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Corporate governance: role of independent directors - EY - India

Corporate governance:

Role of independent directors

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"The role of IDs in fraud prevention and detection has come under the direct scanner of regulators, members and other stakeholders due to the recent exposure of high-profile instances of fraud in India. In the last few months, we can clearly see IDs taking direct interest in reviewing the fraud risk management framework put in place by their organizations for mitigating the risk of fraud." - Arpinder Singh, Partner and National Director, Ernst and Young Private Limited

The regulatory environment in India around corporate governance is changing rapidly and those entrusted with governance i.e. the Board of Directors and the Audit Committee are being made responsible for the prevention and detection of fraud.

The current legislation framework does not differentiate between IDs and executive directors (EDs) as it fails to distinguish between their liabilities. The real question is, since independent directors only play a supervisory role, should they be penalized only in the event of a discrepancy that directly relates to their responsibilities?

We interviewed some legal professionals and directors on this crucial subject to gain their perspective and compiled these into a study.

1. Independent directors and corporate governance


The concept of the institution of IDs is simple. They are expected to be independent from the management and act as the trustees of shareholders. This implies that they are obligated to be fully aware of and question the conduct of organizations on relevant issues.

After the break out of some of the largest corporate scams in the country in recent times and the subsequent increase in the number of resignations by IDs, there is a heightened focus on their role and responsibilities as custodians of stakeholders’ interests. The proposed Companies Bill, 2011, the Corporate Governance Voluntary Guidelines 2009 and General Circular No. 08/2011 issued by Ministry of Corporate Affairs have further stepped up their interest in this subject.

2. Changing regulatory scenario


The corporate governance structure hinges on the IDs, who are supposed to bring objectivity to the oversight function of the board and improve its effectiveness.

However, the problem is that an ID cannot play an effective role in isolation despite their commitment to ethical practices. They cannot stop a decision that is detrimental to the members individually, but if they act collectively, then they can act prudently before arriving at any such decision. IDs may not be in a position to stop fraud at the highest level, but with a high level of commitment and due-diligence, they may be well placed to identify signals that indicate that everything is not as it should be.

The need of the hour is for the legislature to draw a line between IDs and EDs by defining their roles and responsibilities, and demarcating their liabilities. Discretion lies with the enforcement authority to determine the extent of the liability that the IDs may incur.

3. Responsibility of IDs for the prevention and detection of fraud


Globally, with the evolving regulatory landscape, which makes them responsible for the prevention and detection of fraud, directors have begun exercising adequate oversight on the management of the risk of fraud. Non-compliance with these regulations or guidelines can have serious repercussions for directors, including their reputational loss and personal liabilities.

For directors of organizations with operations spread across multiple countries, the risk of non-compliance increases significantly as such organizations need to also comply with global legislations such as Foreign Corrupt Practices Act (USA) and the UK Bribery Act 2010.

The role of IDs in fraud prevention and detection has come under the direct scanner of regulators, members and other stakeholders due to the recent exposure of high-profile instances of fraud in India. In the last few months, we can clearly see IDs taking direct interest in reviewing the fraud risk management framework put in place by their organizations to mitigate the risk of fraud.

The report lists 10 questions every director should ask to ensure compliance with governance:


  1. Do we set and communicate the right "tone at the top"?
  2. Do we effectively assess our corruption risk?
  3. Do we have effective standards, policies and processes to address these risks?
  4. Do we adequately communicate and train directors on our anti-bribery and corruption policies and processes?
  5. How do we know that our training is effective?
  6. What incentives do we provide for compliance and penalties for non-compliance?
  7. How do we monitor and audit to detect improper conduct?
  8. Do our compliance officers have adequate clout, resources and independence?
  9. How do we review the effectiveness of our compliance program?
  10. When we find a problem, do we ensure that an independent and thorough investigation is carried out?

4. How can IDs protect themselves against liability due to fraud, bribery and corruption?


The IDs can play the crucial role of bringing objectivity to the decisions made by the board of directors by playing a supervisory role. While they need not take part in the company’s day-to-day affairs or decision making, they should ask the right questions at the right time regarding the board’s decisions.

Raising the appropriate red flags at the right time would help them in avoiding the occurrence of unwanted situations and their consequences to a great extent.

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