THE ROLE
OF THE NON-EXECUTIVE DIRECTOR IN MODERN CORPORATE GOVERNANCE
Margarita
Sweeney-Baird.
Copyright
(c) 2006 Sweet & Maxwell Limited and Contributors
Legislation: Commission Recommendation 2005/162
on the role of non executive or supervisory directors of listed companies and
on the committees of the (supervisory) board
Company
Law Reform Bill (Draft)
Companies Act 1985 (Operating and Financial
Review and Directors' Report etc.) Regulations 2005 (SI 2005/1011)
Subject: COMPANY LAW
Keywords: Corporate governance; Directors powers
and duties; EC law; Non executive directors; Operating and financial review
Abstract: Discusses the historical role of non
executive directors and their role in the contemporary corporate governance
regime. Reviews pre war academic theories concerning the nature of the company,
the changing responsibilities of non executive directors and their legal and
regulatory context since the 2002 Higgs report, highlighting the
recommendations put forward by the European Commission in February 2005 and by
the Operating and Financial Review (OFR). Considers their liability under
existing UK
and EC law, the proposed reforms in the draft Company Law Reform Bill and the
arguments in favour of creating a specific professional institution to regulate
non executive directors, including the ways in which such a body could be
supervised.
The role of the non-executive director is part of a much
wider academic debate concerning corporate governance in company law. There
have been many developments recently in corporate governance which impact upon
the role of non-executive directors, most notably the Higgs Report, [FN1] the
Tyson Report, [FN2] the Operating and Financial Review and its recently
proposed abolition, [FN3] the recommendations put forward by the European
Commission on February 15, 2005 [FN4] and the Company Law Reform Bill and its
attendant consultant and research processes. [FN5]
The purpose of this article is to consider the role of the
non-executive director and its justification as a regulatory mechanism by
placing the role of the non-executive director within its historical context
and its development within the current commercial environment. The author also
wishes to consider whether, given these developments, the time is now ripe to
consider the development of a professional body regulating non-executive
directors, possibly under the aegis of one of the Financial Services Authority,
the Financial Reporting Council or the Institute of Directors
("IOD"). A completely new institution should not be ruled out either.
Historical and
theoretical context
The debate over for whose benefit the company is run is one
that surfaces regularly throughout the history of company
law. The view of both Berle [FN6] and Dodd [FN7] was in line with the
fundamentals of the "legal" model:
"The directors and other agents are fiduciaries carrying
on the business in the sole interest of the stockholders ... The sole function
of the corporation is, however, conceived to be the making of profit for its
stock-holder-members, so that they are the ultimate beneficiaries of the
business and of the activities of the persons by whom it is carried on ... A
corporation is an association of stockholders formed for their private gain and
to be managed by its board of directors solely with that end in view." [FN8]
This view still
holds sway and Cheffins is of the view that the shareholders are the legal
owners of the company and they are the "ultimate beneficiaries of whatever
success it enjoys since they are entitled to what is left over after other
claims the company is obliged to meet have been satisfied". [FN9] Given
that they are the owners, they have according to Pollock's definition of
ownership "the entirety of the powers of use and disposal allowed by the
law" [FN10]; it is to be expected on the legal view that the company would
be run for their benefit: to reduce the potential other claims on the company's
profits and thereby increase the pot available for distribution to the
shareholders as the ultimate beneficiaries.
Berle was of the view, with which Dodd was very much in
sympathy, that it was necessary to establish a legal control which will more
effectively prevent corporate managers from diverting
profit into their own pockets (a real concern at that time) from those of the
stockholders because of the recognised legal rights held by the shareholders in
those profits and the problems resulting from the doctrine of the separation of
power and control. [FN11] The directors are
"free from any substantial supervision by stockholders
by reason of the difficulty which the modern stockholder *68 has in discovering what is going on and taking
effective measures even if he has discovered it". [FN12]
Ensuring that the
shareholders as the legal owners received full protection of their legal rights
defined the nature of the company and rooted the model of the company within
the legal context. It also placed the role of the non-executive director as a
watch-dog that was generally without use if the company was well run. It is
only in the event of mismanagement that is causing loss to the shareholders
that the non-executive director is expected to act within the legal model of
the company.
Yet Dodd, who wrote this in the 1930s, was of the view that
"it is undesirable, even with the laudable purpose of
giving stockholders much-needed protection against selfseeking managers, to
give increased emphasis at the present time to the view that business
corporations exist for the sole purpose of making profits for their
stockholders. [Dodd] believes that public opinion, which ultimately makes law,
has made and is today making substantial strides in the
direction of the view of the business corporation as an economic institution
which has a social service as well as a profit-making function, that this view
has already had some effect upon legal theory, and that it is likely to have a
greatly increased effect upon the latter in the future".
In Dodd's
analysis the legal model of the company assumed by lawyers was based on a view
"of the nature of business as a purely private enterprise" [FN13]
that could be changed and in Dodd's view should be changed so that the company
could take into account a community of interests. Consequently, the directors
should balance these interests and not automatically prioritise the interests
of shareholders. This view is essentially the "pluralist" model of
the company. This model of the company requires the directors, and in
particular the non-executive directors, to consider this wider community of
interests and places the role of the non-executive director firmly within a
wider social context.
In the event of a conflict between competing interests Berle
thought that the shareholder's interests should retain primacy, and his
principal objection to the pluralist model advocated by Dodds was that the
community standard was unenforceable. Interests external to the operation of
the company have no legal standing to sue the company for the enforcement of
their rights and therefore they are not a valid claim on the company. If those
wider social interests become a valid claim on the company then they would
become part of the legal model. As the directors are the persons responsible
for acting on behalf of the company it is the directors who
are responsible for enforcement. As part of the inclusive model wider social
and community interests are to be included as part of the factors that the
directors must consider when they decide what is in the best interests of the
company but they are not direct claims against the company. Thus they are not
truly part of the legal model but they may arguably be part of the pluralist
model envisaged by Dodds. This can be seen in the new s.156 of the Company Law
Reform Bill [FN14] which provides that
"(1) A director of a company must act in the way he
considers, in good faith, would be most likely to promote the success of the
company for the benefit of its members as a whole",
and
"(3) In fulfilling the duty imposed by this section a
director must (so far as reasonably practicable) have regard to--
(a) the likely consequences of any decision in both the long
term,
(b) the interests of the company's employees,
(c) the need to foster the company's business relationships
with suppliers, customers and others,
(d) the impact of the company's operations on the community
and the environment,
(e) the desirability of the company maintaining a reputation
for high standards of business conduct, and
(f) the need to act fairly as between members of the
company."
Like Berle and
Dodds the CLRSG [FN15] has expressed dissatisfaction with corporate governance
and in response to public opinion is seeking to bring the legal model of the
company in line with public expectations of the appropriate role for the
company. They seek to adopt the inclusive model and this can be seen both in
what is now s.156 of the Company Law Reform Bill and the Operating and
Financial Review ("OFR"). The Government have stated that they are
seeking to
"embed in statute the concept of Enlightened Shareholder
Value by making clear that directors must promote the success of the company
for the benefit of its shareholders, and this can only be achieved by taking
due account of both the long-term and short-term, and wider factors such as
employees, effects on the environment, suppliers and customers". [FN16]
The inclusive
model seeks to portray itself as being similar to the legal model but there are
significant differences. It seeks to recognise wider constituents that have no
direct legal claim against the company. The inclusive model argues that wider
constituents and their relationships can have a positive impact on the
company's profits and because they would benefit the company and its profits
they are therefore justifiable, presumably because they would be acceptable to
the shareholders and thereby become justifiable and *69 enforceable by
the objective rational shareholder even if an individual shareholder
were to disagree. By including these wider social duties as part of the
directors' duties an indirect enforcement mechanism is created that negates some
of Berle's criticism of the pluralist model of the company and brings the law
much closer to Dodd's vision of a wider social context for the company. By so
doing it also places responsibility for the enforcement of these wider social
interests with the directors as was expected by Dodds. [FN17]
The academic debate between Berle and Dodds in the Harvard
Law Review was won by the pluralist view of Dodd, whose analysis on the nature
of the model of the company was far more developed. [FN18] Berle was much more
concerned about particular issues relating to the application of trust and
equitable principles to the company and did not follow his stark comment at the
outset through to an in-depth analysis of the legal model of the company. But
historically, as demonstrated by the actual law in the United Kingdom and the
United States, it is Berle's view of the supremacy of the shareholder and the
stark nature of the legal model of the company that dominated throughout most
of the 20th century, when the company was a going concern (although the
interests of creditors alter that position when the company is on the brink of
insolvency). Traditionally the legal model of the company is often assumed in
much of the academic debate on corporate governance. Indeed, Cheffins in his
seminal work makes it explicit that he is making this assumption in his chapter
on non-executive directors and the company board.He adopts the proposition that
"directors, in carrying out their duties on behalf of
the company, should think ultimately about the company's members". [FN19]
Cheffins does so in the full knowledge of the consequences of this approach for
he acknowledges that in considering the social model of the company,
"It would be necessary to consider on a basic level
whether the law should compel companies to sacrifice profits in order to
operate in a 'socially responsible' manner and to evaluate whether
restructuring the board of directors would be the most appropriate way of
implementing policies designed to foster such conduct".
Since the law is now, some 75 years later than Dodd
expected, clearly moving in the direction of requiring the directors to
consider these wider social issues as part of their duties and report on these
wider social issues in the OFR or in the near future in the business review, it
is now necessary to consider the role of the director, and in particular the
non-executive director, in this modern commercial context. By so adopting a
more social approach to the law should the directors be required to foster more
socially responsible conduct, and should the role of the non-executive director
become a more recognised professionalism and be regulated accordingly to take
account of the wider responsibilities of the non-executive directors in the
inclusive model of the company that is now developing? Much of the academic
debate on the role of the non-executive director assumes that the law operates
on a purely legal model of the company, but given the
development of the OFR or in the future the business review and the likely
implementation of s.156, that debate should be reviewed and the role of the
non-executive director further analysed in its developing context.
