Research Trends and Conclusions: Corporate Governance 2010
Richard Woolley -
In February 2009, the same month as the last edition of this publication was released, the Organisation for Economic Co-operation and Development (OECD) published a damning report entitled “the Corporate Governance Lessons from the Financial Crisis”, in which it stated “The financial crisis can be to an important extent attributed to failures and weaknesses in corporate governance arrangements.”
The report locates these weaknesses within the culture of excessive risk, insufficient accounting and regulatory requirements, and short-sighted remuneration policies that existed within financial institutions and corporate entities in the run-up to the crisis. Policymakers in numerous jurisdictions have made these weaknesses the prominent areas of focus within their reform legislation over the course of the year.
Speaking at the 2010 European Financial Services Conference in Brussels, Michel Barnier – the member of the European Commission responsible for the internal market and services – emphasised the need for coherent regulatory measures to be taken throughout Europe to foster a climate of legal certainty in the market. This will be delivered, Barnier says, through “Better corporate governance. More transparency. Better risk management” and effective external checks and controls in the financial sector. Similarly, in their ongoing dialogue the US Securities Exchange Commission (SEC) and the UK Financial Services Authority (FSA) recently agreed to address “the intrinsic links between the types and degree of risk a regulated entity/registrant assumes and their corporate governance and compensation policies”; a policy it attributes to an emerging international consensus on the necessity of governance reform.
With this increase in regulatory emphasis, it is unsurprising that the lawyers in this edition reported an increase in demand for their services over the past year as clients attempt to align their practices with reform measures and avoid liability and blacklisting. This, coupled with a reduction in the amount of lucrative M&A work following the credit crunch, has seen several corporate departments focus more of their resources on governance. “Corporate governance is an increasingly important issue,” according to John Collis at Conyers, Dill & Pearman, “the work used to be ad hoc and not the norm, but now it is perpetual and ongoing, and advice is constantly in demand.”
However, as several respondents noted, the recent high levels of demand for advice on how to grapple with downsizing and financial restructuring while maintaining good governance is now declining. In its place, lawyers hope to see a sustained call for governance advice as markets recover and companies begin to refocus their efforts from survival to renewed growth, often in the form of M&A and cross-border joint ventures. “Clients are increasingly trading on very diverse stock markets,” according to one source “and this makes corporate governance and due diligence even more important and complex.”
Emerging Regulation
The UK Financial Reporting Council (FRC) recently published the UK Code of Corporate Governance, following on from Sir David Walker’s review of corporate governance in the UK banking system. Under the new code, all directors of FTSE350 companies should be subject to annual election by shareholders, and the board should, at least annually, conduct a review of the effectiveness of the company’s risk management and internal control systems and should report this to shareholders. Such rules are expected to increase the demand for legal advice among shareholders and board-members. Compliance with stricter rules on executive remuneration is also expected to generate advisory and liability-avoidance work. The code stipulates that an entity’s remuneration committee is charged with ensuring the adoption of “a coherent approach to remuneration in respect of all employees” whereby variable remuneration is offered as part of a long-term incentive scheme, which only allows the award to vest after a minimum three years. Similar measures have recently been enacted in Belgium, Austria, Denmark, Singapore and Bahrain.
While Sir David stated that improvements to corporate conduct are better achieved through “clearer identification of best practice and more rigorous processes” than “regulatory fiat”, it is clear that governance advice will be much sought after by boards and shareholders alike in the weeks and months to come. “There has been and continues to be a significant call for guidance, advice and reassurance” according to David Pudge at Clifford Chance LLP in London, which, like many firms in this book, has been providing a series of corporate governance workshops for financial services clients over the past year.
The UK, like the rest of the EU, issues its governance requirements on a “comply or explain” basis. Under this system companies that do not comply with stated requirements are obliged to disclose their reasons for non-compliance. Similar emphasis is placed on disclosure by the Australian Securities and Investments Commission, which obliges listed companies to make immediate announcements when they receive information that might affect the value of their securities. “Inter-jurisdictional pressure for increased transparency is growing,” according to Selina Sagayam at Gibson Dunn & Crutcher LLP’s London office. As such, many lawyers reported an ongoing demand among clients for guidance in adequately meeting disclosure requirements. Law firms with offices in multiple jurisdictions are particularly optimistic about their ability to serve clients as regulations become more uniform between countries.
