   
The
October 2009 edition of the International
Association of Potential, New and Sitting Members of the Board of
Directors (IAMBD)
newsletter
Dear Member,
This monthly newsletter gives the opportunity to remember some
important principles, that many organizations have simply ignored.
After a market crisis it is always important to go back to the
basics and to take into account some
simple but effective
principles and international standards.
We will discuss the Higgs Review of 2003, this excellent review of
the role and effectiveness of non-executive directors.
According to Derek Higgs, in the corporate boardroom, the
importance of the non-executive director is
recognised but their role, perhaps like that of the monarchy of
old, is largely invisible and poorly understood.
When corporate strategies fail or governance lapses, however,
attention rightly focuses on the contribution of the non-executive
director.
Against a background of corporate turbulence, it is very much the
purpose of this Review to let in some daylight on the role of the
non-executive director in the boardroom and to make
recommendations to enhance their effectiveness.
Higgs wrote:
"From the work I have done, I am clear that the fundamentals of
corporate governance in the UK are sound, thanks to Sir Adrian
Cadbury and those who built on his foundations.
The Combined Code and its
philosophy of “comply or explain” is
being increasingly emulated outside the UK. It offers flexibility
and intelligent discretion and allows for the valid exception to
the sound rule.
The brittleness and rigidity of legislation cannot
dictate the behaviour, or foster the trust, I believe is
fundamental to the effective unitary board and to superior
corporate performance.
But the Code can and should regularly evolve to lead best practice
in the boardroom and raise the bar for performance.
Since the Code was adopted in its present form, the most
progressive companies have continued to improve the rigour and
effectiveness of the work of their boards.
As a result many listed companies exceed its current provisions,
and there is every reason why all companies should aspire to the
standards of the best."
SUMMARY OF RECOMMENDATIONS
The board
• The board is collectively responsible for promoting the success
of the company by leading and directing the company’s affairs.
• The number of meetings of the board and of its main committees
should be stated in the annual report, together with the
attendance of individual directors.
A description should be
included in the annual report of how the board operates.
• The board should be of an appropriate size.
At least half the
members of the board, excluding the chairman, should be
independent non-executive directors.
There should also be a strong
executive representation on the board.
The chairman
• The chairman has a pivotal role in creating the conditions for
individual director and board effectiveness.
The Review describes
the role of the chairman and some of the attributes and behaviours
of an effective chairman.
• The roles of chairman and chief executive should be separated
and the division of responsibilities between the chairman and
chief executive set out in writing and agreed by the board.
• A chief executive should not become chairman of the same
company. At the time of appointment the chairman should meet the
test of independence set out in the Review.
Role of the non-executive director
• A description of the role of the non-executive director is
proposed for incorporation into the Code. Guidance is offered for
non-executive directors on how to maximise their effectiveness.
• The non-executive directors should meet as a group at least once
a year without the chairman or executive directors present and the
annual report should include a statement on whether such meetings
have occurred.
• Prior to appointment, potential new non-executive directors
should carry out due diligence on the board and on the company to
satisfy themselves that they have the knowledge, skills,
experience and time to make a positive contribution to the board.
The senior independent director
• A senior independent director should be identified who meets the
test of independence set out in the Review. The senior independent
director should be available to shareholders, if they have
concerns that have not been resolved through the normal channels
of contact with the chairman or chief
executive
Independence
• All directors should take decisions objectively in the interests
of the company.
• A definition of independence is proposed for incorporation into
the Code
Recruitment and appointment
• There should be a nomination committee of the board to conduct
the process for board appointments and make recommendations to the
board
• The nomination committee should consist of a majority of
independent nonexecutive directors.
It may include the chairman of
the board, but should be chaired by an independent non-executive
director. A statement should be made in the annual report setting
out the composition, terms of reference, and activities of the
nomination committee and the process used for appointments.
• The nomination committee should evaluate the balance of skills,
knowledge and experience on the board and prepare a description of
the role and capabilities required for a particular appointment.
• On appointment, non-executive directors should receive a letter
setting out what is expected of them.
• The nomination committee should provide support to the board on
succession planning.
• Chairmen and chief executives should consider implementing
executive development programmes to train and develop suitable
individuals in their companies for future director roles.
• The board should set out to shareholders why they believe an
individual should be appointed to a non-executive director role
and how they meet the requirements of the role.
• Proposals are made to broaden the pool of candidates for
non-executive director appointments, including more executive
directors and senior executives from other companies and directors
of private companies, as well as advisors and those from other
backgrounds.
• A small group of business leaders and others will be set up to
identify how to bring to greater prominence candidates for
non-executive director appointment from the non-commercial sector.
• The Review offers guidance on the process for the appointment of
a new chairman.
Induction and professional development
• A comprehensive induction programme should be provided to new
nonexecutive directors and is the responsibility of the chairman,
supported by the company secretary. The Review provides an
induction checklist.
• The chairman should address the developmental needs of the board
as a whole with a view to enhancing its effectiveness. Resources
should be provided for developing and refreshing the knowledge and
skills of directors.
• The performance of the board, its committees and its individual
members, should be evaluated at least once a year.