The role of
the non-executive director
The particular nature of the role of the non-executive
director can be anything that the company wishes it to be because it is
governed primarily by the employment contract between the company and the
non-executive director and the role is not defined by legislation. Technically
there is no difference in law between the executive director and the
non-executive director. Beyond that, the historical nature of the role of the
non-executive director and its relevance can be gleaned as much from the
omissions as it can from the positive statements about the role. As recently as
the sixth edition of Gower's Principles of Modern Company Law by Paul L. Davies
in 1997 [FN20] there is a statement to the effect that
"(non-executive) directors are expected to do little or
nothing other than to attend a reasonable number of board meetings and,
perhaps, some of the committees that the board may establish. As such they will
be modestly rewarded by directors' fees resolved upon by the company in general
meeting". Although it was later acknowledged on the
same page that "one of the central aims of the Cadbury Committee was to
strengthen the influence of non-executive directors on the boards of listed
companies", the lack of analysis of the role of the non-executive director
is quite remarkable and yet completely consistent with the general
philosophical underpinnings of the text. Gower/Davies are most certainly of the
view that the legal view of the company has held sway. Gower/Davies in the same
text state that
"so far as concerns the wider social duties of public
companies, English company law has made no movement at all. Whatever directors
themselves may say the law states that their duties are owed to the company
which for this purpose and so long as the company is a going concern means the
long-term interests of its members and, as a result of the recent grudging
admissions, its employees". [FN21]
Similarly, Harry
Rajak [FN22] has made an important observation on the very same omission and
provides an excellent summary of the commercial and theoretical position as it
stood in 1989:
"A study of a sample of widely read books on 'management
in big business' (published or republished in the 1960s) reveals a surprising
omission (like the dog that *70 failed to
bark in the night!). There is no discussion of the board of directors or of the
role of the non-executive directors. Moreover, these terms do not even rate an
entry in any index. I am referring to books as profound at
the level of theory as Theo Nichols, Ownership, Control and Ideology, as slick
and well turned as Anthony Jay's Management and Machiavelli, and as well known
as James Burnham's the Managerial Revolution, or as informative as Christopher
Tugendhat's, The Multinationals. There is, of course, much talk of managers and
management, shareholders and entrepreneurs, capitalist, corporate bureaucrats
and investors, but none, or very little, of the functioning of the boardroom
and the differing roles of executive and non-executive directors. These works
are written not by lawyers and accountants, but by economists, politicians, specialists
in management and social scientists interested in business organisations. Not
for them the complexities of group structures or the legal niceties as to
responsibility of the 'main board' of the holding company. Such questions are
left to the company lawyer and the accountant as the technicians--or
maintenance engineers--of the corporate machine. These writers have learnt
Berle and Means' lesson (as to the divorce of ownership from control) all too
well; for them only the managers count. Their autonomy is taken for
granted."
Alex Rubner in
The Ensnared Shareholder makes a telling observation that further reveals the
"uselessness" of the traditional role of the non-executive director
to the practical operation of the well-run company. Their role was symbolic and
to provide an air of respectability to the management:
"Nobles, drawing fees in guineas, lent their names to
corporations; in order to dupe the public, to whom the
presence on the board of a member of the aristocracy symbolized business acumen
and/or respectable management. The credulity of the public has declined, and
aristocrats only have limited publicity value nowadays. Television
personalities and sportsmen ... and ... some well known politicians are now
grilled for director-tasks, for which they have no competence." [FN23]
Similarly, Rubner
refers to professional men and executive directors who for reasons of
expediency play a passive role in the face of a dominant and undisputed power
on the board: "They are expected to speak only on their subject and to
listen on the boss expounding policy". [FN24]
Other non-executive directors were courtesy appointments to
represent large clients. Banks are frequently appointed, Rubner says, as
directors "to endow the client firms with prestige and to act as silent
watch dogs; they are not meant to bark". [FN25] This may be a reason why
the non-executive directors have been described as a "self-perpetuating
oligarchy". [FN26]
Given the lack of a useful role for the non-executive
director in the well-run company it is not so surprising that the management
theorists traditionally ignored them: indeed, it seems to have been beneath
their dignity to waste time on such a useless role. Rubner noted that some
non-executive directors were appointed to get rid of them from the real
executive business of running and managing the company:
"Some people are appointed to boards because they are
being kicked upstairs for incompetence in the lower managerial echelons. As a
sop to their pride deposed managers of companies, which have been taken over,
are not infrequently offered a guinea-pig membership." [FN27]
This is all very
different from what is now expected of the non-executive director.
The important or really useful role of the non-executive
director in recent modern corporate governance is that of oversight. The
monitoring function of the non-executive director [FN28] is, however,
time-consuming and creates an essential conflict. If non-executive directors
are part-time they have limited time to perform all the tasks of ensuring that
the company is properly managed, and thus avoiding liability. If non-executive
directors are full time or gain real experience over time [FN29] and are therefore
able to do the job properly, they may avoid liability but they may not be
independent and their role may conflict with the executive functions of the
chairman and the chief executive officer. It has been suggested that
non-executive directors contact regulators or the company's auditors if they
have concerns. Acting as a whistleblower will surely destroy any working
relationship that the non-executive director has with the executive management.
[FN30] The potential for conflict is heightened if there is a senior
non-executive director. Another area of potential conflict is in meeting
institutional shareholders and shareholders generally. Non- executive
directors may unwittingly pass on inside information and taking on executive
functions may cause conflict with the executive directors. [FN31] Managing
these inherent conflicts in the role will require the non-executive director to
possess strong interpersonal skills as well as a sound knowledge and
information base and good communication skills. [FN32] The company secretary is
now responsible for the quality of information flowing to the non-executive
directors and this does go some way to improving the effectiveness of the
non-executive director for monitoring purposes in the context of the public
company. [FN33]
*71 In the legal model it is acknowledged that the
role of the non-executive director is largely useless in the wellrun company.
Some economists would even argue that the market should regulate and monitor
the company and that the non-executive director is an unnecessary burden. There
is certainly a cost attached to having non-executive directors present in the
well-run company, as most are. Why then did the role of the non-executive
director become so important? What was it in the modern commercial environment
that has created the impetus to so much change in commercial practice,
management theory, legal rules, legal decisions and the political agenda so
quickly? The non-executive director has gone from a useless nonentity scarcely
worthy of mention to a pivotal role at the centre of the debate on corporate
governance. This can be seen in the way that the Cadbury Report went from a
small-scale institution to a major cornerstone in the
development of corporate governance. The Cadbury Report was set up by
accountants concerned as to their potential liabilities. Self-interest was to
the fore, not unsurprisingly given the potential liabilities of the accountants
and the auditors in the event of corporate failure. The Cadbury Committee
despite its government support only had one full-time member and it did not
seek to address wider social issues and was quite happy to remain within the
existing corporate paradigm. Not for them invention of new corporate
structures. [FN34] Corporate mismanagement has been a recognised problem since
the time of Adam Smith and concerns over the control of the management are
present in the debate between Berle and Dodds in the 1930s. So, corporate
scandals and mismanagement are unlikely to give a full explanation for this sudden
turn of events. Although Cadbury was certainly important its timing was
fortunate. It was the spark that caught the growing flame of the
dissatisfaction with the legal model of the company. So, perhaps the answer
lies with Dodds. The non-executive director is part of a social process
governed by public opinion. The non-executive director is there because public
opinion wishes the non-executive director to become the custodian of corporate
social responsibility. For example, the Association of Chartered Certified
Accountants has expressed the view that non-executive directors should act as
the "corporate conscience" in respect of corporate social
responsibility. [FN35] This flame of public opinion is now burning bright in
the development of the OFR at the behest of the CLSRG and
the Government and a wider political agenda that is considering the wider
social purpose of the company. [FN36] By recasting the company within the legal
model the wider social purposes of the company are recognised. But the same issue
identified by Berle to criticise the pluralist view is still present in the
inclusive model--enforceability, or the lack of it. The difference between the
modern expression of the model of the company in the inclusive view and the
pluralist view expressed by Dodds is that legal theory is seeking to enforce
the wider social purpose of the company through the agency of the directors,
and in particular, the non-executive directors, by defining directors' duties
more broadly and by using the disclosure philosophy expressed through the
publication of the OFR (and possibly, in the future, the business review) to
make known what actions have been taken by the company on these wider issues.
Directors are the agents for the enforcement of this wider social purpose and
in this process non-executive directors are of great importance as their
background, experience and maturity are of great value to the company in the
fulfilment of this role. The recognised management experience and knowledge
possessed by the executive directors does not place the executive directors at
an advantage for this purpose. In fact the position is quite the reverse. By
being so involved with the commercial management of the company the executive
directors' interests are more closely aligned with profit maximisation and the
shareholders rather than broader social issues.
Consequently, the non-executive director's role becomes much more involved with
these wider issues and their independence and wider social skills valuable to
the company on a more regular basis. [FN37] This author is of the view that
non-executive directors with their likely responsibility for this task can only
provide an effective enforcement mechanism for this role if they in particular
are of the highest calibre. Since a public non-executive director as suggested
by Sheikh and Rees [FN38] is unlikely to be acceptable, the creation of a
recognised profession of "non-executive directors" with its own
independent professional institution to monitor standards and qualifications,
albeit within a statutory framework, to use Gower's terminology, should now be
considered.
Given the importance of the current legal context to the
developing role of the non-executive director it is necessary to consider that
legal context in more detail before we move on to further consider the
development of a professional institution for non-executive directors.
The current
legal context: corporate governance post-Higgs
One of the most important current developments is the
amendment to the listing rules, contained in r.12.43A. With this coming into
force on March 1, 2004,
listed companies are now expected to apply the Combined Code on Corporate Governance for reporting periods starting on or after November 1, 2004. The
Combined Code [FN39] was published *72 by the Financial Reporting Council and can be found at the
end of the listing rules. This means that companies must now comply or explain
why they have not complied with the Combined Code in a statement in the annual
report and accounts. This statement must be reviewed by the company's auditors.
