Copyright 2011, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Corporate Governance, October 2011
CCGG releases new governance guidelines for equity controlled corporations in recognition that CCGG's general governance policies for public companies may not apply equally to equity controlled companies.
The Canadian Coalition for Good Governance (CCGG), an organization representing institutional shareholders and asset managers, has released new governance guidelines entitled "Governance Differences of Equity Controlled Corporations" (the Supplemental Guidelines). In recognition of the "legitimate governance differences of equity controlled corporations", the stated purpose of the Supplemental Guidelines is to supplement CCGG's "2010 Building High Performance Boards" (the Base Guidelines) governance policy for public companies which CCGG notes "may not apply equally to equity controlled companies".
In the Supplemental Guidelines, CCGG recognizes that "a controlling shareholder may have a legitimate interest in being actively involved in the board of directors of the corporation" and "[i]n fact, many institutional investors expect shareholders that control a corporation by virtue of their equity holdings to have substantial influence over the strategic direction of the company, the election of some of the directors, the appointment of executives, the financial affairs of the business and executive compensation." Accordingly, for equity controlled corporations, the Supplemental Guidelines modify certain policies within the Base Guidelines, including those with respect to board and committee composition, the separation of the roles of the chief executive officer (CEO) and the independent chair of the board of directors, and the adoption of majority voting policies, among others, and reiterates CCGG's views with respect to say-on-pay shareholder votes.
For purposes of the Supplemental Guidelines, a "Controlled Corporation" means a corporation controlled by a person or company (a Controlling Shareholder) or group of shareholders who together (directly or indirectly) control a sufficient number of common shares of the corporation to be able to elect the board of directors or direct the management or policies of the corporation, which can be achieved with as little as 20% of the common shares of a widely held corporation. Accordingly, the Supplemental Guidelines do not relate to corporations that are controlled by virtue of multiple-voting or dual class share structures, which the Supplemental Guidelines state have "unique governance issues". CCGG has indicated that it will be preparing guidelines for such companies in the future.
Independent Directors/Related Directors
Within the Supplemental Guidelines, CCGG refers to the standard of independence as contained in section 1.4 of National Instrument 52-110 – Audit Committees of the Canadian Securities Administrators (NI 52-110). Under NI 52-110, a director is independent if he or she has no direct or indirect material relationship with the Controlled Corporation, the Controlling Shareholder (noted as a "parent" in NI 52-110) or a subsidiary entity of the Controlled Corporation which could, in the view of the board of directors of the Controlled Corporation, be reasonably expected to interfere with the exercise of a director's independent judgment. Noting its dissatisfaction with the current regulatory definition in NI 52-110, as it provides that a director who has a material relationship with a Controlling Shareholder is not "independent" of the Controlled Corporation even if he or she is independent of management of the Controlled Corporation, CCGG includes in the Supplemental Guidelines the concept of a "Related Director" as a director "related" to the Controlling Shareholder, but who may nonethless be independent of management of the Controlled Corporation. Further, in the Supplemental Guidelines, CCGG urges the Canadian Securities Administrators to also draw such a distinction in its governance rules.
For purposes of the Supplemental Guidelines, a Related Director is a director who (i) directly or indirectly controls at least 20% of the common shares (a Significant Shareholder) of the Controlling Shareholder, (ii) is directly or indirectly employed by the Controlling Shareholder (or one of its Significant Shareholders) or (iii) is an immediate family member (as defined in section 1.1 of NI 52-110) of the Controlling Shareholder (or one of its Significant Shareholders). For clarity, the Supplemental Guidelines further provide that a Related Director may or may not be independent of management of the Controlled Corporation and that a member of the board of directors of a Controlling Shareholder who is otherwise independent of the family or entity that controls the Controlling Shareholder will not be considered a Related Director solely as a result of being a member of the board of directors of the Controlling Shareholder.
Related Directors on the Board
The Base Guidelines recommend that at least two-thirds of every board should be independent of management "to ensure directors are aligned with shareholders and not with management". Rather than employing the potentially more restrictive "Independent Director" standard (within the meaning of section 1.4 of NI 52-110), the Supplemental Guidelines provide that Related Directors who are independent of management of the Controlled Corporation can be regarded as independent for purposes of meeting the two-thirds threshold. However, while the Supplemental Guidelines recognize that "it can be valuable to the company for Related Directors (such as professional advisors to or owners or executives of the Controlling Shareholder) to sit on the board", CCGG recommends that the number of Related Directors (whether independent of management of the Controlled Corporation or not) should be proportional to the common share ownership of the Controlling Shareholder, to a maximum of two-thirds, and that the board of a Controlled Corporation should always have a meaningful number of Independent Directors.
Related Directors on Board Committees
The Supplemental Guidelines provide that while at least one member of each board committee of a Controlled Corporation should be an Independent Director (within the meaning of section 1.4 of NI 52-110), a majority of the members of all board committees (with the exception of the compensation committee) should be either Independent Directors or Related Directors who are independent of management of the Controlled Corporation.
