Does Corporate Governance Really Work?
Some Personal Thoughts and Comments: Have a look as it might be more interesting than you think.
[This set of notes are my personal views and were prepared originally in June 2010. Sad to say many of the key issues remain unsolved. This, despite huge efforts during the intervening period to sort some of them at least. The question will no doubt be asked why this is the case? Is it because of a lack of political will, economic circumstances, the power of the banks and other financial institutions, the sheer complexity of the issues to be resolved or a combination of these factors. I am the “common sense lawyer with mismatched shoes” and I don’t go for conspiracy theories in this area of the law whatever my readers might say.
A re-read has suggested a postscript—so I have added a short one.
Many of the topics discussed in this paper are currently being considered in various countries. Some of the factual issues it mentions are changing almost on a daily basis. This paper contains some general comments as at mid June 2010. Key points and thoughts are in bold type.
The two words I want you to focus on during this discussion and particularly during some of the case studies mentioned below, are all too rarely used, which I think is a very big mistake. They are the words “common sense”. I have a feeling they are about to become a much more important part of this debate, as I hope you will see.
What is Corporate Governance?
Corporate Governance includes a wide range of issues. In its narrow sense it is concerned with the way in which companies are directed and controlled, including the systems and processes for ensuring proper accountability and openness. However, it is also concerned with the wider issue of protecting and advancing shareholders’ interests through setting the strategic direction of a company and appointing competent management to do so. In this paper I am going to concentrate mainly on corporate governance and the financial services industry. Many of my comments apply to a much wider range of quoted companies than those connected with financial services.
In the UK, the regulation of corporate governance is provided by a number of different rules, regulations and recommendations. Broadly, they are:
- Common law rules (for example, case law relating to directors’ fiduciary duties).
- Statute (particularly the Companies Act 2006).
- The company’s constitution.
- The Stock Exchange Listing Rules, Disclosure Rules and Transparency Rules.
- The Combined Code on Corporate Governance (of which more below), administered by the
Financial Reporting Council (FRC), which applies to companies admitted to listing by the UKLA, including those whose shares are traded on the London Stock Exchange. Companies should include a statement in their annual financial reports indicating how they apply the compulsory principles of the Code. Its provisions are not mandatory but companies are required to include a second statement disclosing whether or not they comply with the Combined Code and give reasons for noncompliance so called “comply or explain”. The Combined Code has just been updated as will be explained later.
Why is Corporate Governance Such a Hot Topic at the Moment?
I suppose this is fairly obvious to anyone who reads the newspapers or indeed has any savings or investments. The financial crisis has shown us there have been, and probably still are, major problems in the corporate governance and risk management of companies operating particularly in the financial services sector. It has highlighted ways in which existing corporate governance arrangements have in many cases – but not all – failed to provide an effective check against poor decision-making. Although these weaknesses have been most evident in commercial banks and investment banks, many other financial services companies have been affected. This, in turn, has damaged the confidence of the general public in the financial sector as a whole.
In the UK, it has also, whether directly or indirectly, led to higher taxes, increased unemployment, the collapse and government bail-out of two of its largest banks and has contributed to a recession. Therefore, we can say that corporate governance, whether good or bad, has had a major effect on many areas of society which will continue for many years. On that basis, it needs to be much better understood. More recently it has been highlighted in the actions and decisions taken by the boards of The Prudential (“Pru”) and BP.
Corporate Governance is not some strange, academic matter – and if it is still treated in this way, that causes me real concern.
A comment in the Times newspaper last year stated:
“The commercial banks enjoyed big rewards while the markets were going up and have imposed huge public costs when their financial bets turned sour. …the causes of the chaos are much debated. But the agents are known. They are banks. Believing that they were engaged in sophisticated financial engineering, they took on risks about which they were perfectly clueless. They all but took the entire western financial system down with them…and the greatest irony of the fiasco is that the banking system was undermined not, as expected, by unregulated hedge funds, but by the most regulated parts of the financial system: the commercial banks.”
