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Canada’s Corporate Governance Guidelines Are Out of Date, Part 2

Following up from last week’s blog, I argued that Canada’s corporate governance guidelines were out of date because of: 1. Lack of principles and practices; 2. Lack of focus on risk management; 3. Lack of independence of mind; 4. Lack of industry expertise; and 5. Lack of shareholder engagement, here are reasons 6-10 that our Guidelines need an update:

6. Lack of shareholder engagement: The words “investor” and “shareholder” are mentioned once each, in a perfunctory manner, within the 2005 Guideline. Shareholders own the company and regulators and investors are explicitly providing context now: for investor input on director selection; for engagement and dialogue between investors and directors; and for the use of technology in shareholder communication and annual meetings. The foregoing are all absent from the Guidelines. Canada has still not adopted “say on pay,” which has also been a catalyst for shareholder engagement. The US, UK, Australia, Germany, France and other European countries either have say-on-pay or are moving rapidly in this direction. Canada is a laggard.

7. Lack of focus on strategy and value creation. “Strategy” is mentioned only once within the entire Guidelines, and that is that the board should approve a strategic planning process, and approve, at least annually, a strategic plan. It is hardly surprising that many boards short-change strategy at the expense of compliance. This requirement of once a year essentially marginalizes a board in its strategic role. When I interview top directors who add value strategically, the strategic oversight and involvement by boards are much more focused and engaged. There are strategic best practices here that would enhance the performance and value creation that a proper board can make. Regulators drafting this guidance should have experience creating listed company value.

8. Lack of focus on sustainability: The word “environment” or “sustainability” is not mentioned at all in the 2005 Guidelines, a noticeable omission. Australia’s emphasis on economic, environmental and social sustainability risks, within its Corporate Governance Principles and Recommendations, is second to none, as is South Africa’s focus on “integrated sustainability reporting” within King III. This omission is especially noticeable given investor focus on the environmental, social and corporate responsibility. The lack of environmental stewardship and response to climate change is also a broader issue. Canada is also a laggard here.

9. Lack of compensation guidance: The regulatory movement from short-term, quantitative, financial metrics, to risk-adjusted, long-term, qualitative, non-financial metrics for executives is absent from the Guidelines, as is guidance on non-executive remuneration. Investors, regulators and good boards are focusing on leading performance metrics that reflect the entire business model and value chain (most of which is non-financial), and that are longer-term in nature.

10. Lack of focus on the chair of the board: Lastly, but far from least, the position of the board chair has undergone a metamorphosis since 2005. There is no guidance at all offered on the role, responsibility and attributes of an independent chair, within the Guideline. Other codes offer extensive guidance on skill-sets and responsibilities that and on which the chair should possess and execute. Without this regulatory guidance, a chair (and committee chairs) can be bullied or unduly influenced by dominating reporting management such that they are rendered ineffective, albeit formally independent. More guidance is needed. Chair position descriptions should not be drafted by management lawyers or management-retained lawyers.

Conclusion

Does Canada improperly have a false sense of governance superiority? Perhaps so. But in this rapidly changing field, if you rest, you are left behind. Nine years is sufficient rest.

There are arguments (i) by industry and advisors to management that corporate governance in Canada is not broken so does not need to be fixed; and (ii) by regulators who complain of scarce resources and how difficult it is with fragmented securities commissions and the diversity of Canadian companies. I have never been persuaded by these arguments.

To address the second argument, what is required is leadership and political will. Premier Kathleen Wynne’s and the OSC’s Maureen Jenson’s emphasis on gender diversity have resulted in nine jurisdictions collaborating and endorsing recent changes to the disclosure of gender diversity, term limits, and measureable objectives, for example. To address the variety of Canadian companies, South Africa’s King III Code applies to all types of companies (public, private, state and non-profits). The issue is one of drafting.

To address the first argument, namely the arguments by industry, regulators should be conscious of undue influence by reporting management and service providers, whose internal power, business model, or commercial interests may be disrupted by governance rejuvenation. The primary consideration for policy renewal should be evidence-based policy and international consistency with best practices. Regulators should also guard against potential conflicts of interest and regulatory capture, by themselves, including those individuals within regulators who intend to return to private industry, or who have other close association with regulated companies. Regulators should also guard against those provincial regulators who oppose reform on the basis of extraneous and non-relevant considerations, such as a desire to maintain turf.

Richard Leblanc is an Associate Professor, Law, Governance & Ethics, at York University. He can be reached at rleblanc@yorku.ca.

 

Canada’s Corporate Governance Guidelines Are Out of Date

In my teaching, research and consulting, I no longer use “NP-58201 Corporate Governance Guidelines,” June 17, 2005 (“Guidelines”), that apply to publicly traded companies in Canada, as an example of exemplary corporate governance. I regard them as stale and dated. I cannot think of another developed country that has not updated its governance guidelines in almost 10 years. There have been more changes to governance since the financial crisis of 2008 than in a generation. And we are only about half way through all of them. Canadian regulators – including all provinces and territories – need to keep up, and step up.