As a departure from NI 52-110, which generally provides that no member of the audit committee may be a Related Director, the Supplemental Guidelines recognize that Related Directors can bring an important perspective to the audit committee, given their connection to the Controlling Shareholder "which may add value to the Controlled Corporation". Further, while CCGG notes that the "boards of public companies that are not Controlled Corporations usually have compensation and nominating committees comprised entirely of Independent Directors", the Supplemental Guidelines provide that it is appropriate for Related Directors who are independent of management of the Controlled Corporation to sit on the compensation or nominating committees of the Controlled Corporation "to bring the knowledge and perspective of the Controlling Shareholder to executive compensation, appointments and board nominations".
While CCGG encourages the Canadian Securities Administrators to make amendments to NI 52-110 which would allow a Related Director who is independent of management of the Controlled Corporation but has a material relationship with a Controlling Shareholder to have greater participation on the Controlled Corporation's board and its committees (by not being deemed to be non-independent), the Supplemental Guidelines also note that the participation of Related Directors on board committees could give rise to conflicts of interest between the Controlled Corporation and the Controlling Shareholder and suggest that the board of a Controlled Corporation should consider creating a conflict of interest committee made up entirely of Independent Directors to address such conflicts on behalf of the board.
Non-Independent Director/Related Director as Chair
Consistent with the Base Guidelines, CCGG recommends in the Supplemental Guidelines that the chair of the board and CEO of every public company should be separate roles held by different people, as these roles have "different responsibilities and functions", and that the chair of the board should be independent of management. However, the Supplemental Guidelines also provide that if a Controlling Shareholder controls at least 50% of the common shares of a Controlled Corporation, "the influence of the Controlling Shareholder may make the appointment of an independent Chair impracticable" and, accordingly, (i) the roles of CEO and chair may be combined, (ii) the chair may be a Related Director who is also actively involved in management of the business, or (iii) the chair may be a Related Director and the CEO may be the Controlling Shareholder or related to it, provided that there is a lead director who is an Independent Director and the board has an effective and transparent process to deal with any conflicts of interest between the Controlled Corporation, minority shareholders and the Controlling Shareholder.
Majority Voting Policy
In accordance with the Base Guidelines, CCGG recom-mends that boards of all public companies "facilitate shareholders' ability to effectively vote their shares "for" or "against" individual directors" by adopting CCGG's "Majority Voting Policy". The Supplemental Guidelines provide that Controlled Corporations should generally also adopt CCGG's Majority Voting Policy. However, recognizing that if a Controlling Shareholder holds 50% or more of the common shares, it is "highly unlikely that more votes for an individual director will be "withheld" than are voted "for" and therefore adopting CCGG's Majority Voting Policy would rarely lead to the resignation of a director", CCGG, rather than advocating for the adoption of its Majority Voting Policy in all circumstances, advocates that the board of a Controlled Corporation adopt a policy that commits to (i) allowing shareholders to vote for each individual director, (ii) disclosing the results of elections promptly after each annual meeting, and (iii) immediately adopting CCGG's Majority Voting Policy if at any time the Controlling Shareholder controls less than 50% of the common shares.
The Base Guidelines provide that "shareholders should be allowed to have regular, constructive engagement with the boards of companies they invest in [in] order to create open relationships, have the opportunity to explain their perspectives on governance, compensation and disclosure practices, and provide detailed comments on the company's practices", and that when such meetings are about "compensation or other matters related to management, they should normally be held without management or advisers" being present. In the case of a Controlled Corporation, the Supplemental Guidelines further provide that minority shareholders should be able to engage both with the Independent Directors as well as the Related Directors, "either together or separately as may be appropriate for the issues to be discussed".
Consistent with the Base Guidelines, CCGG recommends in the Supplemental Guidelines that Controlled Corporations should hold an annual shareholder advisory vote on compensation and publicly disclose the detailed vote results. While the Supplemental Guidelines note that CCGG recognizes that for some Controlled Corporations the result of a 'say-on-pay' vote may be dictated by the Controlling Shareholder, CCGG believes that it is an important vehicle through which "minority shareholders can express their view on the board's approach to executive compensation".
Modified Governance Policies if CEO is "Related" to Controlling Shareholder
Certain of the provisions of the Supplemental Guidelines are subject to modification in situations where the CEO of the Controlled Corporation is "Related" to the Controlling Shareholder. "Related" for these purposes is defined in the Supplemental Guidelines and includes an executive of the Controlled Corporation who also is (i) directly or indirectly a Significant Shareholder of the Controlling Shareholder, (ii) directly or indirectly employed by the Controlling Shareholder (or one of its Significant Shareholders) or (iii) an immediate family member of the Controlling Shareholder. For example, if the CEO of a Controlled Corporation is Related to the Controlling Shareholder, the Supplemental Guidelines indicate that the Related Directors of the Controlled Corporation cannot be regarded as independent of management of the Controlled Corporation, and therefore at least two-thirds of the board should be Independent Directors as defined under section 1.4 of NI 52-110.
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