Responsibility for Governance and Risk Management
Responsibility for governance and risk management in the first instance is with the board and senior management. They must take into account their duties both to their shareholders and in respect of the regulatory requirements to which they are subject. In discharging these obligations, boards are expected to provide strong independent oversight of executive management. It is clear that many non-executive directors (NED) appointed to the boards of financial services companies struggled to provide such oversight. In particular, they failed to identify and put limits on excessive risk taking. The fact that the regulators (for example in the UK, the Financial Services Authority) approved a particular financial risk model which was prepared by a financial institution such as a bank, should not discharge the board of directors from their duties.
The financial crisis has also highlighted weaknesses in relation to the control of remuneration within financial services companies and also the exercise of ownership rights by shareholders in these companies. Think about this next point. Apparently in the US now a very significant number of shares which are traded by complex computer driven programmes are held by the “owner” for less than one minute.
As Sir David Walker, whose report I will deal with later on suggested, if the British taxpayer has pumped something over £500 billion into the UK financial system, by way of loans, guarantees, insurance and direct equity, then politicians and taxpayers are not going to accept processes which lead, among other things, to the current remuneration structure. I think this may be a polite way of saying that a lot of things have to change…but will they? My view is “probably and eventually but not as much as many would like”.
As I have noted, one role of corporate governance is to protect and advance the interests of shareholders through setting the strategic direction of a company and appointing and monitoring capable management to achieve this. As we have also seen, this statutory corporate governance responsibility, under the Companies Act 2006, is complemented by the “comply or explain” principles of the Combined Code, which is overseen and maintained by the Financial Reporting Council and by financial regulation under the Financial Services and Markets Act 2000.
Just so you are clear about the Combined Code, which has been updated very recently, this sets out standards of good practice on matters such as the composition of the board, directors’ remuneration, accountability and audit and relations with shareholders. The Code contains broad principles and more specific provisions. Listed companies are required to report on how they have applied the main principles of the Code and either to confirm they have complied with the Combined Code’s provisions or – where they have not – to explain both how and why these principles are not in the best interests of the company. This is a key idea behind the Code.
The result is that arrangements for corporate governance in the UK reflect a mixture of primary legislation, prescriptive rules, “comply or explain” codes of best practice, custom and market rules. One question which is now being considered is whether this mixture of arrangements for corporate governance in the UK should, at least in respect of Banks and other Financial Institutions (BoFIs) be replaced by a more clearly statute-based structure. It would be designed to deliver a result closer to the ideal form of corporate governance. This would certainly be a massive departure from the way in which governance has worked in the past. I suggest it would also be remarkable if it actually happens.
Before we go any further, it is perhaps important to ask whether any stronger form of formal statutory provision in relation to governance could have prevented the major collapses in the UK banking and financial sector. For some of the reasons discussed below, I doubt it.
The Turner Review and A Regulatory Response to the Global Banking Crisis
The first review was set up by Alistair Darling, then UK Chancellor of the Exchequer. He asked Lord Turner in his role of Chairman of the Financial Services Authority to review and make recommendations for reforming UK and international approaches to the way banks are regulated. In March 2009, the FSA published its recommendations in the document known as the Turner Review, together with a detailed discussion paper entitled “A Regulatory Response to the Global Banking Crisis”. Among other things, these two documents outlined the FSA’s policy approach to financial services firms’ corporate governance policies and arrangements, emphasising that high standards of risk management and governance in all banks are essential. We should perhaps ask why this needed to be emphasised – is it not obvious? This is a point to which I will return later. We might also wonder what the FSA has (or perhaps has not) been doing about these matters over the previous few years. Turner identified a number of key areas where changes are likely to be required. Turner also asked whether appropriate governance arrangements for banks are different from those which apply to other companies because banks are so fundamental to the whole economic system. Therefore, should codes and rules which might be applicable to banks go further than the general Combined Code?
