UK: Non-Executive Directors and Recent Developments

April saw the role of non-executive directors very much in the news. The National Association of Pension Funds (NAPF) published guidelines on what institutional investors expect from non-executive directors, the outgoing President of the Institute of Directors made his opinions known and the Government announced there would be a review of the role of non-executive directors.

These came in the same month that the Equitable Life announced that it is to sue 15 of its former directors on the grounds that their alleged negligence caused many policyholders a "substantial loss of benefits". Equitable say the 15 served on the board in the summer of 2000 in the run-up to, and in some cases after, a legal challenge over guaranteed annuity rate pension policies, "GARs", which threatened the existence of the insurer. Equitable Life accused the former directors of failing to recognise there were potential problems on which advice should have been sought, and of failing to act appropriately on advice that it was possible that Equitable Life would lose a test case over its treatment of GAR policyholders. The directors are being sued for £3billion even though they are only collectively insured for £5million. They have responded through their solicitors to the points put to them by the challenge and refute any wrong doing but it is expected that the case will last several years and possibly end up in the House of Lords.

Also in April, Sir Roger Hurn stood down as chairman of Prudential because he did not want it to be tarnished by his involvement in the Marconi affair. Ruth Lea, head of policy at the Institute of Directors said that Sir Roger Hurn's case highlighted that all directors were responsible for corporate problems: "It does not matter whether you are non-executive or executive, you are equally accountable."

The month also saw the resignation of Lord Wakeham as head of the Press Complaints Commission as a result of his £80,000 a year non-executive directorship of Enron, the collapsed energy trading group.

The timely publication of guidance by the NAPF on non-executive directors has stated that their view is that a non-executive director should limit the number of positions he holds to 5 and that full-time executive directors should not take on more than one outside directorship. It also stated that pay for non-executive directors should be more closely linked to their experience, knowledge and time with the companies as it was generally perceived among investors that their fees were too low considering their level of seniority and expected expertise. The number of days spent by each non-executive director with the company should be reported in corporate accounts. Non-executive directors should have the option of being paid in shares or cash, however the NAPF was opposed to the issuing of share options because the "greater leverage" involved could compromise decision making. Clearly the direction of the NAPF guidelines is towards more involvement of the non-executives with the companies whose boards they are on and a consideration of their remuneration to compensate them for this extra commitment. There is obviously a fine line between greater involvement and not being independent enough though, the NAPF in June urged the shareholders of WPP to vote out two non-executive directors at the AGM because they had been with the company too long.

The Association of British Insurers (ABI) has echoed the concerns of the NAPF and it, too, has called for an increase in pay in line with greater responsibilities and greater commitment and for non-executive directors to not hold "too many" similar roles. They have not indicated what too many would be however.

Lord Young used his last speech as President of the Institute of Directors in April to state that the role of the non-executive directors should be abolished. The reason being that non-executive directors can never fully supervise the actions of the directors due to time constraints and constraints in their knowledge of the company. To think that they can was "dangerous nonsense" he said. Lord Young suggested that there should only be one class of director and they should be full-time employees of the company, leaving outside scrutiny to shareholders. This is an extreme view and one unlikely to be pursued by government, who appear comfortable with the role of non-executive directors within the corporate governance regime, albeit with some amendments to their role, as the commissioning of an independent review indicates.

Many of the problems with non-executive directors are being highlighted by the first serious economic downturn occurring since the emergence of the corporate governance industry in the early 1990s. The culmination of the work of the Cadbury Committee in 1992, the Greenbury Review in 1995 and the Hampel Review in 1998 was the Combined Code which sets out best practice for companies and which companies should adhere to or explain in their annual reports why not. This has at its heart the role of non-executive directors.

They are supposed to act as checks and balances on the executive team, controlling chief executives, overseeing the audit and overseeing the setting of the pay of the executive directors. In addition their main function is to represent the interests of the shareholders, when their interests clash with those of the management. However their role has been exposed as being woefully inadequate and far short of the expectations the city had of them, none of them preventing the recent high profile collapses of Marconi and Enron and the recent trouble at Equitable Life.

With all this activity as a background, the Chancellor Gordon Brown and Trade and Industry Secretary Patricia Hewitt announced on 15^th April that there would be an independent review of Non-Executive Directors and appointed Derek Higgs to head the review.

The Department of Trade and Industry ("DTI") published a consultation document on the 7^th of June on "The role and effectiveness of non-executive directors".

The Review is assessing: the population of non-executive directors in the UK, who they are, how they are appointed and how they can be drawn from a wider pool of talent; the independence and effectiveness of non-executives; the actual and potential relationship between non-executives and institutional investors; and what could be done to strengthen the quality, independence and effectiveness of UK non-executive directors. It aims to do this by raising the following issues for consultation:

• What role should non-executive directors perform, and how does this compare to the present position?

• What knowledge, skills and attributes are needed, and what can be done to attract, recruit and appoint the best people to non-executive roles?

• Do existing structures and procedures facilitate effective performance by non-executive directors?

• Do existing relationships with shareholders or others need to be strengthened?

• How can non-executive directors best be supported to perform their role?

And in relation to all of the above consideration is needed to be given to and views invited on the following aspects:

• In what ways is the position different for smaller listed companies?

• What can we learn from international experience?

Responses to the consultation are due by the 6^th September, with the intention that Derek Higgs will report to the Chancellor and the Trade and Industry Secretary at the end of the year. In his introduction to the review, Mr Higgs points out that the Government’s preferred starting point is an approach based on best practice rather than regulation or legislation. They have not, however, ruled anything out. It will be interesting to see in which direction the roles of non-executive directors will go and how the government proposes to do this bearing in mind the Combined Code has not been as sturdy as it might have been in steering many companies through this troublesome period. The Government is currently considering the Company Law Review recommendations published in July 2001, which proposed that a general statement of directors’ duties should be set out in legislation. It may be that they combine the findings of the review with the recommendations of the CLR to provide legislative guidance for directors, particularly non-executive directors who at present do not even have the benefit of their position statutorily defined. It is certain that, judging by the mood in the city, the Government will not be able to move on from this consultation without some wide ranging changes to the role of non-executive directors.