General / industry training to be a requirement for directors
A new report has proposed a series of measures to police the actions of local corporates, particularly those pertaining to the conduct of the chairman and board of directors of listed companies. Entitled the “Code of Best Practice on Corporate Governance 2013″, this document recommends that the board of directors “ensure the availability within it of those with sufficient financial acumen and knowledge to offer guidance on matters of finance… Every Director should receive appropriate training when first appointed to the Board of a company, and subsequently as necessary. Training curricula should encompass both general aspects of directorship and matters specific to the particular industry/company concerned”.
Further, it also calls for each company’s board of directors to comprise “Non-Executive Directors of sufficient calibre and number for their views to carry significant weight in the Board’s decisions. The Board should include at least two Non-Executive Directors or such number of Non-Executive Directors equivalent to one third of total number of Directors, whichever is higher. In the event the Chairman and CEO is the same person, Non-Executive Directors should comprise a majority of the Board”.
Additionally, it also advises; “The Board should meet regularly. Board meetings should be held at least once in every quarter of a financial year, in order to effectively execute board’s responsibilities, while providing information to the board on a structured and regular basis”.
At the same time, with regard to the company’s Chairperson, the report requires the “decision to combine the posts of Chairman and CEO in one person should be justified and highlighted in the Annual Report”.
Best practices
Issued jointly by the local Securities and Exchange Commission and the Institute of Chartered Accountants of Sri Lanka, this voluntary code also includes a ‘foreword’ by Asite Talwatte, the co-chair of the “Corporate Governance Committee”, which was responsible for these guidelines, wherein he comments; “This revision took into consideration relevant developments in best practices worldwide and emerging matters specific to Sri Lanka. Corporates are encouraged to adopt this Code in discharging their corporate governance responsibilities”.
Mr. Talwatte, who is also the Managing Partner of the local Ernst and Young unit, also goes on to highlight key amendments to the code, encompassing standards related to “reporting internal control, risk management and related responsibilities of the Audit Committees and Boards of directors”; “reporting requirements of the remuneration committees”; “role of the company secretary in Corporate Governance”; “communication with shareholders”; “disclosure and approval of major and material transactions, including those with related parties”; and “sustainability reporting”.
Further, Mr. Talwatte opines; “A well representative, experienced and knowledgeable committee [was] invited to participate in this project. They reviewed primarily the UK Corporate Governance Code (2010 version), Report of the New York Stock Exchange Commission on Corporate Governance, Code of Corporate Governance – Singapore, Corporate Governance Principles and Recommendations of the Australian Securities Exchange, the Malaysian Code on Corporate Governance and Corporate Governance Voluntary Guidelines – India. The initial drafting of the Code was completed during the latter part of 2012, based on which there were further deliberations of the Committee to fine tune the Code”.
Commenting on board remuneration, the report states; “Levels of remuneration of both Executive and Non- Executive Directors should be sufficient to attract and retain the Directors needed to run the Company successfully. A proportion of Executive Directors’ remuneration should be structured to link rewards to corporate and individual performance… The Remuneration Committee should provide the packages needed to attract, retain and motivate Executive Directors of the quality required but should avoid paying more than is necessary for this purpose”.
Remuneration
It also adds; “The Remuneration Committee should judge where to position levels of remuneration of the Company, relative to other companies. It should be aware what comparable companies are paying and should take account of relative performance, but should use such comparisons with caution, mindful of the risk that they can result in an increase of remuneration levels with no corresponding improvement in performance”.
On the other hand, the report also clearly outlines limits to the type of remuneration to be available to the board of directors, stating; “Executive share options should not be offered at a discount (i.e. less than market price prevailing at the time the exercise price is determined), save as permitted by the Listing Rules of the Stock Exchange”. And; “Levels of remuneration for Non-Executive Directors should reflect the time commitment and responsibilities of their role, taking into consideration market practices. Remuneration for Non-Executive Directors should not normally include share options. If exceptionally options are granted, shareholder approval should be sought in advance and any shares acquired by exercise of the options should be held until at least one year after the Non-Executive Director leaves the Board”. It also adds; “Any new long-term incentive schemes in excess of three years which are proposed should be approved by shareholders and should preferably replace existing schemes or at least form part of a well, considered overall plan, incorporating existing schemes. The total rewards potentially available should not be excessive… Payouts or share option grants under all incentive schemes, including new grants under existing share option schemes, should be subject to challenging performance criteria reflecting the Company’s objectives. Consideration should be given to criteria which reflect the Company’s performance relative to a group of ‘comparator companies’ in some key variables such as total shareholder return… Grants under executive share option grants and other long-term incentive schemes should normally be phased rather than awarded in one large block”.