Some key areas of change identified in the Turner Review (many of which are also to be found in the Walker Review) are as follows:
1. Risk management considerations must be included in remuneration policies to avoid there being incentives for undue risk taking. This has implications for the role of the remuneration committees and for the time commitment required of non-executive directors.
- Shareholder influence seems to have been relatively ineffective in holding back the
risky corporate strategies pursued by some financial services firms.
3. There may be ways of improving the effectiveness with which shareholder views are communicated to the Board. This has been another high-profile debate over the last year or so. We can consider this and indeed the previous comment in the light of the failed bid by the Pru for AIA.
4. Turner recommended that all financial services firms should have an effective risk
management function. In his view, this would include:
(a) Clear, independent and unconflicted reporting lines across the firm including to a firm’s Risk Committee;
(b) Proper resourcing of risk committees which should have clear mandates and memberships. They should not be mixed with other responsibilities, for example, audit or compliance. There should be technically competent risk managers with strong communication skills. Risk managers should have a sufficient position in the organisation to provide a genuine challenge to business managers. The FSA will in future play a more active role in assessing the technical competence of senior risk managers.
5. Improvement in the skill level and time commitment of NEDs. This is a really interesting point. The crisis revealed that NEDs have, in many cases, been unable to provide adequate levels of oversight. Most importantly, they failed to provide non-executive challenges to dominant powerful chief executives pursuing aggressive growth strategies. I think we need look no further than the relationship between non-executive directors at the Royal Bank of Scotland and its previous Chief Executive, Sir Fred Goodwin, to have a clear example of this point. Again the board dynamics in respect of the Chairman and CEO of the Pru are also worth mentioning.
There has already been much discussion on NEDs, which is linked to directors’ duties under the Companies Act 2006. Let me mention just two points. Lord Turner’s view was that NEDs must have appropriate technical expertise to understand the nature of the risks being taken and they must devote sufficient time to enable them to properly oversee complex business. This, of course, has all sorts of further implications for that very small group of people who tend to be non-executive directors of major financial institutions, while perhaps having other jobs as non-executive chairmen or non-executive directors of other major corporate groups in the UK.
The Turner Report produced several pages of complex and not so complex recommendations both for the UK and more widely and was followed by………………………………. .
The Walker Review
This was set up to provide an independent review of corporate governance in banks and other financial institutions. As the Chancellor said in 2009: “It is clear that corporate governance should have been far more effective in holding bank executives to account”. Peter Mandelson, the then Secretary of State for Business, stated that the review was needed to ensure that “we have competent well run and transparent boards, which are engaged with their shareholders and capable of understanding and managing risk effectively”.
Sir David Walker chaired this review and the final report was published on 26 November. Many thought, bearing in mind his position as former Chairman of Morgan Stanley International and a Director of Lloyds-TSB Bank, he might have been soft on the banks. I think we can say that we were proved wrong to some considerable degree. If you do not read anything else, I would suggest, if you have any interest in this topic, you read his summary and recommendations. I would like to look at some of his key recommendations (there are 39 altogether) proposed as best practice. I am particularly interested in the nature of directorships as well; the way companies are run and managed, so I would like to focus on those. Walker stated:
“It is clear that governance failures contributed materially to excessive risk taking in the lead up to the financial crisis. Weaknesses in risk management, board quality and practice, control for remuneration, and in the exercise of ownership rights need to be addressed in the UK and internationally to minimise the risk of a recurrence. Better governance will not guarantee that there will be no repetition of the recent highly negative experience for the economy and for society as a whole but will make a rerun of these events materially less likely”.
He asked several key questions about the role and constitution of the Board. He suggested that there needs to be an environment in which effective challenge of the board executive is expected and achieved in the boardroom before decisions are taken on major risk and strategic issues. Therefore, he recommended that close attention to board composition is needed in order to ensure the right mix of both financial industry capability and critical perspective drawn from high level experience in other major businesses. Non-executive directors should increase the time committed to their roles perhaps to about 35 days each year, and have more training and support. They should have a combination of experience in the financial industry and, as he put it, “an independence of mind”. The FSA’s ongoing supervisory process should give closer attention to the overall balance of the board in relation to the risk strategy of the business.