The annual
report should state whether such performance reviews are taking
place and how they are conducted.
• Supported by the company secretary, the chairman should assess
what information is required by the board.
Non-executive directors
should satisfy themselves that they have appropriate information
of sufficient quality to make sound judgements.
• The company secretary should be accountable to the board as a
whole, through the chairman, on all governance matters.
Tenure and time commitment
• A non-executive director should normally be expected to serve
two three year terms, although a longer term will exceptionally be
appropriate.
• On appointment, non-executive directors should undertake that
they will have sufficient time to meet what is expected of them,
taking into account their other commitments.
If a non-executive
director is offered appointments elsewhere, the chairman should be
informed before
any new appointment is accepted.
• The nomination committee should annually review the time
required of nonexecutive directors.
The performance evaluation
should assess whether nonexecutive directors are devoting enough
time to fulfil their duties.
• A full time executive director should not take on more than one
non-executive directorship, nor become chairman, of a major
company. No individual should chair the board of more than one
major company.
Remuneration
• The remuneration of a non-executive director should be
sufficient to attract and fairly compensate high quality
individuals. It may comprise an annual fee, a meeting attendance
fee, and an additional fee for the chairmanship of committees.
Non-executive directors should have the
opportunity to take part of their remuneration in the form of
shares.
• Non-executive directors should not hold options over shares in
their company.
If, exceptionally, some payment is made by means of options,
shareholder approval should be sought in advance and any shares
acquired by exercise of the options should be held until one year
after the non-executive director leaves the board.
• Where a company releases an executive director to serve as a
non-executive director elsewhere, it should include in its
remuneration policy report whether or not the director will retain
the related remuneration and, if so, its amount.
Resignation
• Where a non-executive director has concerns about the way in
which a company is being run or about a course of action proposed
by the board, these should be raised with the chairman and their
fellow directors.
Nonexecutive directors should ensure their
concerns are recorded in the minutes
of the board meetings if they cannot be resolved.
• On resignation, a non-executive director should inform the
chairman in writing, for circulation to the board, of the reasons
for resignation.
Audit and remuneration committees
• Sir Robert Smith’s recommendations on audit committees,
published today, are endorsed.
• The remuneration committee should comprise
at least three members, all of whom should be independent
non-executive directors. It should have published terms of
reference.
• The remuneration committee should have delegated responsibility
for setting remuneration for all executive directors and the
chairman. The committee should also set the level and structure of
compensation for senior executives. The committee should be
responsible for appointing remuneration
consultants.
• No one non-executive director should sit on all three principal
board committees (audit, nomination and remuneration)
simultaneously.
Liability
• Guidance is provided for incorporation into the Code on the
position of a non-executive director, which may be relevant to the
determination of liability.
• The Government is recommended to consider the principles set out
by the Company Law Review in considering criminal sanctions in
relation to directors.
• A company should be able to indemnify a director in advance
against the reasonable cost of defending proceedings from the
company itself, without trying to establish in advance the
prospects of success of the case.
• Companies should provide appropriate directors’ and officers’
insurance and supply details of their insurance cover to potential
non-executive directors before they are appointed.
Relationships with shareholders
• All non-executive directors, and in particular chairmen of the
principal board committees, should attend the Annual General
Meeting (AGM) to discuss issues that are raised in relation to
their role.
• The senior independent director should attend sufficient of the
regular meetings of management with a range of major shareholders
to develop a balanced understanding of the themes, issues and
concerns of shareholders.
The senior independent director should communicate these views to
the nonexecutive directors and, as appropriate, to the board as a
whole.
• Boards should recognise that non-executive directors may find it
instructive to attend meetings with major investors from time to
time and should be able to do so if they choose.
Moreover,
non-executive directors should expect to attend such meetings if
requested by major investors in the company.
• On appointment, meetings should be arranged for non-executive
directors with major investors, as part of the induction process.
• A company should state what steps it has taken to ensure that
the members of the board, and in particular the non-executive
directors, develop a balanced understanding of the views of major
investors.
• The Review endorses the Government’s approach to more active
engagement by institutional shareholders with the companies in
which they invest, and the Institutional Shareholder Committee’s (ISC)
code of activism.
Institutional investors should attend AGMs where
practicable.
Smaller listed companies
• The recommendation that no one individual should sit on all
three principal board committees at the same time should not apply
to smaller listed companies.
With this exception, there should be
no differentiation in the Code’s provisions for larger and smaller
companies. It may take more time
for smaller listed companies to comply fully with the Code and it
is recognised that some of its provisions may be less relevant or
manageable for smaller companies.
Role of the Non-Executive Director
Strategy:
Non-executive directors
should constructively challenge and contribute to the development
of strategy.
Performance: Non-executive directors
should scrutinise the performance of management in meeting agreed
goals and objectives and monitor the reporting of performance.
Risk: Non-executive directors should
satisfy themselves that financial information is accurate and that
financial controls and systems of risk management are robust and
defensible.
People: Non-executive directors are
responsible for determining appropriate levels of remuneration of
executive directors and have a prime role in appointing, and where
necessary removing, senior management and in succession planning.
