Wednesday, September 10, 2014

Outsourcing whistle blowers- and boards?

Sebi's modified Clause 49 of the listing agreement, which takes effect from October 1, provides for the creation of a whistle-blower mechanism in companies. There are many issues that employees face in blowing the whistle unethical actions or violations of the law. Is it safe to report such things? If the MD is involved, whom do they report to? Will the complaint be acted upon?

A report in BS mentions the possibility of outsourcing whistle-blowing services. Then, perhaps, employees will face safer. Maybe. But who will the third party report to? The Compliance Officer, the MD or the Board? And who hires the third party? If the MD is unhappy with a hyper-active third party, what prevents him from terminating or not renewing the contract?

We are assuming here that all violations take place without the knowledge or consent of the MD. This may not be true in all cases. And if the MD himself is reported about or even a board member, should the third party not be bringing such cases to the attention of the regulator? In short, outsourcing of whistle-blowing needs to be carefully thought through with specifications of which matter should be taken to which authority.

In the Economist, Schumpeter raises the possibility of outsourcing the board itself.  The company would hire a professional services firm to provide board services. The professional firm would find the best directors. This eliminates the problem of self-dealing in companies, namely, management selecting board members convenient to itself. Competition among service providers of this kind would ensure that companies get the best service at competitive rates.

Sounds attractive but I can see several problems. Who will evaluate the performance of the board? The management, I guess. If management finds the board too inconvenient, it will simply not renew the contract. Secondly, if an outside firm is to provide such services, it may prove expensive relative to a company finding its own board members (although the fee should still be affordable for large companies). Thirdly, conflicts of interest could arise where an outside firm is providing boards to several companies.

If the idea is to distance board selection from the management, it would be simpler to just increase those involved in nominating members. Give large institutional investors, lenders, small investors and employees all the right to nominate one or two members each. Don't leave the selection entirely to management.

Incidentally, for public sector companies, such outsourcing already happens in a way. Board members are selected by the Bureau of Public Enterprises with inputs from the concerned ministries. Management at PSUs does not select board members. But here, it is the government as owner that is using its own agency to select the board. The job is outsourced so far as management is concerned but it is not outsourced where the principal investor is concerned. And the question of paying a commercial fee for board services does not arise.


Anonymous said...

I don't so much endorse the idea of "Outsourcing" Governance to ensure independence & objectivity.

The conundrum of how to protect Whistle Blowers can be addressed by enacting a law that protects their interest, by allowing anonymous whistle blowing, by nominating a committee to whom complaints are made and ensure that committee has independent members and if possible one of them being representative of minor s/h, institutional investor and also government.

But don't you think so that SEBI is thinking to utopian to recommend such minor changes when the basic edifice of governance is not addressed in Clause 49 - i.e. splitting the role of Chairman of Board and CEO of Company. The Chairman and MD has to be different persons altogether; former takes care of governance of board and latter takes care of management of company - this fundamental provision is very much their under US & UK governance norms (The Combined Code & SOX). But it is still eluded in Clause 49. The Companies that can be questioned on having both roles vested with one person would include - Reliance Industries, Adani, and others where the Corporate veterans are designated as CMD (Chairman & MD). On the other hand, there are some good companies such as Infosys, Tata, Wipro, ICICI, HDFC, where the two roles are vested with different individuals.

Also, Board evaluation is a long pending lacuna in Clause 49.

And execution of Clause 49 in spirit is still the distant & seldom objective. Governance in India has long way to go...hope we are not waiting for another Satyam or Enron or act again.

T T Ram Mohan said...

Anonymous, I agree that the basic issues you have raised remain addressed. (Board evaluation is sought to be addressed under the amended Clause 49).

Protection of whistle-blowers means little in a country such as ours. Reporting to an independent committee is certainly an improvement but this committee should not have only so-called independent directors. As you say, there should be outsiders as well.