In the US, the Restoring American Financial Stability Act 2010 was recently approved in the Senate and sets out a similar agenda of risk regulation, enhanced disclosure and the separation of executive remuneration from risk. In common with the UK provisions, the bill requires all publicly traded non-bank financial companies to install a risk committee, as well as empowering a company’s shareholders to have a greater voice in deciding executive compensation and board composition. Significantly, the bill seeks to federalise governance and executive compensation issues that were previously matters for state law, thereby making national governance standards more uniform. “Boards will have to spend more time on the regulations” according to one source “and that won’t help the company – complications like these have made more work for lawyers.”
Increased Liability
Lawyers specialising in corporate governance related litigation reported an increase in the number of company directors being made defendants as new regulations begin to take effect and listed companies come under closer scrutiny from governments, shareholders and the public. “Directors and boards are now much more cognisant that they are subject to liability,” according to one source “and they are seeking advice from lawyers as to the proper procedures to be followed to demonstrate correct conduct.”
A prominent example is that of computer manufacturer Dell, which recently instituted numerous corporate governance reforms after it was taken to court by shareholders for perceived breach of fiduciary duty, overstating sales between 2003-2007 by $359 million and profit by $92 million. Before the case was settled in late 2009 Dell had adopted reforms to its accounting, internal audit and disclosure functions and established new principles for board composition, with increased emphasis on director independence. The eventual settlement, which saw Dell agree to pay the plaintiffs’ $1.75 million legal fees, stipulates that the changes must be extended and enforced for four years.
In the UK, the Bribery Act 2010 received royal assent in April and set out numerous measures to bring UK companies into line with the OECD Convention on Corruption. UK companies are now liable for offences carried out by employees and subsidiaries anywhere in the world. The bill also created a new offence whereby a corporate entity that failed to prevent bribery could face an unlimited fine unless it was able to provide proof that it had put “adequate procedures” in place. While a full definition of these adequate procedures is not expected until later in the year, lawyers in the UK are already anticipating a large amount of advisory and dispute resolution work to come.
On a broader scale, the World Bank Group, along with four other multilateral development banks (MDBs) in African, Asia, Europe and the Americas, recently agreed to debar a company from obtaining a contact if it was found to have engaged in corrupt practices in an MDB-financed project. At the time of writing, almost 400 firms, individuals and NGOs had been debarred from projects.
In Ernst and Young’s recent Global Fraud Survey, more than three quarters of respondents within large corporate entities said their directors were concerned about potential liability for actions carried out by their company, while only 28 per cent of in-house counsel felt their organisation was “very well-prepared” to undergo a fraud or bribery investigation. A number of the lawyers we spoke to suggested that private practice lawyers might be called on to fill this gap in corporate liability protection as new corruption regulations are adopted internationally.
The Risk to Risk
Certain lawyers and regulators however voiced concern about the adverse effects of overregulation on financial recovery. Eric Spindler of Blake Cassels & Graydon LLP in Toronto pointed out that proposed changes to the Canadian governance rules were put on hold by the securities regulators in recognition that companies were focused on business sustainability issues in the challenging economic climate. “Companies want efficient best-practice first and foremost,” according to another source in Canada “and there is a concern that too much process could stifle creativity.” This sentiment was echoed in May by Ted Price of the office of the Superintendent of Financial Institutions Canada, who warned that “there is a risk that a global regulatory landscape will develop that will be far more prescriptive than it has been, and certainly more restrictive.” As markets start to move more steadily towards renewed growth it is expected that external counsel will be at the heart of the process by which clients satisfy their regulatory obligations while still allowing for competitive levels of risk.
In the autumn of last year the European System of Financial Supervisors (ESFS) echoed the sentiments of the majority of policymakers worldwide when it stated that “a stronger financial sector in the EU in the future needs convergence between member states on technical rules.” This trend is highly relevant to clients operating in multiple jurisdictions, and lawyers expect the demand for guidance and clarification to be high as jurisdictions harmonise their rules.
Lawyers who specialise in the dispute resolution aspects of corporate governance are finding directors are more eager to seek advice to avoid liability. “Increasingly, directors are asking what they can do on a proactive basis to demonstrate proper conduct in case of future litigation,” according to one source.
For the majority of law firms, corporate governance remains an embedded function of their broader corporate department, feeding into transactional and dispute matters. However, it is clear that the many revelations about irresponsible executive behaviour and poor internal standards have brought corporate governance lawyers closer to centre stage in the wake of the financial crisis. While companies and law firms’ corporate teams are expecting M&A to gather pace and restore faith in global markets in the coming months, they accept that a significant part of such a recovery is contingent upon compliance with emerging corporate governance regulations.