The Combined Code applies to non-executive directors in the
following manner. It acknowledges the role and the responsibilities of the
non-executive director, including the need for board balance and independent
non-executives [FN40] and the importance of the non-executive directors on the
audit, [FN41] nomination and remuneration committees. To facilitate this
process there must be a formal, rigorous and transparent procedure for the
appointment of new directors to the board. [FN42] The code identifies the
support systems that can be put in place to enable them to perform their role
most effectively. It suggests training and induction for non-executive
directors. It advises the courts that when determining liability of directors
[FN43] they should take note of the steps taken by the non-executive directors
to educate themselves and the instructions that they have received from the
executive board. Whether this will be considered relevant by a court when
considering non-executive director liability is quite another matter. The
importance of the role of the non-executive director is highlighted by the
prominence of the statement in s.1A.1 of the supporting
principles to the first and main principle of the code:
"As part of their role as members of a unitary board,
non-executive directors should constructively challenge and help develop
proposals on strategy. Non-executive directors should scrutinise the
performance of management in meeting agreed goals and objectives and monitor
the reporting of performance. They should satisfy themselves on the integrity
of financial information and that financial controls and systems of risk
management are robust and defensible. They are responsible for determining
appropriate levels of remuneration of executive directors and have a prime role
in appointing, and where necessary removing, executive directors, and in
succession planning." [FN44]
The strategic and
ethical importance of the role of the non-executive director is further
highlighted by the wide-ranging guidance on the role of the non-executive
director provided in Higgs's suggestions for Good Practice. [FN45] The sheer
scale of the expectations of the non-executive director is a concern.
The European Commission in its recommendation of February 15,
2005 on the role of non-executive or supervisory directors of listed companies
and on the committees of the (supervisory) board [FN46] has sanctioned the
comply or explain approach of the Combined Code and has recognised that detailed
binding rules are not always the most efficient way of achieving the objectives
pursued. Instead, designated best practice recommendations can be developed by market participants. In order to protect investors it is
recommended that there should be a sufficient number of committed non-executive
directors to ensure that the management function is subject to an effective and
sufficiently independent supervisory function. The three crucial areas where
potential conflicts of interest arise for the management when such matters are
not a direct responsibility for shareholders are in relation to nomination of
directors, remuneration of directors and audit, and it is therefore recommended
that the role of non-executives directors be "fostered" and that
separate committees comprising mainly independent non-executive directors be
created to take responsibility for nomination, remuneration and audit.
Essentially it is envisaged that these committees will make recommendations to
the board, which remains responsible for the decisions taken. For non-executive
directors to be effective they are required to be appointed for a specific term
and to have the "right background" and have sufficient time to fulfil
the role. Particular finance and accounting competence in the audit committee
is also regarded as indispensable. Independence
is also essential and is to be a matter of substance rather than form, meaning
that any material conflict of interest involving directors will be properly
dealt with. All new members of the board, and this must therefore include the
non-executive directors, must have a tailored induction programme covering
their responsibilities and the company's organisation and structure. Evaluation
of the board's own performance should be carried out
annually, as should a review to identify areas where directors need to update
their skills and knowledge. Any changes resulting from this self-evaluation, a
profile of the board's composition, the relevant particular competencies of
individual directors, the independence or otherwise of a director, other
significant professional commitments held by the directors and the internal
organisation and procedures within the company should be made public at least
once a year. Shareholders should be properly informed of "the affairs of
the company, its strategic approach, and the management of risks and con-flicts
of interest". Annex 1 provide more detailed criteria for the committee
structures and Annex II gives a profile of the independent non-executive
directors with criteria for determining the independence or otherwise of the
non-executive director. In the original version these criteria were included in
the main body of the recommendations but owing to protests from both the
European Union members and companies these proposals were toned down. Now the
criteria are merely annexed to the recommendations as "additional
guidance". Implementation of sound corporate governance practices is to be
monitored closely in Member States. The Member States are invited to take the
necessary steps to implement these recommendations by June 30, 2006 and to inform the
Commission of the measures taken to enable the Commission to monitor the
situation and assess whether further measures are needed. The European
Commission are clearly keeping the matter under review and avoiding legislation
on this issue will depend on the success of the current
regime. Gaps and weaknesses must therefore be dealt with as a matter of urgency
despite Commission officials insisting that the Commission has no intention of
establishing a European corporate governance code.
These requirements emanating from the European Commission are
broadly in line with the Combined Code and *73 there should be no need to make further major
amendments to the Combined Code to take account of these recommendations. It is
assumed that the United
Kingdom will, given the various government
pronouncements on corporate governance, continue with the "comply or
explain" approach permitted by the European Commission Recommendations
rather than adopt the legislative option also permitted in the recommendations.
One area that is very specific is that of Recommendation 9.2, "The roles
of directors regarding communication and engagement with shareholders should be
clearly delineated." What is meant by "engagement"? The
Companies Acts make no mention of this and the listing rules do not require any
"engagement" with the general shareholders. The Combined Code does
make reference to "dialogue with institutional shareholders" [FN47]
and the OFR is prepared for and directed at shareholders in accordance with
normal company law principles. The Government clearly intends the information
in the OFR to be used by institutional shareholders to engage with management:
[FN48]
"The Government believes increased shareholder
engagement is a key driver of good corporate governance,
deliverable through access to clear and meaningful information about the main
drivers of a company's performance." [FN49]
In its response
to the public consultation the Government said that the OFR regulations are
designed to result in useful and relevant reporting that will assist
shareholders to assess companies' strategies and their potential to succeed.
[FN50] Since the OFR itself is to be abolished the position on this is now even
more unclear. How is engagement to be satisfied, if engagement implies a
two-way dialogue for all shareholders? It is likely that the larger
institutional shareholders will be able to enter into meaningful dialogue upon
request since the code itself advises it [FN51]: the same is not true for the
shareholder with a small holding. An engagement inequality could result.
Improved systems of communication beyond the AGM and the development of
e-enfranchisement [FN52] to enhance shareholder democracy may improve the
position of the small shareholder but two-way dialogue for all shareholders
will be difficult to achieve. Some may also question whether any form of
shareholder engagement can deal with the worst excesses of management deriving
from the agency problems caused by the separation of power and control inherent
within the company structure. [FN53]
As the Combined Code applies directly to non-executive
directors and corporate governance, on the face of it the Combined Code would
appear to be of greater importance to the role of the non-executive director.
In terms of compliance with specific details this is
certainly true but the Operating and Financial Review ("OFR") is, in
this author's view, a more significant development in company reporting for
non-executive directors and the model of the company. The OFR is a narrative on
a company's past and future performance and must include details of any
potential social and environmental risks. It was to be a criminal offence to
recklessly approve an OFR [FN54] and auditors were to check the consistency of
the OFR with company accounts. The OFR was a key recommendation of the
independent Company Law Review [FN55] and in July 2002 the Government consulted
on the underlying principles of the OFR in its White Paper Modernising Company
Law. [FN56] The draft regulations on the OFR and Directors' Report were
published on May 5, 2004 in the form of secondary legislation under existing
law, [FN57] with a further draft published on January 21, 2005 that has now
been implemented and has become the Companies Act 1985 (Operating and Financial
Review and Directors' Report etc.) Regulations 2005. [FN58] The changes
necessary to comply with the Accounts Modernisation Directive [FN59] are
included in the statutory OFR to avoid duplication of effort. The new reporting
standard (termed a "Reporting Exposure draft" or "RED") for
the OFR has now been issued by the Accounting Standards Board ("ASB")
[FN60] and *74 was to
commence for financial years beginning on or after April 1, 2005 [FN61] and the
Financial Reporting Review Panel's ("FRRP") [FN62] administrative
enforcement role, which extends to cover defectiveOFRs and
Directors' Reports, was to begin one year after the regulations come into
effect and apply to OFRs and Directors' Reports for financial years beginning
on or after April 1, 2006; thus delaying the enforcement mechanism by one year.
[FN63]
The past tense is used in relation to the enforcement
mechanism for the OFR because the statutory story does not end with the
development of the OFR. Despite all the preliminary work undertaken in the
Company Law Review by the CLRSG, the consultation processes that were involved
in the development of the White Paper issued by the Government on Modernising
Company Law and the rush to implement the OFR by s.13 of the Companies (Audit,
Investigations and Community Enterprise) Act 2004 making an amendment to s.257
of the Companies Act 1985 to make the Companies Act 1985 (Operating and
Financial Review and Director's Report etc.) Regulations 2005, which were only
made on March 21, 2005
and came into force the following day, and the detailed work on the development
of the Company Law Reform Bill that the Government only sent to the House of
Lords on November 1, 2005,
the Government has suddenly done a complete u-turn on policy. On Monday
November 28, 2005 the chancellor announced at the CBI conference that as part
of his plans to cut the burden of red tape on business [FN64] he would abolish
the need for an OFR, which was to come into effect this year. Further to this
the DTI issued a statement [FN65] that they intended to bring forward
regulations before the recess of Parliament, under s.257 of the Companies Act to repeal those provisions of that Act which impose
obligations on companies in relation to the preparation of the OFR. The
regulations will leave in place those provisions of the Companies Act 1985
relating to the requirements to prepare a business review which are necessary
to implement the Accounts Modernisation Directive (2003/51). The Government
also intend to bring forward amendments in due course to amend the Company Law
Reform Bill. If this is the case the enforcement mechanism for the OFR is
unlikely to ever come into force. This also leaves the future development of
legal regulation on company reporting on this issue clearly within the hands of
Europe and the development of policy at a
European level will determine how far the law and regulations move towards a
more social model of the company. In the future it will be a document known as
a business review that will operate in place of the present OFR. The fact that
the chancellor's statement is out of step with the development of public
opinion on this can be seen in the response of the business community to his
proposal to abolish the OFR. Major city investors, the Financial Reporting
Council ("FRC") and the Association of Chartered Certified
Accountants all expressed dismay at the proposals. [FN66] The Association of
British Investors is even to discuss the possibility of including the OFR
standards into the Combined Code on Corporate Governance. At the moment,
moreover, several companies are preparing an OFR on a voluntary basis,
reflecting as it does best practice in corporate governance.
For the present, the OFR provides a focus for
stakeholders who are interested in wider social and community purposes of the
company. It requires the directors to consider these issues and provide
information on the company's approach to these matters. The regulations also
make it clear that the OFR is prepared to "assist the members to assess
the strategies adopted by the company and the potential for those strategies to
succeed". [FN67] The Government's position was clearly that the members'
interest must drive the content of the OFR [FN68] despite the fact that the
CLRSG had referred to "users" and the Radcliffe Report clearly
recognises that "the OFR ... will also provide information that will
inform the decisions of other users--employees, customers, suppliers, society
more widely". [FN69] Since the regulations specifically require the
directors to include details on wider social issues, the movement towards the
social model of the company as envisaged by Dodds is apparent. Paragraph 4(1)
of Sch.7ZA provides that the review must include:
"(a) information about environmental matters (including
the impact of the business of the company on the environment),
(b) information about the company's employees, and
(c) information about social and community issues".
