Sunday, 31 May 2015

Issues regarding INEDs

From the last newsletter of MSWG:

... the Malaysian Code on Corporate Governance 2012 (the Code) recommends a 9-year term limit for INEDs (Independent Non-executive Directors) and the Listing Requirements makes reference to this recommendation where the companies must either comply or explain.

The Code provides under Recommendation 3.3 that there must be strong justifications for the board of a PLC to retain as an INED a person who has served in that capacity for more than 9 years. Also, the prior approval of shareholders is required to be sought.

Over the last 3 years, since the introduction of the Code in June 2012, we observed that the following have been practised:

  • INEDs tenure limit of 9 years have been exceeded sometimes as long as 20 or 30 years.
  • INEDs have been re-elected over the limit without strong justifications.
  • No resolutions were proposed for re-elections.
  • Multiple number of INEDs who have exceeded the limit were being put up for re-election simultaneously.

Focus Malaysia wrote an article (partially behind paywall) about the same matter: "Firms don’t fully comply with governance code".

My opinion, for what it is worth:

  • Asking Board of Directors to give a justification about the independence of a director whose tenure limit exceeds 9 years is akin to asking companies if their Corporate Governance is any good: both will result in useless, self serving statements.
  • With 55% of the listed companies on Bursa having INEDs with a tenure of more than 9 years, the obvious conclusion is that voluntary measures don't work. If the regulators want to be serious about this rule then they should simply enforce it. INEDs who are deemed to be useful to a listed company can still stay on, but as an non-independent director.

David Webb wrote "Principles of Responsible Regulation", one snippet:

As a result of the prevalence of controlling shareholders, investors large and small are usually minority shareholders, and if they are to have any real influence in the ordinary decision-making of companies, then they should have proper representation in the form of truly independent directors in the board room. But they don't.

Under HK listing rules, a so-called "Independent Non-Executive Director" is only as independent as the controlling shareholder wants him (or occasionally her) to be, because the controller gets to vote on the elections in general meetings. The result is often a sham system of illusory checks and balances where rubber stamps fill the required 3 seats on the board (or 1/3, whichever is greater) and form the committees that are supposed to monitor the executive management of the company.

And his recommendation:

"Independent directors should be elected by independent shareholders; any shareholder or the board can nominate candidates, but controlling shareholders must abstain from voting."

Webb's other recommendations also appear to be highly relevant in the Malaysian situation, with the exception of the second (Malaysia does have quarterly reporting).

On another matter, not only INEDs have an important role to perform versus minority shareholders, external auditors also.

Michael Dee wrote an open letter to the employees of Noble Group, his third recommendation being:

" ..... speaking of the now extinct Lehman Brothers, change your auditor, E&Y, who have been auditing Noble’s finances for 20 years now.

This is far, far too long. Auditors are guardians for investors and 20 years breeds too cozy a relationship. E&Y were Lehman’s auditor along with other infamous companies now defunct.

Noble says they rotate E&Y partners every five years but this is just substituting players on the same team. Your management have said E&Y doesn’t have to defend your financials, however they should defend their role in singing off on them.

Here it is instructive to review two aspects of E&Y which are relevant to establishing how much trust one should have in their work. First, as Lehman’s auditor they signed off on the earlier mentioned Repo 105.

Since then, it must be noted, E&Y has paid US$109 million in fines and penalties relating to their Lehman auditing work, including $10 million just recently paid to NY State over their role in the Lehman collapse.

“Auditors will be held accountable when they violate the law, just as they are supposed to hold the companies they audit accountable,” said New York Attorney General Eric Schneiderman.

The Public Companies Accounting Oversight Board (PCAOB), an accounting watchdog established by the US Congress has recently issued scathing comments about E&Y.

As reported by the WSJ in 2012 and 2013 the PCAOB found in their review of over 100 audits that they were deficient about 50 percent of the time.

In half of the audits reviewed, “E&Y hadn’t obtained enough evidence to support its audit opinions giving its clients a clean bill of health“ as reported in the WSJ last year.

But this isn’t a recent problem, the WSJ also reported in 2011 that in over half of the E&Y deficient audits it was because “E&Y was deficient in its testing of how clients applied fair value to their hard-to-value securities”.

This is directly relevant to Iceberg’s charges. Also directly relevant is that in 2012 it was reported E&Y had paid a record US$2 million fine with the PCAOB Chairman saying; “These audit partners and E&Y — the company’s outside auditor for more than 20 years — failed to fulfill their bedrock responsibility”. Not a ringing endorsement I would say."

I think it would be a good idea if listed companies are forced to change auditor every say ten years. It would increase the chance that possible irregularities would be noticed, especially in cases where auditors have become "too cozy" to the companies they are auditing, or when their fees for non-audit related services have become too high.

No comments:

Post a Comment