Here are the deficiencies to the Guidelines as I see them:

1. Lack of principles and practices: Our Guidelines are four pages long. The UK’s new Code (September 2014) is thirty-six pages. Australia’s Principles and Recommendations (March 2014) are forty-four. South Africa’s “King III” (2009) is sixty-six pages, to pick only three examples. Quantity is not necessarily quality, but by having such succinct guidelines, the opportunity to set out (i) best practices that (ii) achieve the objective of principles is gone. It is comply or explain against a perfunctory unitary guideline, which can be – and is – gamed by reporting management. There should be more robust guidance, where the regulator explains various ways good governance can occur, from which listed companies can pick and choose according to their circumstances.

2. Lack of focus on risk management: Take risk for example. The Canadian Guidelines simply state that the board should identify principal risks and ensure appropriate systems are in place to manage these risks. I have no idea what this actually means, nor may directors. Risk management oversight now involves an explicit risk appetite framework, internal controls to mitigate, technology, limitations, and assurance provided directly to the board and committees by independent risk, compliance, and internal audit functions. None of these practices, which are very much addressed by other regulators, appear in the 2005 Guidelines. Consequently, many public companies have immature risk management, especially in addressing non-financial risks such as cyber security, operations, terrorism and reputation. Regulatory inaction has an effect. Even a forward-thinking director may be blocked by intransigent management to devote greater resources to mitigating risk because of inadequate regulation.

3. Lack of independence of mind: In Canada, a board can subjectively believe a director to be independent, but this belief need not be independently validated, nor tied to any objective or reasonable standard. Nowhere else can a conflict of interest lack a perceptual foundation. As a result, directors tell me how colleagues are compromised by an office, perks, vacations, gifts, jobs for friends, social relatedness, relations to major shareholders, excessive pay, excessive tenure, interlocks, and other forms of capture. If a director or chair is captured, they are owned by management and totally ineffective. If there is a difference between regulatory independence and the independence of mind of directors, the fault lies with the regulation. Regulators should implement an objective standard of director independence, not a subjective one.

4. Lack of industry expertise: It was admitted in open forum that the original 1994 committee did little research. Sufficient industry expertise on boards is glaringly absent from the Guidelines, and consequently in many boardrooms. We are suffering from an independence legacy, perpetuated by entrenched directors, and unsupported by academic research. For example, in Australia, two academics claim has cost their country’s decline in shareholder value between 30 and 50 billion Australian dollars (“Does “Board Independence” Destroy Corporate Value,” by Peter L. Swan and David Forsberg).

Fraud, meltdowns and underperformance such as Nortel, RIM and CP all had a paucity of industry experts on their boards, including, most recently, Tesco in the UK. JP Morgan at the time of the risk management failure did not have a single independent director with banking experience. Prior to Bill Ackman’s involvement in CP, not a single independent director had rail experience. I recently assessed a similar board and not a single director had the necessary industry experience. The Guidelines should require relevant industry expertise on boards. I recommended this to OSFI when I was retained by them to examine their earlier guidelines, and this is now the law for all federally regulated financial institutions, along with risk expertise being present on boards.

5. Lack of financial literacy and internal audit: There is no requirement to be financially literate to sit, initially, on an audit committee of a Canadian public company. This presumes someone can acquire financial literacy as opposed to having it to begin with. There is also no requirement to have an internal audit function for a Canadian public company. This should also change so audit committee members hit the ground running, and there should be a comply or explain approach to internal audit. In many compliance failures, there is a defective or non-existent internal audit function, with a weak audit committee lacking recent and relevant expertise. Regulators are now moving towards “independent coordinated assurance,” which means that reporting to, and functional oversight by, the board and committees are fulfilled by internal and external personnel who are independent of senior and operating management, including, most importantly, an effective and independent internal audit function.

Join me next week where I will talk about 6-10, including: lack of shareholder engagement; lack of focus on strategy and value creation; lack of focus on sustainability; lack of compensation guidance; and lack of focus on the chair of the board.

Combatting Political Corruption in Canada

There are now two RCMP investigations of potential breach of trust and bribery allegations of a sitting politician involving Senator Mike Duffy and the Prime Minster’s former chief of staff, Nigel Wright.

Senator Pamela Wallin is accused of having taxpayers, at least partially, fund her travel to private events, speeches and board meetings. (Why are Senators even permitted to serve on boards?)

In Quebec, the Montreal mayor who replaced the former mayor has also been charged with multiple corruption counts this past week. SNC Lavalin, a Quebec company, has been charged with bribery and is banned from World Bank contracts for ten years. Arthur Porter, former director of Air Canada, McGill University Health Centre CEO, and member of Canada’s Security Intelligence Review Committee, is fighting extradition from Panama to face bribery charges. The Quebec-based sponsorship scandal is well known, and former Quebec-based Prime Minister Brian Mulroney was reputed to have received cash payments in envelopes.