Those wider
interests may not have had direct standing to sue on the basis of the OFR,
since the OFR has clearly been directed towards the members, but the existence
of other enforcement mechanisms that may be just as effective in driving forward a wider social/inclusive model of the company
is clear. There is public opinion which will be galvanised by the disclosure
philosophy and the real *75 knowledge available to the various
interest groups from the OFR. The Radcliffe Report was set up to give directors
more guidance on what was to be included in the OFR. [FN70] The Government is
of the view that the business review will still require reporting on material
information relating to employee, social and environmental matters, etc. So it
will still further the movement towards a more social model of the company
using only it seems the enforcement mechanism provided by disclosure. [FN71]
The interrelationship between the OFR and its future
embodiment in the business review, the Combined Code and the role of non-executive
directors becomes apparent for human capital management and the composition of
the board in terms of its ethnic and gender diversity. The OFR reflects the
ideas developed by the Company Law Review, the Kingsmill Report [FN72] and the
Radcliffe working report. The 2001 Kingsmill review on women's pay and
employment recommends that human capital management ("HCM") be
properly evaluated in companies' annual reports. That review resulted in the
creation of the Accounting for People independent task force in January 2003 by
the Secretary of State for Trade and Industry and the Accounting for People's
report. [FN73] Dr Val Singh has highlighted the importance of gender and
ethnicity for the operation of the company. [FN74] The Higgs Review of 2002 looked
at the role and effectiveness of non-executive directors
generally and made several recommendations to create more diverse and effective
boardrooms. 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. Given that the nomination
committee should, according to Higgs, provide support to the board on
succession planning, this evaluation of future needs must be actively
considered on an ongoing basis. To widen the number of non-executive directors,
nomination committees should consider a wider range of backgrounds: lawyers,
accountants and consultants, private companies, charitable or public sector
bodies and more candidates from layers below board level and groups not
traditionally represented on the board such as human resources, change
management and customer care executives. Many of these recommendations have
been incorporated into the Combined Code and now appointments to the board are
more transparent and can be judged against objective criteria. In December 2004
the DTI issued a booklet entitled "Building better boards", which
reviews the existing corporate governance arrangements to ensure diversity in
the boardroom and outlines a range of initiatives to develop what Lord
Wedderburn would describe as the "gene pool" of directors and
non-executive directors. It is clear from this document that the Government has
accepted the findings of the Tyson Report and has concluded that, despite the
good work of the Higgs Report and the Combined Code, women are still
substantially under-represented on company boards. Tyson
recommended that the selection processes for non-executive directors should be
rigorous and transparent, boards should have more and better evaluation and
training, and research and measurement should be implemented to encourage
greater board diversity. The government initiative in response to this is for
the moment to place responsibility for action primarily with companies and
individuals. [FN75] Yet the Government is clearly not happy with the current
situation and statistics that reveal that there are as few as 4 to 6 per cent
of female non-executive directors, so the current system is still under review.
[FN76] Patricia Hewitt has stated that the Government will "review how
effectively the OFR is working--including HCM reporting--in 5 years time after
the new system has bedded down", [FN77] and the DTI has included a HCM
report in its 2004-2007 business plan as a good example. If the government
initiative facilitated the creation of a professional institution charged with
responsibility to take forward the monitoring and development of non-executive
directors then those companies and individuals that the Government refers to
would have a substantive institution to facilitate the process. As the
development of the Financial Services Authority and the self-regulatory
organisations, or even the ASB and the FRRP referred to above, evidences, there
are precedents for this already. A professional institution could facilitate
the creation of a meritocracy for non-executive directors that truly represents
the United Kingdom.
The stated purpose of the current OFR, and
presumably the business review will follow a similar path, is to help investors
make better-informed decisions and encourage an open dialogue between
shareholders and business to stimulate long-term wealth creation. By providing
reliable information about the value of the company the OFR is designed to
encourage shareholders to exercise effective and responsible control over the
company management. [FN78] This control, it is hoped, should motivate directors
and *76 managers to
maximise company value over personal objectives. Such control has been notably
lacking, deriving as it does from the separation of ownership and control first
identified by Berle and Means. [FN79] The OFR essentially seeks to empower
shareholders with information to address their lack of control over the
company. By contrast, the role of the non-executive director seeks to create an
internal control system within the company's own board to address the lack of
control by shareholders over the company. The non-executive director must with
the rest of the board take responsibility for the information that is given to
the shareholders. This includes the OFR. [FN80] Thus the OFR provides a further
source of liability for the non-executive director [FN81] and with the
provisions of the Combined Code considerably extends the responsibilities of,
and consequently the liabilities of, the non-executive director. It was the
enforcement capability through the agency of the FRRP that reduced the
objection made by Berle to the pluralist model of the company. If breaches of
the relevant OFR standards could be enforced then so could
a wider view of the social purpose of the company. By the same token the
possible lack of direct enforcement capability for the business review gives
substance to the objections to the pluralist model of the company made by Berle
and may bring the model of the company closer to its roots in the legal
tradition while also reducing the scope of liability for the non-executive
director.
The potential
for liability
It is important to emphasise that non-executive directors are
still subject to the general common law imposing fiduciary duties and a duty of
care and skill on directors, classically described in Re City Equitable Fire
Insurance Co Ltd. [FN82] These duties are owed directly to the company and
require the directors to act honestly and in good faith in the best interests
of the company, to use the powers granted to them for the purposes for which
they were conferred, to take proper care of the assets of the company, not to
make personal profit unless permitted in the articles or approved or ratified
by the company in general meeting by an independent majority of shareholders,
to avoid conflicts with the company and not to compete with the company. These
fiduciary duties have traditionally been viewed strictly by the courts. By
contrast the traditionally lax [FN83] duties of skill and care have changed as
the law seems to be moving [FN84] towards a more objective
and demanding standard. In Dorchester Finance Co Ltd v Stebbing, [FN85] the
non-executive directors were liable on the same basis as the executive
directors and it was held that the scope of the duty of skill of a
non-executive director should be determined subjectively by reference to that
director's own skill and experience and the duty of care should be determined
objectively by reference to the standard expected of the ordinary reasonable
man. The twofold objective/subjective standard is generally accepted to
represent the law and is in this author's view likely to be followed in the
higher courts. [FN86]
The statutory duties that the non-executive directors are
subject to apply equally to all directors and are to be found mainly in the
Companies Acts and the Insolvency Act of 1986. The Companies Acts provisions
include administrative and accounting duties such as the duty to keep books up
to date and the duty to file annual returns. Sections 212 to 214 of the
Insolvency Act 1986 impose criminal and civil liability on the non-executive
director where the company continues to trade when the non-executive director
knew or ought to have known that there was no reasonable prospect of the
company avoiding insolvent liquidation or if the non-executive director
knowingly continues to carry on business with the intention of defrauding
creditors in the knowledge that there was no reasonable prospect of the
creditors being paid by the company. Liability can also be imposed on the
non-executive director through a raft of statutory law including
health and safety regulations, environmental legislation, the Company Directors
Disqualification Act 1986, competition law and financial services law. The
Company Directors Disqualification Act of 1986 applies to non-executive
directors and has the practical effect of raising standards of skill and care.
Further, Re Barings [FN87] shows that a director may still be found unfit even
though no breach of a legal duty has been established. The range of potential
liabilities for the non-executive director is considerable.
One of the main weaknesses in the corporate governance
structure for any director has been the lack of indemnity cover and exposure to
legal action. [FN88] As the recently settled legal action between Equitable
Life and Ernst and Young demonstrates, the risk of exposure is real and may be
even greater for the non-executive director as the non-executive may not have
the necessary understanding of the relevant sector of the market place. In 2003
the non-executive directors of Equitable Life sought to have the claims against
them struck out on the grounds that as non-executive directors they were not
liable for the negligence and breach of fiduciary duty that Equitable Life was
claiming. Langley J. delivered a judgment that cast doubts on the rights of
non-executives and observed:
"I've concluded that Equitable's claims against the
non-executive directors aren't ones of which it can be said that they have no
real prospect of succeeding. I should stress that this
conclusion does not mean that I think Equitable's case is right or even
probably right." [FN89]
Consequently the
non-executive directors spent years in the throes of legal action in a case
against all 15 (six full *77 time directors and nine non-executive)
directors that was finally settled in December 2006 on the basis that Equitable
Life paid £10 million towards a proportion of the legal costs of the nine
directors who had not already reached a settlement with Equitable Life. The
non-executive directors clearly did not have the resources to meet the legal
costs of the action and their no win no fee contingency arrangements prevented
them from settling the action on the basis that each side would meet their own
costs. Six directors had settled on this basis in October 2006 when the claim
against the auditors collapsed. Only one non-executive director, David Wilson,
settled on the basis that he met his own legal costs and it is significant that
he was named in 2004 as Britain's 97th richest man with a reported fortune of
£410 million. Quite simply he could afford to meet his legal costs. Other
non-executive directors did not possess, and cannot be assumed to possess, that
level of resource and they require adequate insurance provision to protect them
from the costs of potential legal actions. If Equitable Life had succeeded in
their legal action and the non-executive directors had been found liable
without adequate insurance provision in place there could have been further
renewed reluctance on the part of potential non- executive
directors to take up the role. [FN90] As it is, the non-executive directors of
Equitable Life have given a significant proportion of their life to fighting
this legal action at considerable cost because Equitable Life did not meet all
the legal costs involved.
Section 727 of the Companies Act 1985 has always relieved
directors from liability for negligence, default, breach of duty or trust, if
in the opinion of the court they have acted honestly and reasonably and ought
fairly to be excused. Section 727(2) permits the non-executive director to seek
relief if he has any reason to apprehend that any claim will or might be made
against him. But this provision requires a legal action to be taken and
requires a court to consider to matter. This is not likely to be an attractive
proposition to any current, or for that matter, future non-executive director.
The costs of bringing the action are likely to be considerable. Although ss.19
and 20 of the Companies (Audit, Investigations and Community Enterprise) Act
2004, which came into force on April 6, 2005, [FN91] permit, but do not
require, companies to indemnify directors in respect of proceedings brought by
third parties and applications for relief from liability (covering both legal
costs and the financial costs of any adverse judgment except criminal
penalties, penalties imposed by regulatory bodies such as the Financial
Services Authority and the legal costs of unsuccessful criminal defences or
applications for relief), and permit, but do not require, companies to pay directors'
costs of defence proceedings as they are incurred, even if
the action is brought by the company itself or is a derivative action, the
director is still liable to pay damages and repay his defence costs to the
company if his defence is unsuccessful. A similar but more tightly drawn
provision permitting insurance against liability or indemnification against
liabilities incurred already exists in s.310(3) of the Companies Act 1985.