Key questions to be addressed are the relative weight to be attached respectively to the experience and qualities of individual members of the board, to its composition and to the process and style of the overall functioning of the board. Specifically his Review considered:
i. whether to extend the current statutory statement of the responsibility of the board at least in the case of BoFIs to include an explicit responsibility to depositors and policyholders or to a still wider external group, such as the society as a whole;
- whether, in the light of recent experience with unitary boards, some form of two-tier board structure (which would not be excluded under current UK statutory provisions) might have merit as an alternative option;
- whether the respective responsibilities of executive and non-executive directors should be separated in statute;
- whether, similarly in the light of recent experience of BoFIs, the long- established conventional wisdom and practice that NEDs make an essential contribution to governance continues to be as realistic as previously envisaged;
- whether a forced breakup of major global banks would significantly diminish the relevance and difficulty of the corporate governance challenge; and
- whether reliance on the Combined Code and the “comply or explain” basis for ensuring conformity with best practice standards is still adequate in the case of BoFIs.
So far as the function of the board and review of performance are concerned, he suggested that NEDs should be ready, able and encouraged to challenge and test proposals one strategy put forward by the executives. One obvious failure here involved the NEDs of RBS in respect of its disastrous takeover of ABN-Amro. Another was the takeover of Halifax/Bank of Scotland by Lloyds-TSB.
The chairman of the board should be expected to give a substantial proportion of his time to the business of that company with a clear understanding that if necessary the chairmanship takes priority over any other business commitments. I have always wondered how at this level someone can chair a major bank and still have time for three or four other directorships. The answer seems to be, they cannot. The chairman should have a track record of successful leadership capability in a significant board position and have relevant financial industry experience. It seems to me that if a review of the structure of boards of financial companies has to make this sort of statement, then something has gone wrong in the past. Again, think about these comments in the light of the way in which the chairman of BP, a non-financial company, has (or rather has not) been fulfilling his role.
One of the other key points was the role of the institutional shareholders. He said:
“There is need for fund managers and other major shareholders to engage more productively with their investee companies with the aim of supporting long-term improvement in performance. Boards, in turn, should be more receptive to such initiative. The Institutional Shareholders’ Committee (ISC), the FRC and the FSA should play a larger role in promoting such enhanced engagement by owners on the basis of principles of stewardship with which fund managers should be expected to conform on a “comply or explain” basis. The recommended disclosure should ensure that clients know whether a fund manager in pitching for their business operates a model that includes engagement with a view to long-term performance improvement.”
Walker believes there should be more attention at board level in the high-level risk process particularly to the monitoring of risk and discussion leading to decisions on the company’s risk appetite and tolerance for risk. This will need a dedicated NED focus on risk issues, in addition to and separate from the executive risk committee process. He is keen to ensure that there should be an independent chief risk officer who would participate in risk management and oversight at the highest level, have total independence from individual business units, report to the Board Risk Committee and have direct access to the chairman of that committee if necessary. This is a critical point.
If you have an extremely powerful CEO of a bank or financial institution, I wonder if it is possible for the relevant NEDs or chief risk officer actually to stand up to that individual. We have heard stories about UK chief executives and US combined chairman and chief executives of some of the major banks, forcing their views on the rest of their board, who put up little in the way of resistance. Clearly, this cannot be correct, but how and whether this point can ever be resolved is crucial to the success of corporate governance. It is the subject of much current discussion – indeed it seems to be a key point.
Walker recommended the role of the Board Remuneration Committee should be extended, where necessary, to cover all aspects of remuneration policy on a firm wide basis with particular emphasis on the areas of risk; not less than half of expected variable remuneration should be on a long-term incentive basis, with vesting subject to performance conditions, deferred for up to five years and there should be increased public disclosure about the remuneration of highly-paid executives.