Disclosure
At the same time, the report also offers up specific rules focusing on the disclosure of major or material related party transactions pertaining to the company, indicating; “Further to complying with the requirements under the Companies Act, Securities and Exchange Commission law and Colombo Stock Exchange regulations; as applicable, Directors should disclose to shareholders all proposed material transactions, which if entered into, would materially alter/vary the Company’s net assets base or in the case of a Company with subsidiaries, the consolidated group net asset base”.
It adds; “Prior to a Company engaging in or committing to a ‘Major related party transaction’ with a related party, involving the acquisition, sale or disposition of greater than one third of the value of the Company’s assets or that of a subsidiary which has a material bearing on the Company and/or consolidated net assets of the Company, or a transaction which has or is likely to have the effect of the Company acquiring obligations and liabilities, of greater than one third of the value of the Company’s assets, Directors should disclose to shareholders the purpose and all material facts of such transaction and obtain shareholders’ approval by ordinary resolution at an extraordinary general meeting. It also applies to transactions or series of related transactions which have the purpose or effect of substantially altering the nature of the business carried on by the Company”.
Relating to this area, the report also specifies the requirements to be met for board directors to be truly ‘independent’, noting; “For a Director to be deemed ‘independent’ such Director should be independent of management and free of any business or other relationship that could materially interfere with or could reasonably be perceived to materially interfere with the exercise of their unfettered and independent judgment”.
Adding to this, it states; “Each Non-Executive Director should submit a signed and dated declaration annually of his/her independence or non-independence against the specified criteria set out”. Further, it also requires; “The Board should make a determination annually as to the independence or non-independence of each Non- Executive Director based on such a declaration made of decided criteria and other information available to the Board. The Board should determine whether the Director is independent in character and judgement and whether there are relationships or circumstances which are likely to affect, or could appear to affect, the Director’s judgement. The Board should specify the criteria not met and the basis for its determination in the annual report, if it determines that a Director is independent notwithstanding the existence of relationships or circumstances, which indicate the contrary and should set out in the Annual Report the names of Directors determined to be ‘independent’”.
Elaborating even more, the report also specifies disqualifications for being considered ‘independent’, stating; “A Director would not be independent if he/she: has been employed by the Company, subsidiary or parent of the Company during the period of two years immediately preceding appointment; currently has or has had within last two years immediately preceding appointment as Director, a Material Business Relationship with the Company, whether directly or indirectly; has a close family member who is a Director or chief executive officer or Key Management Personnel (and/or an equivalent position); is a significant shareholder of the Company or an officer of, or otherwise associated directly with, a significant shareholder of the Company; has served on the Board of the Company continuously for a period exceeding nine years from the date of the first appointment; is employed in another company or business: in which a majority of the other directors of the Company are employed or are Directors; or in which a majority of the other Directors of the Company have a Significant Shareholding or Material Business Relationship; or that has a Significant Shareholding in the Company or with which the Company has a Business Connection; is a Director of another company: in which a majority of the other Directors of the Company are employed or are Directors; or that has a Business Connection with the Company or Significant Shareholding in the Company; has a Material Business Relationship or a Significant Shareholding in another company or business: in which a majority of the other Directors of the Company are employed or are Directors; and / or which has a Business Connection with the Company or Significant Shareholding in the same. The above list is not exhaustive, and should be viewed as a guide rather than a set of rules on the basis of which independence can be conclusively determined”.
Senior Independent Directors
In keeping with this focus on being ‘independent’, the report also states; “In the event the Chairman and CEO is the same rson, the Board should appoint one of the independent Non-Executive Directors to be the “Senior Independent Director” (SID) and disclose this appointment in the Annual Report”. It also elaborates; “The Senior Independent Director should make himself available for confidential discussions with other Directors who may have concerns which they believe have not been properly considered by the Board as a whole and which pertain to significant issues that are detrimental to the Company”.
Continuing its exacting disclosure standards, the report also stipulates; “There should be a formal and transparent procedure for the appointment of new Directors to the Board… Nomination Committee should be established to make recommendations to the Board on all new Board appointments. Terms of Reference for Nomination Committees are set out”. Further, it also adds; “The Chairman and members of the Nomination Committee should be identified in the Annual Report.
The Nomination Committee or in the absence of a nomination committee, the Board as a whole should annually assess Board-composition to ascertain whether the combined knowledge and experience of the Board matches the strategic demands facing the Company. The findings of such assessment should be taken into account when new Board appointments are considered and when incumbent Directors come up for re-election”.