These provisions provide some relaxation of the rigour of the prohibition which
exists by virtue of s.310 of the Companies Act 1985, where it remains the case
that companies will still not be permitted to exempt directors from, or
indemnify them against, liabilities to the company itself: the insured v
insured, often now described as the "Equitable Life claim scenario".
That sort of exposure to liability, as the Equitable Life case clearly
demonstrates, still exists. Moreover, the indemnity cover provided by the
company under ss.19 and 20 above is not a right that the non-executive
directors can rely on. It is only something that the company is permitted to
provide and if it is provided there must be an appropriate statement made in
the directors' report and the shareholders have a right to inspect any
indemnification agreement entered into by the company or an associated company.
Shareholders clearly have the right to challenge or object to the provision of
even this limited form of indemnification.
The Combined Code provision A.1.5 includes a reference to the
need to provide appropriate directors' and officers' insurance [FN92] and thus
highlights the importance of this issue. In September 2003
the Institute of Chartered Secretaries and Administrators ("ICSA") in
response to a request from the Higgs Review issued a guidance note on
insurance. [FN93] That guidance highlights that directors' and officers'
insurance is normally taken out in one of three formats, [FN94] resulting in
potential overlaps and gaps in coverage.
In the future, ss.210-216 of the Company Law Reform Bill will
provide a legal basis for the provision of insurance by the company for
directors under s.211 and qualifying third-party indemnity provisions under
s.212. Even under the proposed reforms it seems that company law principles
could be compromised, as expressed in s.210(1) of the Company Law Reform Bill,
by the company seeking to exempt the directors from liability. Although there
is the right given to the company to provide insurance under s.211, this is not
something that the non-executive director can demand as of right. Moreover,
s.212(3)(b)(ii) prevents the provision of qualifying third-party indemnity
provisions to liabilities incurred by the director in defending civil
proceedings brought by the company against him. If this analysis remains *78 the case, a professional institution with the
trappings of a professional regulatory institution, including full professional
indemnity insurance cover, is in this author's view becoming essential. There
should be full indemnity insurance cover to cover all potential liabilities,
including liabilities to the company itself, available for non-executive
directors as of right and at a reasonable cost. The provision of
adequate directors' and officers' insurance cover is the quid pro quo that a
professional institution could provide for validating that individuals have the
necessary skills and experience for demanding posts especially in the financial
services sector. If non-executive directors with appropriate skills have
independent insurance cover, this will ensure that the right people are
appointed and are sufficiently questioning and independent. Non-executive
directors protected by proper insurance cover are more likely to remain
objective and avoid manipulation by the board. In the meantime all
non-executive directors should be made aware of the ICSA Guidance Note and its
contents when considering any appointment. The Combined Code contains a
specimen appointment letter for non-executive directors and suggests that a
copy of the D & O policy is provided. Good professional advice in
considering the coverage of the D & O insurance is essential.
Directors are also at risk of legal action from the
Government. The crown has lost its preferential creditor status with the
introduction of the Enterprise Act 2000 and is more likely to pursue directors
of insolvent companies. Further potential scope for liability for the
non-executive director already exists with further incarnations of the
Corporate Manslaughter Bill, the Health and Safety (Directors' Duties) Bill
2005 and the Corporate Responsibility (Environmental, Social and Financial
Reporting) Bill likely to appear on the legislative horizon. The Combined Code
of Best Practice will also provide ammunition for legal
claims even if it lacks a statutory basis. A non-executive director can face
devastating liabilities often for little compensation [FN95] and those
potential liabilities look set to increase.
By the Combined Code and the European recommendations
focusing detailed attention on the importance of the non-executive directors on
the issues of nomination, remuneration and audit they may be distracting
attention away from the most important issue for non-executive directors, and
that is the monitoring of board activities generally. The legal model has
always assumed that whatever the uselessness of the role of the non-executive
director when the company is well run they are expected to act in the event of
mismanagement. As the Equitable Life case demonstrates, the non-executive
directors are expected to be liable in the same way as the executive directors
and probably more so as their stated purpose is to monitor and supervise the
board. In fact they are probably more exposed to legal liability because they
may not have sufficient skills and experience to meet the objective elements of
the duty of skill and care and if inexperienced they may be at risk of
manipulation by the executive team that they are responsible for overseeing. If
non-executive directors are appointed to the board they must not allow
themselves to be sidetracked and spend their time on peripheral issues, however
important. They must focus primarily on monitoring as that is where their
primary liabilities are focused. Non-executive directors may require support to
achieve this focus, and this support is more likely to
come from a professional institution that caters to their needs rather than
from the board that the non-executive director is meant to be supervising.
A weakness in the current law that serves to emphasise the
potential for liability is the degree of uncertainty as to the precise nature
and scope of the legal duties that the non-executive director is subject to.
The draft Companies Bill, published originally in July 2002, [FN96] provides
general principles by which directors are bound in Sch.2. That draft was
superseded by Pt B of the Company Law Reform Bill published in April 2005 and
is now included in Pt 10 and ss.154 to 238 of the Company Law Reform Bill now
before the House of Lords. The provisions in the proposed s.158 require
directors to exercise the care, skill and diligence of a reasonably diligent
person with both the knowledge, skill and experience which may reasonably be
expected of a director in his or her position, and any additional knowledge,
skill and experience which the particular director has. If enacted, as the
Government clearly intends at some time in the future, this statement of the
expected duties of the non-executive director would clearly endorse the
application of both the objective and the subjective duty of care applicable to
the non-executive director cumulatively and would endorse cases [FN97] that are
bringing the common law duty of care of a director closer to the standard
imposed by s.214 of the Insolvency Act 1986. More relevantly for present
purposes the statement of directors' duties will provide a
much-needed clarity to the statement of directors' duties that will provide
more specific guidance to the non-executive director of what is expected of him
or her without taking expensive legal advice.
The modern commercial
environment and the development of a professional institution
Although much has been done to improve the position of the
non-executive director, gaps and weaknesses remain, most notably financial
acumen [FN98] and the continued under-qualification of certain non-executive
directors, [FN99] especially *79 apparent in
highly specialised sectors, e.g. financial services, as demonstrated by the
apparent alleged failure of the non-executive directors in Equitable Life. It
is these gaps and weaknesses that the author suggests could be addressed by the
creation of a professional institution to regulate the skill level of
non-executive directors. Indeed, the author is of the view that this lack of
experience within non-executive directors is exacerbated by the failure to draw
on the full talent pool available and possibly in and of itself justifies the
creation of a professional institution to address these issues. It is suggested
that an external legal framework for creating this institution is necessary because
professional self-regulatory organisations develop over
time. Since the role of the non-executive director is largely a creature of the
past 20 years there is no time to wait for such an organisation to evolve
naturally as it might well do given the passage of time and the development of
a community spirit within the group of non-executive directors.
A similar proposal was put forward by Lord Wedderburn in his
reply to the Higgs consultation process. [FN1] Lord Wedderburn suggested that
the Higgs Review should propose that an institution be established, possibly
called the Corporate Governance Standards Board, whose functions should
include: keeping a list of persons who qualify under tests of independence,
experience, knowledge and market sector; establishing training schemes; raising
public awareness of the functions of non-executives; proposing non-executives
for boards on whose election the shareholders could decide; and producing
annual reports that assess progress towards resolving the problems of
separation of ownership and control. [FN2] Such an institutional structure
would be similar to a professional group as suggested here.
Such a professional institution would not be incompatible
with the suggestion of Dean Tyson of the London Business School, who recommends
the development of a high-visibility initiative which provides regular and
reliable measures of board composition for individual companies, and which
monitors both progress on achieving rigorous and transparent processes for
non-executive director appointments and progress on
building more diverse boards. Tyson recognised that such an initiative would
have more influence if it were independent of government and drew a substantial
share of funding from the business community. A professional institution as
suggested here could meet these criteria and fulfil the role outlined in the
Tyson Report. A professional institution would give substance to the initiative
suggested by Tyson and would create an institution to take forward those suggestions.
Normally a professional group would have a monopoly over a
certain activity; in this case that would be that of the role of the
non-executive director, that monopoly being justified because of certain
benefits that would accrue to society. A professional institution could
certainly take over the role of regulating the non-executive director's
performance and ensuring that non-executive directors' moral, ethical and
professional standards are maintained. It is submitted that this benefit would have
advantages because there is an important principle at stake--Quis custodiet
ipsos custodies? (who guards those who guard?)--and, at the moment, there is no
one. Alternatives such as the performance review of the non-executive director
by the company [FN3] that they are themselves reviewing does have some benefits
as outlined by Tyson but it can create a conflict of interest for the
non-executive director that undermines the very nature of the post. It is
suggested that this professional group should be self-regulated within a
statutory/code framework because this would allow
membership of the regulatory body of the professional institution to extend
beyond the existing non-executive director membership to the full range of
stakeholder interests involved. This might include, as suggested by Lord
Wedderburn, City institutions' institutional investors, banks, accountancy
professions, management interests, employee organisations generally and trade
unions representing workers and management, CBI, scholars with experience in
the field, environmental interests, bodies concerned with equal opportunities
and the like.
Having a professional institution and (the author would also
recommend) a code of ethics and standards developed by the professional
institution directly applicable to the specific situation of the non-executive
director would in all probability impact also on future legal decisions as it
would provide customary evidence of the relevant standards of ethics and skill
and care to be expected of the non-executive director. Providing such rules in
the form of a code provides many advantages such as flexibility, and the
possibility of developing rules quickly in response to changing circumstances
by persons experienced in the field. But codes still need to be enforced. To do
this a professional institution must have the power to take such action. In a
different age they might have developed through customary rules but in the
modern commercial fast-moving environment a specific institution with the power
to develop the code and given enforcement powers at the outset would be better.
If the professional institution was a monopoly then
expulsion would be available as a sanction. A wider range of sanctions and
enforcement powers would in this author's view be advisable. The lack of direct
enforcement of a code by a professional institution would become a striking
omission that would need to be addressed.
