All companies and funds (whether listed or not) that are serious about quality outcomes for shareholders and investors will strive to follow best practice in corporate governance. Be warned, that in this time of corporate collapses and market volatility when excesses and loose internal controls have found many directors of companies and responsible entities (REs) wanting, courts and regulators are increasingly willing to penalise dilatoriness in corporate governance.
Chapter 6CA of the Corporations Act 2001 (Corporations Act) imposes both civil and criminal sanctions for failure to continuously disclose market sensitive information.
Court action and a compliance culture
Whether it is failure to implement internal controls or have working policies on transparency and accountability, the regulators and courts are cracking down heavily on companies and fund managers. If anything does go wrong and proceedings are brought under the Corporations Act, the existence of a substantial and successfully implemented compliance program and the existence or non-existence of the corporate culture of compliance will be taken into account by the judges in considering the quantum of the penalty.
Justice French of the Federal Court in ASIC–v–Chemeq Limited provided a list of factors relevant to the level of penalty for a contravention of the continuous disclosure provisions of the Corporations Act. These factors included whether—
1. the company has effective policies and procedures in place to comply with its continuous disclosure obligations
2. there is a rigorous education and enforcement regime within the company to ensure those policies and procedures are followed (in other words, a robust compliance culture)
3. there are systems of internal control in place to ensure directors and senior executives receive training and participate in refresher courses to understand their obligations as directors
4. there are systems in place to report when obligations are breached, and
5. there are appropriate mechanisms in place to deal with the situation where there is a breach of compliance or a requirement to give either internal or external disclosure.
This month, the Australian Securities Exchange (ASX) announced that it is writing to all listed company boards that have failed to adequately comply with corporate governance standards in the face of increasing market volatility. Listing Rule (LR) 4.10.3 requires all listed entities (companies and trusts) that have securities quoted on the ASX to include in their annual reports a corporate governance statement disclosing the extent to which the entity has followed the ASX Corporate Governance Principles and Recommendations (2nd Edition) (ASX Recommendations) during the reporting period.
The ASX Recommendations take over from and revise the March 2003 ASX Corporate Governance Principles and Recommendations (1st Edition) (First Edition). The ASX Recommendations were published in August 2007, but took effect from 1 January 2008. The 10 principles contained in the First Edition have now been reduced to eight and certain principles that overlapped obligations under the Corporations Act have been amended to avoid duplication and confusion.
The ASX Corporate Governance Council (Council) has deleted references to 'best practice' in the current edition of the ASX Recommendations. In the view of the Council, the connotation of the use of the words 'best practice' sent out the wrong message to companies. It seemed to indicate companies who did not follow the ASX Recommendations felt they were not required to do so or to explain why they were not doing so because they may have felt they were complying with 'almost best practice'. The whole point is that the ASX Recommendations, whilst not being mandatory (for other than the top 300 S&P all ordinaries index companies which must have an audit committee), should be followed in the spirit of the eight principles. Where this is not appropriate or suitable to the particular company, the company has to articulate where it has departed from the ASX Recommendations and what it is doing in other ways to protect investors and the integrity of the market system (i.e., the 'if not, why not' approach).
The eight principles
Briefly, the eight ASX Recommendations are as follows:
1.The structure, composition and role of the board, senior executors, listing executive and non executive directors and specification of their roles.
2. Maintaining a balance on the board of appropriate skills and enough independence on the board to stop abuse and that a nomination committee be established.
3. Ensuring integrity on the board and executive management, including ethical standards and compliance with legal obligations by having a code of conduct. This restated recommendation includes elements of the old principle 10. This code can contain the company policy on directors and employees trading in company securities including, blackouts and trading windows. Guidance note (GN) 9 suggests the use of the code drafted by the Australian Institute of Company Directors (AICD) as a template.
4. Internal and external audits of the company's financial trading and risk position. Importantly there is a requirement in ASX Recommendations 4.1 and 4.3 that an audit committee be established with a formal charter and with at least three directors, the majority of whom are independent. As the company's approach to identifying areas of significant business risk and managing that risk are required, often this committee has a dual role and is called an audit/risk committee.
5. Provision of a timely and balanced picture of all material matters (i.e., listed entities must have a continuous disclosure policy).
6. Upholding shareholder rights through a communications policy.
7. Managing risk through effective and internal controls (i.e., internal communications and verification process to ensure accurate information passes from managers to the board).
8. Ensuring that rewards/remuneration are appropriate and fair by establishing a remuneration committee and the corporate governance statement must specify who is on it. This restated recommendation includes elements of the old principle
9(i). The AICD's corporate governance papers include a very good guide on directors' remuneration. The Australian Investment Managers Association publication, Corporate Governance: A Guide for Investment Managers and Corporations (July 1997), has an excellent guide for share options schemes.
Deadline for compliance
Entities whose financial year begins on 1 January must comply with the latest ASX Recommendations regarding disclosure obligations for the year ended 31 December 2008 and thus include in the annual report published in 2009 details of compliance in the corporate governance report. Those companies whose financial year is coextensive with the normal financial year, their obligations will cover the period from 1 July 2008 to 30 June 2009 and will be a subject matter of the corporate governance report published in their annual report in 2009. Notwithstanding this, the Council has requested all listed companies and funds make an early transition to the new ASX Recommendations and incorporate the references to the second edition in their corporate reporting for the 2007/2008 year.
Those entities quoted on the ASX which are managed investment schemes should have regard to GN 6 and 9. GN 9 states the following:
"Compliance with LR 4.10.3 by such entities can be made by reference to the corporate governance position of the responsible entity (RE). Further, the annual report on corporate governance issues should also discuss the relationship between the trust and the RE on the basis of appointment in the deed, details of the constitution and particularly details of fees, etc. that apply."
Generally trusts that have units stapled to listed shares should also have regard to GN 2 and have to be careful to avoid inconsistency as to which entity is reporting/disclosing and avoid confusion from the governance requirements under the managed investments regime regulated under Part 5C of the Corporations Act. Reports need to state clearly when referring to 'boards' or the 'company' whether they are referring to the company or the RE. They must be careful to state clearly what the exact nature of the relationships are between the company and the RE when giving details about audit nomination or remuneration committees on the one hand and compliance committees and on the other. Entities with stapled securities need to take special care with reporting remuneration and the requirements of LR 8.1, 8.2 and 8.3.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.