Going into even greater detail, the report requires; “Upon the appointment of a new Director to the Board, the Company should forthwith disclose to shareholders: a brief resume of the Director; the nature of his expertise in relevant functional areas; the names of companies in which the Director holds directorships or memberships in Board committees; and whether such Director can be considered ‘independent’”.
Also suggested; “All Directors should be required to submit themselves for re-election at regular intervals and at least once in every three years… Non-Executive Directors should be appointed for specified terms subject to re-election and to the provisions in the Companies Act relating to the removal of a Director, and their re-appointment should not be automatic”.
In terms of disclosures, the report states; “The Annual Report of the Company should set out the following information in relation to each Director: name, qualifications and brief profile; the nature of his/her expertise in relevant functional areas; immediate family and/or material business relationships with other Directors of the Company; whether Executive, Non-Executive and/or independent Director; names of listed companies in Sri Lanka in which the Director concerned serves as a Director; names of other companies in which the Director concerned serves as a Director, provided that where he/she holds directorships in companies within a Group of which the Company is a part, their names need not be disclosed; it is sufficient to state that he/she holds other directorships in such companies; number/percentage of Board meetings of the Company attended during the year; the total number of Board seats held by each Director indicating listed and unlisted Companies and whether in an executive or non-executive capacity; names of Board Committees in which the Director serves as Chairman or a member; and number/percentage of committee meetings attended during the year”.
Corrupt activity
In addition, the report requires a “Directors’ Report, which forms part of the Annual Report, should contain declarations by the Directors to the effect that: the Company has not engaged in any activity, which contravenes laws and regulations; the Directors have declared all material interests in contracts involving the Company and refrained from voting on matters in which they were materially interested; the Company has made all endeavours to ensure the equitable treatment of shareholders; the business is a going concern, with supporting assumptions or qualifications as necessary; and they have conducted a review of the internal controls, covering financial, operational and compliance controls and risk management and have obtained reasonable assurance of their effectiveness and successful adherence therewith, and, if it is unable to make any of these declarations, to explain why it is unable to do so”.
Another key set of amendments, as highlighted previously by Mr. Talwatte, pertains to the area of internal controls and risk management, about which the report states; “The Board should have a process of risk management and a sound system of internal control to safeguard shareholders’ investments and the Company’s assets… The Directors should, at least annually, conduct a review of the risks facing the Company and the effectiveness of the system of internal controls, so as to be able to report to shareholders”. It also adds; “This could be made the responsibility of the Audit Committee”; “Companies should have an internal audit function”; the “Board should require the Audit Committee to carry out reviews of the process and effectiveness of risk management and internal controls, and to document to the Board and Board takes the responsibility for the disclosures on internal controls”.
Elaborating further on the functions of the audit committee, the report comments; “The Audit Committee should have a written Terms of Reference, dealing clearly with its authority and duties. The Audit Committee’s written Terms of Reference must address: The Committee’s purpose – which, at minimum, must be to: Assist Board oversight of the: preparation, presentation and adequacy of disclosures in the financial statements, in accordance with Sri Lanka Accounting Standards; Company’s compliance with financial reporting requirements, information requirements of the Companies Act and other relevant financial reporting related regulations and requirements; processes to ensure that the Company’s internal controls and risk management procedures are adequate to meet the requirements of the Sri Lanka Auditing Standards; assessing the Company’s ability to continue as a going concern in the foreseeable future; and independence and performance of the Company’s external Auditors”.
Whistle-blowing
It also requires; “The duties and responsibilities of the Audit Committee – which, at a minimum must include those set out in the Code of Best Practice on Audit Committees issued by the Institute of Chartered Accountants of Sri Lanka in 2002, and should also include: making recommendations to the Board, pertaining to appointment, re-appointment and removal of external Auditors and to approve the remuneration and terms of engagement of the external Auditors; discussion of the audit plan, key audit issues and their resolution, management responses and the proposed remuneration of the Auditor; discussion of the Company’s annual audited financial statements and quarterly financial statements with management and the Auditor; discussion of the Company’s earnings press releases and financial information and earnings guidance provided to analysts and rating agencies; discussion of policies and practices with respect to risk assessment and risk management; ensuring that a process of sound system of internal control is in place; ensuring that an effective internal audit function is in place; meeting separately, periodically, with management, Auditors and internal auditors; establishing mechanisms for the confidential receipt, retention and treatment of complaints alleging fraud, received from internal/external sources and pertaining to accounting, internal controls or other such matters; assuring confidentiality to whistle-blowing employees; presenting a report to the Board on identified related parties and related party transactions on a regular basis; setting clear hiring policies for employees or former employees of the Auditors; and reporting regularly to the Board of Directors”.
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