the previous three years, as an executive officer of any company whose compensation committee at the same time included an individual who currently serves as an executive officer of MFI or any of its sister concerns or subsidiaries or affiliates.
6. The Director is not an employee, nor is any member of his or her immediate family an executive officer, of another company as to which payments by MFI to that company, or from that company to MFI, including their respective subsidiaries and affiliates or sister concerns, for property or services have exceeded more than 2% of the other company’s consolidated gross revenues, in any of the other company's past three fiscal years.
However, notwithstanding anything to the contrary in the standards #1 through #5 above, any MFI shall not treat as categorically immaterial, but instead will discuss case by case and will disclose, (i) any relationship between a Director and MFI or any of its sister concerns or subsidiaries or affiliates that is required to be disclosed under the relevant section of the Indian Companies Act, 1956 (and other SEBI/RBI directives from time to time) and (ii) any contributions made by MFI or any of its sister concerns or subsidiaries or affiliates to any tax-exempt organization of which a Director serves as an executive officer if, within the preceding three years, such contributions in any single fiscal year exceeded 2% of the tax-exempt organization’s consolidated gross revenues.
Likewise, an MFI Director will be deemed to meet special independence standards required of Audit Committee members if the Board of Directors determines that the Director qualifies as independent under the above-described standards and that the Director meets the following additional criteria:
A. The Director has received no direct compensation from MFI or any of its sister concerns or subsidiaries or affiliates (including, without limitation, any consulting, advisory or other compensatory fees) except (a) fees which MFI pays to its Directors for their services as members of the Board and members or Chairs of Board Committees and (b) fixed amounts of deferred compensation for prior service, which are not contingent in any way on continued service.
B. The Director is not an affiliate of MFI (i.e., not controlling, controlled by, or under common control with, the MFI), such as a 2% plus shareholder.
C. The Director is not providing simultaneous service as an Audit Committee member in audit committees of more than 3 companies (or MFIs) at any point in time
I hope that the industry associations in
(Sa-Dhan and MFIN), regulators, supervisors, lenders, investors and other stakeholders provide due thought to this very critical aspect of director independence. They would also need to establish guiding benchmarks for the various compensations issues given above and ensure the implementation of these standards on the ground as only “real” independent directors can enhance the quality of Corporate Governance (in Indian MFIs), which is certainly at a low ebb... India
I hope that the industry associations in
Have A Nice Day!
[i] "Materiality" is to be considered from the standpoint of the Director and that of each person or organization with which the Director is affiliated, including organizations of which the Director is a partner, shareholder or officer. The determination that, as to each Director individually, there is no material relationship (whether financial, business, personal or otherwise) will have to be made after due consideration of the information provided by the Director and any other information that may be known to the Board. The purpose is ultimately to determine whether a Director has any relationship with the MFI that may interfere with the exercise of the Director’s independence with regard to the MFI and its management.
[ii] "Immediate family" means a Director's spouse, parents, stepparents, children, stepchildren, siblings, mothers- and fathers-in-law, sons- and daughters-in-law, brothers- and sisters-in-law, and any person (other than a tenant or employee) who comprise the Director’s household but not the physical space necessarily
[iii] This is a suggested number and has to be debated further and decided accordingly, as per consensus.