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Thursday, 25th April 2024 |
| Regulation and corporate governance - the screw is tightening |
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| In light of corporate scandals such as Enron, Worldcom and Tyco, a number of initiatives have been launched aimed at improving corporate governance. Kevin Allen examines one recent initiative, the Higgs Report, which was written by veteran board member Derek Higgs, and which reports on the role of non-executive directors. |
In the wake of these and other scandals, the screws are being tightened on the way in which companies are allowed to operate. A number of recent initiatives have been launched both at home and abroad, whose effects will soon be felt in Irish boardrooms.
The latest of these is the Higgs Report, published in January 2003. The author, Derek Higgs, is a 58 year-old London-based investment banker and veteran board member. Higgs was commissioned by the UK’s Department of Trade and Industry and H.M. Treasury to independently report on the role and effectiveness of non-executive directors. Many of his recommendations are expected to be incorporated into the UK’s Combined Code sometime this summer. As the Irish Combined Code mirrors the UK’s, Higgs is of particular interest to directors, employees and shareholders of Irish listed companies. Following publication of the report there has been some criticism from FTSE 100 company directors on some of the recommendations, so it will be interesting to see to what extent they will survive as promulgated.
The main recommendations are:
• no individual should be both chairman and chief executive;
• a former chief executive should not become chairman of the same company;
• at least half of the members of the board, excluding the chairman, should be independent non-executive directors;
• non-executive directors should be indemnified in the event of being sued by the company or third parties, where they have not breached any duty or obligation;
• board appointments should result from a rigorous recruitment process by a nomination committee;
• there should be separate and independent audit and remuneration committees;
• the inclusion of more extensive disclosure in the annual report including how the board operates, the roles of chairman and chief executive, the processes used for board appointments, and reviews of the performances of each committee, the board and individual directors.
Higgs’s proposals prescribe a comprehensive test of independence for non-executive directors which excludes any relationships or circumstances which could affect or appear to affect the director’s judgement. This includes an executive director holding more than one non-executive directorship in a different company, or directors who are related to each other. Higgs argues that there should be a strong executive representation on the board, so that power is not concentrated in one or two individuals.
Importantly, the report sees a need for greater communication between the board and shareholders - it recommends that a senior independent director be designated and available to shareholders if contact with the chairman or chief executive has failed to resolve their concerns. Non-executive directors, it is recommended, should actively develop an understanding of the views and concerns of major investors via meetings and consultations.
Welcome news, no doubt, to institutional investors who own the majority of shares traded on the Irish Stock Exchange. In a related development in the UK, institutional investors have begun to flex their muscles. Through their representative organisations, the Association of British Insurers and the National Association of Pension Funds, a new initiative has been launched on best practice for executive remuneration. One of the chief aims is to prevent extravagant pay-offs to executives in the event of failure, which they say are damaging to a company’s reputation as well as being costly to shareholders.
Some commentators feel there is only a small pool of potential non-executive directors who are both able and independent, and foresee a difficulty in meeting the ‘more than 50 per cent of the board must be non-executive directors’ requirement. Others express concern about the possibility that the senior independent director, being an additional centre of power, may become a divisive figure and result in the ‘too many cooks’ syndrome. Higgs does accept that his recommendations may not be appropriate for every company but he does favour the ‘comply or explain’ approach taken by the current Combined Code. Under this approach listed companies have to report on whether they comply with the code and if not, explain why not.
It was no coincidence that the publication of the Higgs Report happened on the same day as proposals clarifying the roles and responsibilities of audit committees were announced by Sir Robert Smith, the chairman of multinational engineering group, Weir. In his report, Smith recommends that audit committees have at least three non-executive member directors, one of whom is to have appropriate financial experience. Smith also prescribes that the committee’s activities be reported in a separate section of a company’s annual report and that the committee chairman be present to answer shareholder questions at the company’s AGM. Higgs endorses this view in his report.
It would be foolhardy to think that Higgs is the only corporate governance party in town or that private companies don’t have to concern themselves with regulatory and corporate governance developments. The Public Accounts Committee enquiry here in Ireland into bogus non-resident accounts in late 1999 has created its own dynamic for change. A new Bill has been published which, if enacted in its present terms, will require directors of all Irish Companies to complete an annual Compliance Statement, positively confirming (or otherwise) that their company has complied with all relevant regulatory legislation and regulations. Auditors will have a duty to look over directors’ shoulders to confirm in their view that these Compliance Statements are reasonable and, if necessary, report any inadequacies or defects which they have come across, whether through their audit or non-audit work carried out on behalf of the company.
Imposing new rules on corporate Ireland is one thing, but what about enforcement. Is it going to happen? Unfortunately for the non-compliant the answer is, yes. The Office of the Director of Corporate Enforcement, established in late 2001, has been very busy. In 2002 the ODCE dealt with 1,300 cases relating to claims of failure to comply with company law. The number of reports made to the ODCE is expected to double this year. The main themes have been failure to convene AGMs and EGMs, maintain company registers and proper books of account, breach of directors’ loan provisions, trading while insolvent and reckless trading. The ODCE has of course been greatly assisted in its work by the new requirement on auditors to report any activity that they suspect to be indictable and on liquidators to report directors’ conduct that contravenes company law.
At EU level an EU Company Law experts group set up by the European Commission has also made corporate governance recommendations in a report published in November 2002. In that report, in addition to recommending the need for better disclosure being made to shareholders and creditors, strengthening shareholder rights and minority protection and accountability of directors, they express the need for a structure to facilitate the co-ordination of EU States’ efforts to improve corporate governance.
Across the Atlantic, the Sarbanes-Oxley Act was signed into law last autumn. Sarbanes-Oxley provides for a major tightening of corporate governance rules and a much greater burden of disclosure from corporate officers and advisors. Masterminded by Senator Sarbanes and Congressman Oxley, the legislation will also impact on Irish companies who have their securities issued on markets in the US, or who otherwise are required to make filings to the US Securities and Exchange Commission. One of the principal provisions in the Act is the requirement that the chief executive and chief financial officers certify the accuracy of company financial statements, with criminal penalties for non compliance of up to US$5 million and/or 20 years imprisonment. Irish companies listed on US markets and indeed Irish subsidiaries of US Issuers are already feeling the heat as a result of this development.
Up until recently, joining the board of a listed company (or indeed a private company) may have been seen as glamorous, (possibly) lucrative and with little downside. CEOs were the magazine cover heroes of the boom. The recent downturn in the global economy, advent of a bear market and raft of scandals have changed the corporate landscape. In the UK, policyholders are suing 15 former directors of the world’s oldest mutual assurance company, Equitable Life, for over ?3 billion. In the US, many former directors are facing prison in addition to hefty fines and an occasional ‘perp walk’. The Higgs Report is just one of a number of recent initiatives which make it clear that directors will have to pay greater heed to compliance issues going forward. It is also evident that the role of non-executive directors will come more sharply into focus. The old comparison of a non-executive director to a bidet (looks good but not everyone is sure exactly what its for) looks like becoming redundant as NEDs are given more power. Corporate governance is knocking louder and louder on the doors of company boardrooms. |
Kevin Allen is a partner in A&L Goodbody and is head of their business regulation and corporate governance unit.
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| Article appeared in the April 2003 issue.
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