If there is to be a professional institution for
non-executive directors, who should it be? There are arguments to exclude
certain organisations. The professional institution so charged with
responsibility for "legislation", or to put it more appropriately
"setting standards" should under the doctrine of the separation of
powers be quite separate from the enforcement mechanism of the Financial
Reporting Review Panel. Thus any links with the FRC and its sub-group the ASB
and the FRRP would have to be put into question. Similarly since the FSA is the
competent authority for listing and the FSA's developing legislative role in
the European context could impinge on its independence in the context of
administering an executive professional institution, the FSA would not be a
suitable institution for developing a professional institution for
non-executive directors. The links being created between the FRRP and the FSA
adds emphasis to this argument. [FN4] The best alternatives are *80 therefore a completely new institution or an
institution developed under the aegis of the Institute of Directors, although
it is arguable that the IOD's role in relation to executive directors could
conflict with its role in relation to non-executive directors. This latter
argument is not strong and, given the fact that there is
no legal difference between the legal duties of executive and non-executive
directors and much of the training is identical, the synergy in having the IOD
regulating the non-executive directors in a more formal context has much to
commend it.
Another concern of note on this issue is that the large
mutual life companies are failing to provide their non-executive directors with
access to professional advice, according to data collated by the
Myners/Treasury-backed review into governance of the sector. [FN5] This is
despite the Combined Code provision A.5.2. that states that non-executive
directors should have access to professional advice at the company's expense
where they judge it necessary to discharge their responsibilities as directors.
In March 2004, following the publication of the Penrose Report [FN6] into the
failings at Equitable Life, Paul Myners, chairman of Marks and Spencer, was
asked to lead a Treasury-backed review into the corporate governance of mutual
assurers. Lord Penrose had in his report criticised the failure of Equitable
board members to ask about, or understand, the actuarial and financial risks
the troubled mutual was running. Lord Penrose said that none of the
non-executive directors "had relevant skills or experience of actuarial
principles or methodologies over most of the relevant period". All were
ill equipped to manage a life office and depended totally on actuarial advice
which they were incompetent to handle objectively. This clearly raises issues
of training and competence and access to professional
advice discussed above. Understanding financial risks is a complex matter that
requires training. Understanding actuarial risks is an even more complex matter
that requires training and access to independent professional actuarial advice.
Non-executives require training as to the range of the financial risks that
they are exposed to in each type of company and of the specific risks inherent
in some forms of company. This issue applies equally to the many financial
institutions because of the complexity of the range of financial instruments.
Catastrophic financial failures have arisen because of junk bonds, hedge funds
and financial derivatives, to name but a few. A professional institution could
provide training, or direct the provision of training, and ongoing support
services to the non-executive directors of financial institutions and companies
generally. These could train the non-executive director to recognise the range
of risks that the company is exposed to and most importantly alert the
non-executive director of the necessity to seek further specialist professional
advice where necessary. Even a training and technical support department of a
professional institution would be likely to have its limitations. Actuarial
risk assessments require independent actuarial advice and a professional
institution could advise the non-executive director where this could be best
obtained. A professional institution could also monitor whether other professionals,
such as actuaries, are providing truly independent professional advice to
non-executive directors.
The Penrose Report also highlights that a
non-executive director cannot rely on regulatory standards of solvency to fully
understand the financial position of the company. Lord Penrose concluded that
the regulatory returns and measures applied by the regulators did not keep pace
with the industry developments, and therefore regulatory solvency became an
increasingly irrelevant measure of the realistic position of the society.
Therefore the training of the non-executive directors within the financial
services industry on financial issues must include, but not be limited to, the
prudential rules of the Financial Services Authority. This is indeed an exacting
requirement. The training of the non-executive director must be comprehensive
on financial matters and will be exacting for many potential non-executive
directors to undertake.
On the issue of training and education much has already been
done to address this issue. Many business schools now offer relevant courses
and the Company Direction programme run by the Institute of Directors is open
to both aspiring non-executives and existing company directors looking to raise
their skill levels. Successful completion of the Chartered Director programme
of eight modules [FN7] represents the first step towards qualifying as a
chartered director under the Institute of Director's Chartered Director Scheme.
To achieve final qualification candidates are also expected to have a minimum
of three years' experience as a director and go through a professional review
to show that they can use their skills and knowledge effectively. There is much
to be said for taking this scheme as a basis and applying
it flexibly to "aspiring non-executives". At present few choose to be
a non-executive director as a career path but its development as a career path
for mature persons of standing should not be ruled out. This could be achieved
by the creation of a professional institution for non-executive directors
either under the Institute of Directors or as a result of direct liaison with
them. Certainly, their experience of creating an independent professional
qualification would be extremely valuable. Other valuable initiatives abound.
There is the FTSE 100 Chairmen's mentoring programme, the DTI/Cass Business
School conference on "Thinking laterally--the 21st Century
Board", and initiatives such as that of 3i, who have developed an
independent directors' programme and have stressed the importance of induction,
training and performance review (and have created a pool of pre-qualified
candidates who have been through a recruitment and referencing process and have
a track record on the boards of unquoted companies), could also be included. A
professional institution could provide an umbrella organisation to bring these
initiatives together and provide an appropriate standard of qualification or
validation of existing skills and experience to suit each level of appointment
as a non-executive director.
Historically the non-executive director was often
rather useless in the legal model of the company but increased liability within
the current legal context of the company requires the non-executive director to
meet higher standards. Given the importance of the role of the non-executive
director in the modern commercial context and its importance to the enforcement
of the inclusive model of the company, improved standards of regulation of
non-executive directors could be crucial to the success or otherwise of the
wider social context of the company that is now developing. Whether the
inclusive model, and hence the wider social purpose of the company, will
succeed will depend ultimately on its enforcement. If enforcement fails then the
argument put forward by Berle against the pluralist argument, and by this
author for the inclusive model of the company, will prevail. A purely legal
model of the company will result and the interests of shareholders will retain
primacy at all times and the market mechanism such as it is will regulate with
many of the failings resulting from the separation of ownership and control. If
enforcement succeeds, a wider model of the company that takes account of social
processes will prevail. For enforcement to be successful the non-executive
directors will have to be of the highest possible calibre and, to achieve this,
the regulation and development of the role of the non-executive director is
essential.
The creation of a professional institution would
create an institution that could cater specifically to the needs of the
non-executive directors as they seek to meet these
increased expectations and potential liabilities. It could regulate training,
provide standardised qualifications and validation, group insurance policies,
monitoring of the number of non-executive directors and their backgrounds,
encouragement and support to new and prospective members and so much more. A
professional institution could also affiliate with other similar institutions
in other countries. Higgs recommended that all companies operating in
international markets could benefit from having on their board at least one
international non-executive director with relevant skills and experience. If
this is the case then those international non-executive directors would benefit
from an institution that can respond to their needs. A professional institution
is a useful method of fulfilling this ancillary purpose. Enforcement through
the strict application of legal liability as witnessed in the Equitable Life
case will improve standards of skill and care in all probability, but at the
expense of the numbers willing to take on the role of the non-executive
director. The United Kingdom is a leader in the field of corporate governance
and the creation of a professional institution would provide an institution to
take the role of the non-executive director to the global marketplace in a
manner compatible with best practice in global corporate governance standards
and in accordance with a redefinition of the legal model of the company.
Since the above was written the government have
under s.257 of the Companies Act 1985 enacted the Companies Act 1985 (Operating
and Financial Review) (Repeal) Regulations 2005, SI 2005/3442. The regulations
commence on January 12, 2006 and remove the requirement for an OFR.
Margarita Sweeney-Baird The author would like to
thank Professor Harry Rajak for his invaluable support, kindness and time.
FN1. Review of the role and effectiveness of
non-executive directors, January 2003, Derek Higgs, www.dti.gov.uk/cld/non exec
review.
FN2. The Tyson Report on the Recruitment and
Development of Non-Executive Directors, A report commissioned by the Department
of Trade and Industry following the publication of the Higgs Review of the Role
and Effectiveness of non-Executive Directors in January 2003, London Business
School, June 2003 (copies available from the London Business School).
FN3. The draft regulations on the OFR and
Director's Report were published initially on May 5, 2004 in the form of
secondary legislation made under an amendment to s.257 of the Companies Act
1985 by s.13 of the Companies (Audit,
Investigations and Community Enterprise) Act 2004
with a further draft published on January 21, 2005. The final regulations are
The Companies Act 1985 (Operating and Financial Review and Director's Report
etc.) Regulations 2005, SI 2005/1011. They were made on March 21, 2005 and came
into force on March 22, 2005. Despite this the Government now intends to abolish
the Operating and Financial Review; see below.
FN4. Commission Recommendation of February 15,
2005 on the role of non-executive or supervisory directors of listed companies
and on the committees of the (supervisory) board (2005/162).
FN5. Company Law Reform White Paper, March 2005,
Company Law Review, www.dti.gov.uk/cld/review.htm. The final version of the
Company Law Reform Bill was introduced to the House of Lords on November 1,
2005 and is available on www.publications.parliament.uk/pa/ld200506/ldbills/034/2006034.htm.
FN6. A. A. Berle Jr, "Corporate Powers as
Powers in Trust" (1931) 44 Harvard Law Review 1049-1074.
FN7. E. Merrick Dodd Jr, "For whom are
corporate managers trustees?" (1932) 45 Harvard Law Review 1145-1163. In
an interesting analysis of the legal model of
the company Lee Roach contrasts Berle and Dodds
in the course of an analysis of the Harvard debate and the inclusive model and
the pluralist model of the company and similarly notes the interesting
parallels that can be drawn between the work of the Company Law Reform Steering
Group and the Harvard debate between Berle and Dodds. See Dr Lee Roach,
"The legal model of the company and the Company Law Review" (2005) 26
Company Lawyer 98-103 at p.101.
FN8. Dodd, fn.7 above, at pp.1146-1147.
FN9. Brian R. Cheffins, Company Law Theory,
Structure and Operation (Oxford, 1997), p.54.
FN10. Pollock, First Book of Jurisprudence
(1996), p.179.
FN11. Adam Smith was of the view that some loss
was inevitable because of the separation of ownership and control. In his
Wealth of Nations he said:
"The directors of such companies, however,
being managers rather of other people's money than their own, it cannot be
expected that they should watch over it with the same anxious vigilance with
which the parties in a private copartnery frequently watch over their own. Like
the stewards of a rich man they are apt to consider attention to small matters
are not for their master's
honour and very easily give themselves a
dispensation from having it. Negligence and profusion, therefore, must always
prevail, more or less, in the management of the affairs of such a
company."