Four matters were given priority throughout his report. First, the aim has been to develop proposals for best practice which, when adopted, would be likely to add value over time to the benefit of shareholders, other stakeholders and for society more widely. The principal emphasis is in many areas on behaviour and culture, and the aim has been to avoid proposals that are really just “box-ticking” as a distraction from and alternative to much more important (though often much more difficult) substantive behavioural change. Could my idea of common sense be relevant here?
Second, he looked at the weight that has increasingly been given by many shareholders and boards to short-term horizons and objectives – a view that does not appear to have been lessened by lower inflation and lower interest rates. He looked wherever possible at ways of lengthening time horizons, for example in communication and engagement between major shareholders and boards and in setting long-term incentives in remuneration schemes for executives. Remember my point earlier about some groups only being shareholder for a couple of minutes. Will those organisations have the same view of a company as a pension fund? How will sovereign wealth funds or hedge funds consider these issues?
Third, there is emphasis throughout the review on the importance of safeguarding the flexibility provided in the Combined Code through the “comply or explain” approach. Few matters, if any, in corporate governance (for example, precise board composition and criteria for independence in a NED) required hard and fast rules. Circumstances and situations vary, and a theme throughout his Review is that boards should be readier than previously to adopt a non-compliant position where they believe this to be substantially justified and give an adequate explanation for it.
The fourth criterion and a challenge throughout his review was to identify improvements in governance that are both proportionate but also capable of being implemented without putting UK BoFIs at a competitive disadvantage as against their non UK-domiciled competitors. The recommendations throughout the Review are made with this point in mind. He hopes the recommendations made, with appropriate and necessary adaptation to regulatory and other structures elsewhere, will come to be seen as relevant for developing governance practices elsewhere.
So Walker’s Report to my mind is a very useful document. If you read some or all of it, you will see he has said what needed saying —a refreshing change.
A few comments now on the Combined Code:
(a) The Code and its predecessors have contributed to clear improvements in governance standards since it was first introduced in 1992. The flexibility allowed by the Code remains preferable to a more prescriptive framework.
(b) There is a recognition that the quality of corporate governance depends ultimately on behaviour not process, with the result that there is a limit to the extent to which any regulatory framework can deliver good governance. I believe we can rephrase this by saying boardroom behaviour is probably more important than board structure. This to my mind is absolutely key. Pages and pages of rules and regulations continue to be produced. However, as I have previously written, if people are not going to work on the basis that they want good governance then those rules and regulations can never work effectively.
(c) Market participants have apparently expressed a strong preference for keeping the current approach of “soft law” underpinned by some regulation rather than moving to a system that is more reliant on legislation and regulation. I suggest this will only work if the regulation itself has some “teeth”, so it can be enforced.
The FRC shares the above view concerning “soft law” but this depends on there being agreement that the contents of the Code will lead to best practice and on companies and investors acting in the spirit and not just the letter of the Code. This has always been suggested as one of the benefits of UK regulations in the past. A good example is, perhaps, the City Code on Take-Overs and Mergers.
The final comment which the FRC has made, which I think is extremely important and should not be forgotten, is that it is of critical importance that there are sufficient institutional investors willing and able to engage actively with the companies in which they invest. We should note that those who invest in listed companies have rights as shareholders but they also have, or I should say ought perhaps to have, responsibilities, particularly the investing institutions. We therefore await with interest the new Stewardship Code being prepared by the FRC.
One debate during the last year or so has been on why institutional shareholders have not been so heavily involved in the companies in which they invest as they should (or might), and to what extent this has accelerated the crisis over the last couple of years. I think many of those institutions agree with this concern. However as one manager of a major fund has said: “If I am told by the executives, the NEDs, the investment bankers and others that the acquisition of XXX is a good one, it is hard for me to disagree, particularly with the limited information I have”.
The revised Code (renamed the UK Corporate Governance Code) becomes effective at the end of June.