See “‘Pristine Canada Mired in Scandal After Montreal Arrest.”  Two journalists yesterday called the incumbent Prime Minister incompetent and tone deaf to address it.

The Charbonneau Commission in Quebec has heard from 80 witnesses involving allegations of price fixing, collusion, cash payments to win business, influence peddling, threats and extortion. Current and former politicians have been arrested, offices have been raided, and there are likely more arrests to come.

Quebecers are understandably outraged. Potholes in Montreal are well known, and asphalt suppliers evidently colluded to inflate prices by 80% and reduce the asphalt quality. I see this when I visit Montreal. It is a feeling. It starts right with the taxis refusing to take credit cards and wanting cash only. You get a sense of deep cultural and historic embeddedness in the way business is done. A royal commission inquiry was called by the Quebec prime minister, Louis Gouin, in 1909. It lasted 115 days, had 914 witnesses and 548 pieces of evidence were presented. In the words of an executive via private email, “it took about 100 years to go from 25% to 3%, which may mean another 15 years to clean the rest.”

Canadians have been bombarded over the last few months with stunning lack of ethics, internal controls, and even the most rudimentary governance and accountability practices in government. The Senate had to issue new rules on basic concepts such as producing receipts for taxis and providing a specific purpose for travel when claiming expenses. The Senate used to proceed on the “honor” system. Imagine for a moment if an executive claimed travel on “the honor system.”

See a few examples from the new rules:

“3. Require a Senator to provide a specific purpose for travel when claiming expenses.”

“5. Require taxi receipts be provided when claiming taxi expenses.”

The Senate, in 2013, actually had to instruct Senators to provide receipts!

And the Senate, in 2013, actually had to request an independent auditor to audit its financial expenses. Imagine if a public company did not have an auditor?

And the bar for extracting a politician is not malfeasance or misfeasance, like it is in a company for an executive, but actual criminal charges and even prison. In other words, unless a politician actually goes to prison, he or she may not have to resign, or even answer allegations, and there are no other mechanisms, such as compelled public testimony or recall.

Imagine if a CEO said to a board of directors that this was the condition of succession or replacement – prison.

Anti-corruption is not rocket science. There are proven methods to corrupt and bribe. What is needed is a complete rehaul, including codes, controls, audits, assurance and reporting (including whistle-blowing).

The foregoing takes time, energy and money. The advantage I am seeing is that a judicial inquiry is afoot and there are arrests. This, I have not seen before. These are positive steps, but the recommendations from the judicial commission must be far reaching, deep and enforced. Corruption can be counteracted, but the judicial report should be rigorous, and there should be built-in time frames and personal/office accountability for implementing the recommendations, with penalties for non-implementation, reporting and follow up. This is how you do it.

In other words, government (at all levels) has to not only lead by example, but should impose the same huge overlay of regulation (and cost) that it imposes on public companies, on itself. Then, and only then, will it have the credibility, transparency and best practice accountability that the private sector now has.

Interview regarding governance and accountability aspects of Toronto Mayor Rob Ford

Here is my CBC interview regarding Mayor Rob Ford, with two other panelists:

The Mayor of Toronto’s entrenchment needs to end

Mayor Rob Ford’s stubborn refusal to address substantively the allegations of drug use, and the reputational contagion and distraction it has caused, needs to be addressed in short order.

Councillors should take all reasonable steps to procure Mr. Ford’s addressing of the issue, and if not, escalate as appropriate, including initiating removal from office if Mr. Ford does not answer the allegations, so the City’s business can continue. Mr. Ford’s brother, Councillor Doug Ford, is in a conflict of interest and should recuse himself from any process.

In a corporate setting, a Chief Executive engaging in similar patterns of behavior would not be tolerated by any board of directors. The CEO would have been fired long ago.

There are two issues here. One is behavour. The second is the ability to operate. The behavior – ranging from alleged conflicts of interest, boozing, womanizing, and now crack cocaine use, means that the Mayor’s political influence has become toxic. His ability to reach across the aisle, procure concessions, exert influence, and come to deals – so critical in the political process, has effectively ended. Operators and CEOs in the private sector would likely exercise an abundance of caution in discussions and City investment for reputational reasons and the inability of the Mayor to broker consensus.

Any CEO who had similar patterns would be unable to lead and operate as well.

Corporations now take extremely seriously reputation risk and the corporate brand. All executives, and indeed any employee, are representative of that brand now, with social media. There are internal controls over integrity, codes of conduct, social media response teams, and crisis planning that were not present even a few years ago.

The notion that a CEO could not respond in a business setting simply would not happen. Toronto City Council needs to hold their chief executive accountable, so the more important issues before the City can be addressed.


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