A major contribution of the non-executive
director is to bring wider experience and a fresh perspective to the
boardroom.
Although they need to establish close relationships with the
executives and be well-informed, all non-executive directors need to
be independent of mind and willing and able to challenge, question
and speak up.
All non-executive directors, and indeed
executive directors, need to be independent in this sense.
At least a proportion of non-executive directors also need to be
independent in a stricter sense. There is natural potential for
conflict between the interests of executive management and
shareholders in the case of director remuneration, or audit (where
decisions on the financial results can have a direct impact on
remuneration), or indeed in a range of other instances.
Although there is a legal duty on all
directors to act in the best interests of the company, it has long
been recognised that in itself this is insufficient to give full
assurance that these potential conflicts will not impair objective
board decision-making.
Requiring a greater degree of independence
on boards has been a central theme in the recent US corporate
governance reform measures. The Sarbanes-Oxley Act requires all
members of the audit committee to be independent.
Under the new NASDAQ listing rules and the
new NYSE listing rules, a majority of the board must be independent.
The Bouton report on corporate governance
in France also recommended that half the board should be
independent.
INDEPENDENCE
Definition of independence (Higgs Review)
"The Code currently provides that the majority
of non-executive directors should be independent of management and
free from any business or other relationship which could materially
interfere with the exercise of their independent judgement, leaving
it to boards to identify which of its nonexecutive directors are
considered to meet this test.
This definition gives little guidance to
companies as to what the test should entail. Shareholder bodies, in
particular, have drawn up their own definitions against which
appointments are assessed. There are over a dozen such definitions
in the UK, all with different criteria.
This proliferation of
definitions is, I believe, unhelpful. What is needed is a set of
guidelines which can be
intelligently and consistently applied.
I have considered carefully the different definitions which are
applied in different jurisdictions and by various bodies in the UK,
together with the different approaches provided in response to
consultation.
I am not convinced by the case, made in some submissions, that
independence should be defined in statute.
On the basis of my work, I recommend that it should be a provision
of the Code that all directors have to take decisions objectively in
the interests of the company. That is the existing legal position,
but it is valuable to state it clearly as it is a fundamental
feature of the unitary board.
Requiring some board members to be more obviously free from other
connections with the company would thus not be seen as reducing the
need for independence of mind from all of them.
I also recommend including in the Code a definition of independence,
which I hope will replace the current multitude of definitions which
many consultation responses regretted. This proposed
new definition addresses not just
relationships or circumstances that would affect the director’s
objectivity, but also those that could appear to do so.
I very much hope that business and investor
bodies will endorse this new definition so that, for the first time,
there is a widely accepted definition of director independence.
When a director is proposed for appointment or re-appointment, the
board should state whether they are to be regarded as meeting the
test of independence. It is the responsibility of the whole board to
produce the statement, and for the individual director to ensure its
accuracy.
The definition makes it clear that receiving additional remuneration
beyond the director’s fee compromises an individual’s independence.
In addition, it is important that a non-executive director is not so
dependent on the income from their role or shareholding as to
prejudice independence of judgement, and I would expect boards to
take this into account in determining independence. "
Independence - Summary
A non-executive director is considered independent when the board
determines that the director is independent in character and
judgement and there are no relationships or circumstances which
could affect, or appear to affect, the director’s judgement.
Such relationships or circumstances would include where the
director:
• is a former employee of the company or group until five years
after employment (or any other material connection) has ended;
• has, or has had within the last three years, a material business
relationship with the company either directly, or as a partner,
shareholder, director or senior employee of a body that has such a
relationship with the company;
• has received or receives additional remuneration from the company
apart from a director’s fee, participates in the company’s share
option or a performance-related pay scheme, or is a member of the
company’s pension scheme;
• has close family ties with any of the company’s advisers,
directors or senior employees;
• holds cross-directorships or has significant links with other
directors through involvement in other companies or bodies;
• represents a significant shareholder; or
• has served on the board for more than ten years.
The board should identify in its annual report the non-executive
directors it determines to be independent. The board should state
its reasons if a director is considered to be independent
notwithstanding the existence of relationships or circumstances
which may appear relevant to its determination.
Dear
Potential, New or Sitting Members of the Board of
Directors,
You
have the duty to prudently represent the interests of the
shareholders. You have to understand the needs and desires
of employees, customers and regulators. You have to do your
best to understand the risks in your organization, and to exercise
oversight. Year after year, you have to do more, and you
have more responsibilities.
Our Mission: To help you make
informed business decisions in good faith.
Our International
Association provides networking, training, certification, alerts and
updates you can use.
Best Regards,
George
Lekatis
President of the International Association of Potential,
New and Sitting Members of the Board of Directors (IAMBD)
General
Manager, Compliance LLC
1200 G Street NW Suite 800, Washington DC
20005, USA
Tel: (202) 449-9750
Email:
lekatis@members-of-the-board-association.com
Web:
www.members-of-the-board-association.com
HQ: 1220 N. Market Street
Suite 804, Wilmington DE 19801, USA
Tel: (302) 342-8828
|