In the final version of the Code, the FRC has maintained the approach set out in its consultation and focused, I think on the whole, on changing the Code’s “tone” by making what some consider limited, but significant, changes including:
- A new introduction which focuses on what a board does, how it sets the values of the company and that it needs to take responsibility for ensuring good governance and determining how it should operate in accordance with the Code.
- A new section at the start of the Code setting out the revised main principles, which are designed to guide board behaviours.
- To “increase accountability”, requiring all directors of FTSE 350 companies to be proposed for annual re-election.
- To “promote proper debate”, new principles on the leadership of the chairman, the responsibility of non-executive directors to provide constructive challenge and time commitment expected of all directors.
- To “enhance the board’s performance”, requiring the chairman to regularly review directors’ development needs and that board evaluation of FTSE 350 companies should be externally facilitated every three years.
- To encourage boards to be “well balanced”, a new principle on board appointments to
be made with due regard for the benefits of diversity on the board, including gender.
- To improve “risk management”, providing that the board should be responsible for determining the nature and extent of the significant risks it is willing to take and that the company’s business model should be explained in the annual report.
- Performance-related pay should be designed to promote the long-term success of the company.
The annual re-election of board of FTSE 350 members is the most controversial aspect of the revised Code. Many critics have said it will encourage short termism and be disruptive. Those in favour have said it will make boards more accountable to shareholders. Companies have also criticised the Code’s new specification that the search for candidates should be made “with due regard for the benefits of diversity on the board, including gender”. This apparently is aimed at encouraging boards to be “well balanced” and avoid “group think”. Apparently, according to recent research, only about 12% of directors of FTSE 100 Companies are women.
As part of the changes aimed at boosting board performance, the Code recommends a board chairman should hold regular development reviews with each director. FTSE 350 companies should each have “externally facilitated board effectiveness reviews”, whatever that means, at least every three years. By who exactly; surely not the same firms who have advised the boards until now?
Risk management remains the board’s responsibility. “The board is responsible for determining the nature and extent of the significant risks it is willing to take in achieving its strategic objectives” it recommends. It adds that once a year boards should conduct a review of the effectiveness of their company’s risk management and internal control systems and report to shareholders that these checks have been carried out. The Code also recommends companies spell out more clearly the links between performance and pay.
There are a couple of interesting changes but will they really progress this debate – I don’t think so. Much playing around with words, but I believe no real change in a lot of the substance nor dealing with many of the points I noted earlier.
We now await the second part of this initiative which is the FRC’s new Stewardship Code, out later on this Summer which will, for the first time and formally outline the role and responsibilities of investors as owners of companies.
The FRC’s policy objectives for the stewardship code are that it should:
- Set standards of stewardship to which mainstream institutional investors should aspire.
- Promote a sense of ownership among institutional investors in order to encourage UK and foreign shareholders to apply and report against it.
- Ensure that engagement is closely linked to the investment process within the investment firm.
- Contribute towards improved communication between shareholders and the boards of the companies in which they invest.
- Secure sufficient disclosure to enable institutional shareholders’ prospective clients to assess how those managers are acting in relation to the stewardship code so that this can be taken into account when awarding and monitoring fund management mandates.
On the issue of shareholder engagement, the FSA states it will consult on a disclosure rule that will require investment firms to disclose publicly the extent to which they comply with the stewardship code and explain, where relevant, their reasons for non-compliance. It also states that planned EU legislation may affect their work in this area. But at the moment we have gentle pressure, rather than anything stronger.
In 2009 we had the Turner Report and the Walker Report. We also had a major Treasury paper on the origins of the financial crisis, which picked up a number of the matters I have discussed. We have had the FSA making changes to improve corporate governance and risk oversight and accountability in financial services firms; we have had the EU preparing a report on corporate governance practices to be ready by the end of the year; we have had the Committee of European Banking Supervisors preparing their own report; and of course, we have had the G7 and the G20 putting forward their own proposals.