FN12.
Dodd, fn.7 above, at p.1147.
FN13.
ibid., at p.1163 where he also said that "If we recognize that the
attitude of law and public opinion toward business is changing, we may then
properly modify our ideas as to the nature of such a business institution as
the corporation and hence as to the considerations which may properly influence
the conduct of those who direct its activities".
FN14.
This is based on cl.B3 of the Company Law Reform White Paper, fn.5 above.
Interestingly, the reference to the need to take account of short-term interests
has been omitted in the House of Lords Bill.
FN15.
Building on the work of the Law Commission's 1998 Paper 261, "Company
directors: (Regulating Conflicts of Interests and Formulating a Statement of
Duties)".
FN16.
ibid., at p.5.
FN17. As
Dodd noted, "If incorporated business is to become professionalized, it is
to the managers, not to the owners, that we must look for the accomplishment of
this result." Dodd, fn.7 above, at p.1153.
FN18. As
acknowledged by Lee Roach also. See Roach, fn.7 above, at p.101. For further
analysis in America on the nature of the legal model of the company, Clarke in
his text on Corporate Law (Little, Brown and Co, Boston, 1986), at pp.675-703,
contrasts what he describes as "Dualism: The Norm of Strict Profit Maximisation,
Monism: Long-run Identity Between Public and Private Interests, Modest
Idealism: Voluntary Compliance with the Law, High Idealism: Interest Group
Accommodation and the Public interest as Residual Goals and Pragmatism:
Contracting to Provide Public Services". Although very complicated, the
thrust of this analysis seems to seek to further social goals within the
context of the legal model of the company without actually seeking to alter the
model of the company.
FN19.
Cheffins, fn.9 above, Ch.13, "Non-Executive Directors and the Company
Board: the Case for Reform", pp.602-603.
FN20.
Paul L. Davies, Gower's Principles of Modern Company Law (6th edn, Sweet
and Maxwell, 1997), p.193.
FN21.
ibid., at p.69.
FN22.
Harry Rajak, A Sourcebook of Company Law (Jordans, 1989), p.458.
FN23.
Alex Rubner, The Ensnared Shareholder (Macmillan, London, 1965), p.56.
FN24.
ibid., at p.57.
FN25.
ibid., at p.57.
FN26. I.
Stratton, "Non-executive directors: are they superfluous?" (1996) 17
Company Lawyer 162.
FN27. Rubner,
fn.23 above, at p.56-57.
FN28.
National Association of Pension Funds, "Independent Directors--What
Investors Expect", May 9, 2002.
FN29.
The NAPF is considering on a case-by-case basis the issue of independence
and in particular whether a non-executive
director is independent after serving nine years in the role. The Combined Code
provides that they are no longer to be considered independent. Sundeep Tucker,
"Lobby group shifts stance on non-execs --corporate governance
guidelines", Financial Times, January 17, 2005,
http://global.factiva.com/en/arch/print results.asp.
FN30.
Review of the role and effectiveness of non-executive directors. Response by UK
Society of investment Professionals (to the Higgs Review) available on the DTI
website at p.3, J. E. Rogers, chief executive, September 5, 2002.
FN31.
CIMA, "The Role of the Non-Executive Director: Making Corporate Governance
Work", p.9. (available at www.cimaglobal.com).
FN32.
Robert Bittlestone, managing director of management consultancy Metapraxis,
proposes the following theory about Neds: Director effectiveness =
timeavailable x personal competence x information quality. He cites Marconi as
an example of a company that failed because of untimely information. CIMA,
ibid., at p.12.
FN33.
Higgs Report, fn.1 above. Although private companies will no longer need a
company secretary under s.247 of the Company Law Reform Bill, all public
companies will still be required to have one
under s.248 of the Bill. This indicates the continuing importance of the
company secretary's role in the context of the public company.
FN34.
Saleem Sheikh and Prof. William Rees (eds), Corporate Governance &
Corporate Control (Cavendish Publishing, London, 1995), p.381.
FN35.
Review of the role and effectiveness of non-executive directors, comments from
the Association of Chartered Certified Accountants, September 2002, p.2,
available on the DTI website.
FN36.
Saleem Sheikh, "Non-Executive Directors: Self Regulation or
Codification?" Submission to the Higgs committee, available on the DTI
website, at p.11 where it is stated that "There is another wider role
attributable to NEDS that ought to be taken seriously by them: they must also
exercise corporate social responsibilities which entails considering the
interest of other 'stakeholders' on the corporation".
FN37.
Rob Lake, "Governance for Corporate Responsibility: The Role of
Non-Executive Directors in Environmental, Social and Ethical Issues," A
discussion paper, May 2003.
FN38.
Sheikh and Rees, fn.34 above, Ch.18, "Corporate Governance and Corporate
Control--Self Regulation or Statutory Codification?", at p.381; because of
"cost and the likely negative impact on the calibre of personnel available
to fulfil a fully public role", see M. Sweeney-Baird, "Institutional
shareholders, non-executive directors and corporate governance" (1999)
6(2) European Financial Services Law 71-77 at p.76.
FN39.
The code was intended to apply for reporting years beginning on or after
November 1, 2003. The new code supersedes and replaces the Combined Code that
was issued by the Hampel Committee on corporate governance in June 1998. The
new code derives from the recommendations of the Higgs Review, "Review of
the role and effectiveness of non-executive directors", published January
2003, and the Smith Review of Audit Committees, "Audit Committees Combined
Code Guidance", published January 2003.
FN40.
Principle A.3, Combined Code on Corporate Governance, published July 2003.
FN41.
See the Smith guidance on audit committees, fn.39 above, at para.2.3, appended
to the Combined Code on Corporate Governance, ibid.
FN42.
Principle A.4, Combined Code on Corporate Governance, ibid.
FN43.
ibid., Sch.B, guidance on liability of non-executive directors: care, skill and
diligence.
FN44.
Code of Best Practice, s.1A.1 Supporting Principles, Combined Code on Corporate
Governance, ibid.
FN45.
Appended to the Combined Code on Corporate Governance, published July 2003 at
p.63 and available on the FSA website.
FN46.
2005/162 [2005] O.J. L52/51.
FN47.
Principle D.1, Combined Code on Corporate Governance, fn.40 above.
FN48.
DTI, Operating and Financial Review and Directors' Report Regulations,
government response to public consultation, December 2004, para.2.25 at p.14,
and see also para.2.45.
FN49.
Annex B to the Explanatory Memorandum, Final Regulatory Impact Assessment
on the Operating and Financial Review and
Director's Report Regulations, Purpose and Intended Effect. Objectives, para.
4, DTI, January 8, 2005.
FN50.
DTI, fn.48 above.
FN51.
E.1 Institutional Shareholders, dialogue with companies, Combined Code on
Corporate Governance, fn.40 above, and under E.3 institutional shareholders
have a responsibility to make considered use of their votes. In future if s.866
of the Company Law Reform Bill is enacted institutional investors may be
required to give information about the exercise of voting rights under
regulations issued by the Treasury or the Secretary of State.
FN52.
See for example cll D16, D17, D50 and Part E and F of the draft Company Law
Reform Bill, which was included in Pt 7 Draft Clauses in the Company Law Reform
White Paper, March 2005, Company Law Review, www.dti.gov.uk/cld/review.htm, and
see now ss.308, 315 and Sch.5 Pt 3 of the Company Law Reform Bill currently
before the House of Lords.
FN53.
"The government acknowledges that some critics believe stakeholder
engagement theory--encouraging shareholders to exercise effective and
responsible control to head off the worst excesses of agency problems--is
imperfect; providing little guidance to
management on how to choose between the multiple, and sometimes, competing
interests of stakeholders. But it considers this a first necessary plank in
encouraging the adoption of long term value maximisation as the single
objective function of the firm, where shareholders are involved to add positive
value to the company." Annex B to the Explanatory Memorandum, fn.49 above:
Risk Assessment, para.32.
FN54.
New s.234 of the Companies Act 1985.
FN55.
Modern Company Law for a Competitive Economy, July 2001, URN 01/942.
FN56. CM
5553--I & II, July 2002.
FN57.
The consultation period on the initial draft concluded on August 6, 2004 and on
November 25, 2004 Patricia Hewitt announced the Government's response in a
written statement laid in Parliament. Regulations are made under an amendment
to s.257 of the Companies Act 1985 by s.13 of the Companies (Audit,
Investigations and Community Enterprise) Act 2004.
FN58.
The final regulations are The Companies Act 1985 (Operating and Financial
Review and Director's Report etc.) Regulations 2005, SI 2005/1011. They were
made on March 21, 2005 and came into force on
March 22, 2005. The regulations were made under an amendment to s.257 of the
Companies Act 1985 by s.13 of the Companies (Audit, Investigations and
Community Enterprise) Act 2004.
FN59.
Directive 2003/51 of the European Parliament and the Council of June 18, 2003
amending Council Directives 78/660, 86/635 and 91/674 on the annual and
consolidated accounts of certain types of companies, banks and other financial
institutions and insurance undertakings; [2003] O.J. L178/16. The Fourth
Council Directive of July 25, 1978 (78/660) is based on Art.54(3)(g) of the
Treaty on the annual accounts of certain types of companies; [1978] O.J.
L222/11. Further practical guidance for directors from the Radcliffe Committee
was also to be expected. The concept of "materiality" at the core of
the Radcliffe Report has now been subsumed into the concept of 'to the extent
necessary' as a result of the wording of the EU Modernisation Directive rather
than the wording used by the CLRSG and/or in the government White Paper, but
the result of the analysis is largely the same.
FN60. By
virtue of the Reporting Standards (Specified Body) Order 2005 (SI 2005/692),
coming into force on April 6, 2005. This order specifies the Accounting
Standards Board established under the accounting Standards Board limited as a
body which may issue standards under regulations made under the
Companies Act 1985. Such regulations may provide
for issue by the ASB of standards in relation to matters to be contained in
reports which are required by the Companies Act 1985 Pt 7 to be prepared by the
directors of a company.
FN61.
reg.1(3) of the Companies Act 1985 (Operating and Financial Review and
Directors' Report etc.) Regulations 2005.
FN62.
