Huishan: all INEDs resign at the same moment, coincidence?

China Huishan Dairy Holdings has been lately in the news, for all the wrong reasons (for instance here, here and here).

The company made an announcement regarding several issues at hand. One of them was the resignation by all four independent non-executive directors.

• Mr. Song would like to spend more time on his other business and commitments
• Mr. Gu is getting increasingly busy with his other commitments and is afraid he may not have sufficient time to perform his duties as an INED
• Mr. Tsui would like to concentrate on his company’s business and personal commitment which requires more of his dedication
• Mr. Kan would like to concentrate on his other own commitments which require more of his dedication

It must be noted that every statement is different which seems to add to the credibitly of each one.

I strongly doubt though the sincerity of the reasons stated. Surely the real reason is that the company is in turmoil and the INEDs don't want to get dragged into the matter any further.

The fact that all four resign exactly now can not be a coincidence.

I am very much against these kind of "useless statements", if the directors don't want to give the true reason then a simple statement like "no comment" is much better. At least the reader does not feel like he is taken for a fool.

"Local Corporates Need To Buck Up on Corporate Governance"

I wrote before about James Hay from the Pangolin Fund.

Another interesting interview with BFM can be found here.

00:46 about research on pangolins needing funds
01:45 bonds versus equities
04:50 corporate governance, strong correlation between good CG and returns
05:15 many listed companies are family controlled
05:40 the need to visit companies and meet management
06:10 many companies, especially in Malaysia, still destroy value, diluting shareholders
07:20 lack of shareholder activism, very few fund managers go to AGMs and question management and INEDs
08:20 need to look in past history, company announcements
09:40 short term "adventures" by management in unrelated industries destroys value
10:10 companies should give excess cash back to shareholders, not waste it in risky investments
12:55 Hay also got "fooled", like in Silverbird's case
14:00 concentrated investing, intention to hold the shares for the long term
15:30 Challenger, Singapore listed
16:50 12% performance per year, calculated in USD

Why are so few local fund managers speaking out about bad CG?

It seems they "outsource" that work to MSWG, which is of course the "easy" solution, but not enough.

Related Party Transactions, "a national sport in Asia"

I have often warned about Related Party Transactions (and its closely related cousin "Conflict of Interest"). Basically, these should be avoided by companies, and if they are unavoidable due to the nature of the business, they should be done in a very transparent and upfront manner.

In Malaysia, RPTs (and Conflict of Interest situations) are of course almost a way of life, many of the Corporate Governance abuse cases described in this blog handled about them.

GMT did recently some research regarding Hong Kong and Singapore companies.


Over 90% of all companies were engaged in some form of related party transactions in 2014. It makes us wonder if the remaining 7-8% simply forgot to declare them! These transactions averaged 7% of combined sales and expenses which is highly material to profit. A whopping 13% (46 companies) had related party transactions in excess of 20% of combined sales and expenses. However, of these, 31 were state owned enterprises (SOE) which clearly do a lot of business with other SOEs. Who knows whether they conduct business at market prices or in line with government policy? What we’re really interested in are those private companies with a large amount of related party transactions because that’s where minority shareholders are at greatest risk. That leaves us with just 15 companies which we list in alphabetic order below:

Some of GMTs findings (unfortunately the names of the companies are left out, I guess one has to subscribe to their services for that):

• Company 1: The largest related party balances of any company GLOBALLY, at US$6.2bn. It is paid interest income on amounts owed to it but doesn’t pay interest on amounts it owes. This boosted 2014 pre-tax profit by 20%.
• Company 2: Two CEOs have been sent to jail in the last decade.
• Company 3: Around 45% of expenses routed through two companies owned by the founder. One of these paid the founder an estimated US$22m in dividends over the past two financial years.
• Company 4: Building the world’s 5th tallest building in China, financed with a US dollar loan from a related party.
• Company 5: Over 35 pages of connected party transactions.

As a safeguard, RPTs have to be evaluated by the independent directors (INEDs), if the deals are properly done at arms length.

However, as David Webb put it: 

Once appointed by the board, the INEDs are re-elected by shareholders at the next annual general meeting, and thereafter by rotation (typically standing every three years, if they survive that long). Unfortunately, the controlling shareholders are allowed to vote in these elections, so they nearly always determine the outcome. Yes, the sheepdog is appointed by the flock, not by the shepherd. It is a clear absurdity that the controlling shareholders effectively appoint the people who are supposed to prevent them from abusing the company. This is shareholder democracy Hong Kong-style.

In fact, INEDs are often so closely allied to the executive directors that, if the company is taken over, the INEDs resign at the same time as the executive directors, and the new controlling shareholders will appoint new "independent" directors of their choice.

GMT concludes with "Now we’re working on the rest of Asia". I certainly hope they don't skip Malaysia, there will be lots of juicy material to be found.

INEDs approved by independent shareholders

Good article in the Business Times (Singapore) about the election and roles of INEDs (Independent Non-Executive Directors) by David Smith, head of corporate governance at Aberdeen Asset Management Asia.

Some snippets:


At present we allow the controlling shareholder to vote on the election of the individuals - the INEDs - charged with reviewing the performance of the executive. But how can an individual be expected to be independent from management if management are the controlling shareholder who recruited, nominated and elected that individual?

It is important that before we consider further amendments to the Listing Rules or Codes of Corporate Governance, which inevitably pile even more responsibilities onto INEDs, we should step back and consider a) the abuses we seek to prevent, and b) the mechanisms that we might wish to implement by which we can prevent such abuses.

.... INEDs are separately approved by both a) all shareholders and b) just independent shareholders.

.... where an individual does not pass the "independent vote", the board make representations as to why the individual is fit to be an independent director at the company. On certain transactions, those that did not pass the "independent vote" could be restricted from providing an opinion.

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.