A couple of comments. The collapse of Lehman Brothers took place almost two years ago. I am not sure from a pure corporate governance point of view very much has really changed, although we can, of course, say that there are a lot of reports in progress and a lot of paper has been produced and many conferences and discussions are being held. We can, however, I think, take the view that eventually matters will change to some small degree at the very least – they have to.
The Jenner & Block report on Lehman’s collapse came out a few months ago – all 2,200 pages. It is an “interesting” commentary of Lehman’s last few years of complex financial engineering. If you have time, I suggest you read the summary in the first part of that report.
So where are we after all this? As you now know, we have a lot of law. This includes the new rules regarding directors as set out in Sections 170-177 of the Companies Act 2006 – one of my favourite areas, but not one that we have time to look at today! Indeed, some see these sections as an entirely new area of UK company law. We have the rules set out in detail by the FRC, the key one being the Combined Code. We have the FSA rule book which, if any of you have ever had to look at it, is massive and – I know many would say – incomprehensible document. We also have other codes of practice and reports to which I have referred.
In simple terms, one of the most important points seems to me (and I have written about this in the past and it has become one of my concerns about UK Company Law / Business Law), is that we now perhaps have too much law; too much complex law; laws which are unenforceable; and laws which are unenforced. If we cannot solve these issues, I am not convinced that matters will improve. I was pleased to see the Institute of Directors agreed with this view when it published its updated directors’ handbook earlier this month.
Consider the following example in report of some of my concerns, although I should note that recently (and certainly since I originally gave this paper in October 2009), the FSA has become significantly more aggressive in its role as enforcer. I am using this particular example because, as I have suggested, despite the mass of regulations which we have in the UK, we are going to need either a more ethical and moral system (not likely I think, although certainly these are the new “buzz” words) or a lot more enforcement by a much better group of enforcers if the brave new world of Turner and Walker, among others, is ever going to become a reality.
In Autumn 2009, two traders from Dresdner Kleinwort were found to have committed market abuse by selling $65 million of Barclays Bank bonds based on inside information. As one newspaper noted:
“The punishment for this serious offence, which the FSA has pledged to stamp out was not a permanent ban from the City, or a hefty fine, it was a jolly strict ticking off. The decision merely to censor the traders was decided not by the FSA itself but by its Regulatory Decision Committee. Not only is this a very embarrassing position for the FSA, it sends precisely the wrong message about the City’s ethics and regulation at precisely the wrong time. With the City under attack from all sides and the FSA threatened with extinction by the Tory Party, the last thing they need is to provide more ammunition to those who say they learned nothing from the financial crisis and are determined to return to business as usual. As it happens, business as usual seems to have been exactly the defence the two traders used. They were just doing what everybody else did. Those who thought it was acceptable practice included Dresdner’s Compliance Department. An embarrassed FSA said that the decision only to censor the pair of traders reflects the fact that some participants may, in the past, “not have paid sufficient attention to their obligations in this area”. It further stated: “This is like letting someone off a dangerous driving charge because they were not paying sufficient attention. They should have been. That is the whole point.”
[Two very current governance issues at the time were .] As I am sure you know, Prudential plc, based in the UK, intended to acquire AIA the business of AIG in Asia. Some commentators suggested that ultimately the Pru (as it is known) might dispose of its UK businesses entirely and even go as far as moving its primary listing, perhaps to Hong Kong. This deal raised a number of key corporate governance issues. The first is why Boards elect Chief Executives (the Pru appointed a new one about six months ago). Are they chosen to be good stewards of the existing business; to run it well, to evolve it as its markets evolve and to hand it all in good shape to a successor, or do they appoint a Chief Executive to change the business out of all recognition in a matter of months and in effect walk away from everything it has done and built up over the last 150 years? Big questions but good questions I think. We could never know of course, but it would be fascinating to ask some of the non-executive directors how they looked at the above comments in the light of corporate governance, as well as the stewardship of companies. We know that somewhere before the deal’s final collapse, the massive (US$ 21 billion plus) rights issue had to be delayed because the FSA had concerns about solvency issues. That in itself was not a “good thing” on such a high-profile financial deal. Who was watching the governance issues? The Pru did have five sets of financial advisors, after all. One assumes they had high profile PR companies around to assist. We could also wonder about the abortive deal fees – in excess of £450 million. A huge, and ultimately wasted, sum. I wonder who and indeed what were the real drivers of this transaction. I maybe should balance these comments a little by saying if the deal had gone through, the deal doers would now be heroes.