Supervision of Accounts and Reports (Prescribed Body) Order 2005 (SI 2005/715)
in force April 6, 2005. This order appoints the FRRP established under the
Financial Reporting Review Panel Ltd to exercise the functions mentioned in the
Companies (Audit, Investigations and Community Enterprise) Act 2004, s.14(2).
These functions are the keeping under review of certain periodic accounts and
reports produced by issuers of listed securities and informing the FSA of any
conclusions that the FRRP reaches. The FRRP may, under s.245F of the Companies
Act 1985 require the production of documents, information or explanations. This
applies to certain classes of issuer. By virtue of the Companies (Defective
Accounts) (Authorised Person) Order 2005 (SI 2005/699); in force April 6, 2005,
the FRRP is authorised to make an application to court under s.245B of the
Companies Act 1985 for a declaration or a declarator that the annual accounts
of a company do not comply with the requirements of that Act and an order requiring
the directors of the company to prepare revised
accounts. Under both orders the FRRP is required
to keep appropriate records.
FN63.
Directive 2003/51, fn.59 above.
FN64.
Better Regulation, Draft Simplification Plan, November 2005, see especially at
p.7, published on November 29, 2005, available on DTI website
FN65.
Available on www.dti.gov.uk/cld/hottopics.htm.
FN66.
Mark Milner and Jill Treanor, "Big investors may insist on good governance
reviews", Guardian Unlimited, November 29, 2005, http://business.
guardian.co.uk/story/0,16781,1653062,00.html.
FN67.
Sch.7ZA, para.1 of the Companies Act 1985 inserted by reg.9 of The Companies
Act 1985 (Operating and Financial Review and Directors' Report etc.)
Regulations 2005, SI 2005/1011.
FN68. Para.A.12,
Operating and Financial Review, Practical Guidance for Directors, Chairman,
Rosemary Radcliffe.
FN69.
ibid., para A.12.12. This is also supported by the Government. See DTI,
fn.48 above, at para.2.4.
FN70.
The Operating and Financial Review, fn.68 above. Once the OFR Regulations are
finalised the guidance is to be updated by the same body. Rosemary Radcliffe's
independent working group was set up by the Government in 2002 to develop broad
principles and practical guidance. That guidance helps directors decide what
principles and processes to follow in deciding what information to include in
their OFR, based on what is important for the success of their business. Thus
the OFR defines what social purposes the company should be interested in.
FN71.
Better Regulation, fn.64 above; see especially at p.7.
FN72.
Denise Kingsmill, Accounting for People: A Consultation Paper issued by the
Task Force on Human Capital Management, May 2003.
FN73.
www.accountingforpeople.gov.uk.
FN74.
Report on diversity of FTSE 100 Directors, July 2004, Commissioned by the DTI,
Dr Val Singh. See especially para.1.1 where reasons are given for why the issue
of diversity is so important: including the need to increase the talent
pool and cloning of directors fromsimilar backgrounds
can lead to "group-think", thereby inhibiting creativity and
innovation, while not representing the workforce and the customer base in terms
of diversity and being part of a decent society.
FN75.
DTI, "Building better boards", December 2004, p.7.
FN76.
"The Higgs Review found that the majority of NEDs in UK companies are
white, middle-aged males of British origin with previous plc director
experience. In the survey of companies completed for the Higgs Review,
non-British nationals accounted for only 7% of NED positions, while British
citizens from ethnic minority backgrounds accounted for only 1% of such
positions. The survey also found that although 30% of managers in the UK
corporate sector are female, women hold only 6% of NED positions." Taken
from the Tyson Report, fn.2 above, at p.5 Further at p.16 of the Tyson Report
it is stated that "Board size constraints may explain why women account
for a larger fraction of NED positions in larger companies than in smaller
ones. Women hold 11% of NED positions of FTSE 100 companies compared to about
8% for FTSE 250 firms, and less than 4% (3.9%) in other listed companies".
It is on the basis of this statistical evidence that Dean Tyson made her
recommendations.
FN77.
DTI press release, May 5, 2004: "Hewitt announces new plans to strengthen
corporate Britain".
FN78.
Explanatory Memorandum, fn.49 above, at para 7.3.
FN79. A.
A. Berle and G. C. Means, The Modern Corporation and Private Property (rev.
edn, Harcourt, Brace & World, Inc, New York, 1967).
FN80.
s.234AB Companies Act 1985. The OFR must also be signed on behalf of the board
by a director or the secretary of the company.
FN81.
The new s.256A of the Companies Act 1985 provides that directors who comply
with a reporting standard for the OFR (issued by the ASB) are presumed (unless
the contrary is shown) to have complied with the provisions of the 1985 Act
relating to the contents of an OFR.
FN82.
[1925] 1 Ch. 407.
FN83. Re
Brazilian Rubber Plantations and Estates Ltd [1911] 1 Ch. 425 at 437 where
Neville J. observed that "[a director] may undertake the management of a
rubber company in complete ignorance of everything connected with rubber,
without incurring responsibility for the mistakes
which may result from such ignorance".
FN84.
See Baker v Secretary of State for Trade and Industry [2001] B.C.C. 273.
FN85.
[1989] B.C.L.C. 498.
FN86.
Norman v Theodore Goddard [1991] B.C.L.C. 1028 and Re D'Jan of London Ltd [1994]
1 B.C.L.C. 561.
FN87. Re
Barings Plc (No.5), Secretary of State for Trade and Industry v Baker (No 5)
[1999] 1 B.C.L.C. 433.
FN88.
John Barlow, "Directors and officers' liabilities--through the looking
glass" (2004) Liability Risk and Insurance [April 2004, LRI 164 (17)]
FN89.
Equitable Life Assurance Society v Bowley [2003] EWHC 2263 (Comm), QBD, [2004]
1 B.C.L.C. 180.
FN90.
The third Ernst and Young corporate governance survey of board members of the
United Kingdom's leading 500 companies found that 40% said that they would
be less likely to accept a non-executive
directorship than in the previous 12 months. See (2004) 25 Company Lawyer 115.
FN91.
Companies (Audit, Investigations and Community Enterprise) Act 2004
(Commencement) and Companies Act 1989 (Commencement No.18) Order (SI 2004/3322)
(c.154); see Sch.2, www.legislation.hmso.gov.uk/si/si2004/20043322.htm,
published December 21, 2004.
FN92.
"The company should arrange appropriate insurance cover in respect of
legal action against its directors."
FN93.
ICSA Guidance Note 030925: Directors and Officers Insurance,
www.practicallaw.com/AW4064, provides a checklist on matters that directors
should consider in connection with directors' and officers' insurance. The aim
of the guidance is to help directors understand director and officer insurance,
evaluate their needs and evaluate their existing cover as provided by the
company.
FN94.
"A policy which is taken out by the company (and most usually the policy
schedule will be in the name of that company) and which provides cover for
indemnifiable risks under one section and
non-indemnifiable risks under another--commonly referred to as sections A and
B;
A policy which is taken out by the company (again
most usually the policy will be in the name of that company) and which provides
cover for non-indemnifiable risks. This type of policy is particularly popular
for companies that wish to provide significant limits of indemnity for
directors and officers when the company does not, cannot or will not indemnify.
Particular care attention must be paid to the wording of the operative clause
in such policies (ie regarding when indemnity can be provided);
A policy covering an individual named person, eg.
Mr David Smith, who may have one/or a number of directorships, executive or
non-executive positions which he wishes to insure under his 'own personal
policy'." ICSA Guidance Note, ibid., at p.2.
FN95.
The European Commission has adopted a non-binding Recommendation on directors'
remuneration suggesting that Member States should ensure that listed companies
disclose their policy on directors' remuneration and inform shareholders how
much individual directors are earning and in what form. See
www.europa.eu.int/comm/internal market/company/docs/directors-remun/2004-
recommendation en.pdf, published on October 6, 2004. The Directors'
Remuneration Report Regulations SI 2002/1986 provides for details of the
directors' remuneration to be disclosed in the
remuneration report.
FN96.
DTI White Paper, "Modernising Company Law" ("White Paper")
published July 2002, Company Law Review Final Report. See further, DTI
consultation on director and auditor liability, December 2003.
FN97.
See, for example, Norman v Theodore Goddard, fn.86 above; Re D'Jan of London
Ltd, fn.86 above; and Bishopsgate Investment Management Ltd (in liq) v Maxwell
(No.2) [1994] 1 All E.R. 261.
FN98.
"A recent survey by the Economist Intelligence Unit and KPMG has revealed
that financial information and the understanding (or lack of it) of financial
issues are major barriers preventing the implementation of successful corporate
governance policies. Nearly a quarter of the international companies in the
survey cited a 'lack of financial understanding on the part of senior
executives and the board' as a significant stumbling block." CIMA,
"The Role of the Non-Executive Director", fn.31 above, at p.12.
FN99.
DanMace, "Helping Directors Direct" (2000) 15(7) Journal of
International Banking and Financial Law 247, where it is noted that "there
are no entry requirements for directors. There is no training requirement.
There are no
requirements for continuing education. Even in
listed companies, directors need no qualifications or proven understanding of
their duties".
FN1.
Lord Wedderburn of Charlton Q.C., FBA, "Non-Executive Directors, Leaders
and Monitors, Christmas Tree Decorations or Custodians? Widening the Gene
Pool", A submission to the Higgs Review of the Role and Effectiveness of
Non-executive Directors: September 2002.
FN2.
Lord Wedderburn, ibid., at p.16.
FN3.
Principle A.6., Combined Code on Corporate Governance, fn.40 above.
FN4.
Paul Grant, "FRRP teams up with FSA to review accounts", Accountancy
Age, April 6, 2005.
The links exist in relation to listed company accounts;
www.financialdirector.co.uk/news/1139889.
FN5.
Andrea Felsted and Sundeep Tucker, "Larger mutuals are 'failing to give
non-executives access to advice"', Financial Times, December 15, 2004, Document
FTFT000020041215e0cf0003a, http://global.factiva.com/en/arch/print results.asp.
FN6.
Report of the Equitable Life Inquiry, Rt Hon. Lord Penrose, March 8, 2004,
H.C. 290; A. Samuel, "The Penrose
Report--how to wreck a life assurer?" (2004) Compliance Monitor 16.7 (1).
FN7.
Directors' duties, liabilities and legal responsibilities, finance, setting
strategic direction, human resource strategy, marketing strategy, leading and
directing change, decision-making and performance management