Tied into these points are relevant sections in the Companies Act 2006 dealing with directors’ duties. In any transaction the directors are required to have regard to, amongst other things, the interests of employees, the need to foster the company’s business relationships with suppliers, customers and others, and the likely consequence of any decision in the long term. The prospect of moving a mature business from one side of the world to another must have given the Board some difficult issues to consider.
Finally, despite the fact that the prospectus for the rights issue was nearly 1,000 pages long, how would the vast majority of shareholders have decided whether this was a good deal (whatever that actually means to those shareholders) for the company? Sadly, we will never know.
We do, however, know that the future of both the CEO and Chairman is being considered by several large institutional shareholders. Perhaps this will become a classic corporate governance case study. It certainly shows us that so-called “mega-deals”, even if sanctioned by the board, may not get such an easy ride from the shareholders as in the past.
Finally, I will mention BP, but only in the context of governance. I have already looked in some detail at the role of a company chairman. I scanned 10 days of newspaper reports around the beginning of June looking for some references to the chairman of BP. In this particular scenario I would have assumed he would have been “out there” to support his CEO and indeed to take a prominent “PR” role. Quite the opposite appears to have been the case. He has been almost invisible. I believe there were almost no references to him in the newspapers during the period. The media dealt with the question of whether he would be the “best” member of the board to resign. This point is now becoming the focus of the media debate – surely that can’t be right.
It strikes me as surprising that in the light of the current debate on corporate governance, and particularly the Walker Report’s consideration of the role of the chairman, he has been such a background figure. It would be interesting to understand why he took this position of almost total invisibility until his meeting in the White House last week. Although at the least he should now hire some new PR advisors following that meeting. The whole weight of response seems to have been left to the CEO. To my mind the CEO’s job should be on the practicalities of getting the oil flow stopped. The rest should be the responsibility of the chairman—if he chooses to delegate to, or work with, others, fine, but he ought to be showing some real signs of visibility and leadership. In addition the CEO really can’t deal with the practicalities of the clean up on the Gulf as well as with the politicians in Washington. BP‘s board behaviour may well be another case study in corporate governance.
I ask again, do all these rules I have just discussed really work in practice? This is a case in point. To go back to my initial focus – is it “common sense” for the Chairman to have taken such a low profile in such a high-profile matter?
What we can say, finally, is that at the moment the whole area of corporate governance seems to be in a state of tremendous volatility. We only have to look at the last two examples – the Pru and BP to see that governance is getting a much higher profile than in the past and that I believe is a welcome change.
AND I AM DELIGHTED IF YOU MADE IT TO HERE– WELL DONE
Postscript August , 2014
The more I reflect on all this, which I do, the more I wonder whether to some degree so many of the issues raised are to do, no more and no less, with human nature and the capitalist system in which we live and work. There may be nothing wrong with that as I believe the alternatives would be a lot worse.
I worry about the tidal waves of rules, proposals, laws, consultation papers, policies and so on which appear all too often. I think I am convinced ( because I can’t find much else to help me and as a company lawyer, it’s all I have to look at ) that the rules and laws are there and we probably don’t need ever more in most cases. We “just”need the existing ones to be enforced ( see #gouldsmantra).
The fiasco at the SFO under its previous leadership was just that. The new team seems to making real efforts to improve matters, although whether the SFO can survive in its current form in the present circumstances must be a debatable point. It needs government and political support, in all senses. Real leadership in this area needs to be more than just polite words and if government can’t deliver , we might as well pack up and go home …. and on that note …I’m off.