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The obligations of directors to shareholders

Tuesday, 28 January 2014   (0 Comments)
Posted by: Angela Oosthuizen
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Article: The obligations of directors to shareholders

January 28, 2014 at 5:21am
By the Institute of Directors in Southern Africa As published in The Professional Accountant, Q4-2013

In the old days, say, 20 years ago, being a director was sort of a cushy job, at least for what was called outside (i.e. non-executive) directors. There is a humorous quote from Agatha Christie in her novel The Seven Dials, which very accurately describes how directorship used to be viewed: 

‘[Coote] got me in as a director of something or other,’ declares one character. ‘Very good business for me – nothing to do except go down into the city once or twice a year to one of those hotel places – Cannon Street or Liverpool Street – and sit around a table where they have some very nice new blotting paper. Then Coote or some clever Johnny makes a speech simply bristling with figures, but fortunately you needn‘t listen to it – and I can tell you, you often get a jolly good lunch out of it.’ 

This has changed dramatically with the advent of corporate governance. In the past, most directors were also part of the executive team - in other words, directorship was usually associated with a management position. Now with the governance requirement to have a larger contingency of independent outside directors on the board in order to strengthen oversight, directorship has developed into a fully-fledged profession. We also place much more emphasis on the difference between the management role and that of directors. 

Role of directors/board: A living person has a mind which can have knowledge or intention, or be negligent, and has hands to carry out his intentions. A corporation has none of these; it must act through living persons. This is essentially the role of the board. The board is providing strategic direction whilst management executes the strategy. The board's duty is dualistic: it needs to look after the performance of the company (contributing know-how, expertise and external information, networking, representing company, adding status; policy formulation, foresight and strategic thinking) and whilst keeping the company under prudent control (judging, questioning, supervising management, watchdog, confidant and safety valve, accountability, supervision of management). 

Boards need to use their judgment to achieve the right balance between conformance and performance, and it presents a dilemma that is insoluble. It should be clear from this already that it is no easy task to be a director. Add to that the greater responsibility that is placed on the shoulders of directors by legislative developments, and it is clear that we need very astute and experienced individuals to serve as directors. 

The stereotype of the retired executive taking up directorships is gradually changing as younger people begin to see directorship as a career path in itself. And although it is an emerging profession, there are no professional standards for a person to serve as a director. The closest that we come to such standards are the disqualifications provided for in the Companies Act, 2008 due to insolvency, conviction of fraud, etc. The Institute of Directors in Southern Africa (IoDSA) was recognised as the professional body for directors at the end of 2012 and we have since launched the professional designation, Chartered Directors (South Africa) which lays down the standards for individuals to serve as directors. Currently the designation is voluntary, but our hope is that the market will start insisting that CD(SA)s serve on board in order to ensure quality of and effective stewardship by boards. 

The new CD (SA) designation will provide these emerging professionals with a way of demonstrating that they meet a certain standard of knowledge and experience, and that they are committed to continuing professional development to maintain that standard. Holders of the CD (SA) designation will also have to adhere to a code of professional conduct and submit to the organisation’s disciplinary procedures.
Directors are required to have knowledge on corporate governance, corporate and other relevant legislation, financial and other reporting, and industry knowledge for a start. 

Directors are elected by shareholders, normally. King III prescribes a system for nomination committees to assist the board and shareholders in the election of directors to ensure that the board is properly composed. The nomination committee vets candidates for whether they have the requisite skills and attributes to serve on the board, and then makes recommendations to the board as to which candidates should be put forward for election by shareholders. 

But companies and prospective directors must do their homework before board appointments. Companies are hugely dependent on the skills and qualities of their directors for their long-term profitability and sustainability. This importance is reflected in the focus on the governance and performance of boards in new legislation, like the revised Companies Act, and voluntary codes such as the King Code of Governance for South Africa. 

Not surprisingly, companies are increasingly concerned to ensure that their boards contain the right mix of skills and expertise to help them implement their business strategies effectively. 

"Companies need to develop a robust process and set of criteria for assessing the board skills they need, what the gaps are and how to identify suitable new candidates,” says Parmi Natesan, senior governance specialist at the IoDSA. "There are certain obvious things that everybody looks at, such as independence and experience, but there are other issues that can be forgotten, such as whether the prospective director actually has enough time available to discharge his or her commitments properly, or whether the fee required is affordable.” 

Natesan goes on to say that prospective directors also need to take the time and trouble to perform a similarly intensive due diligence exercise on companies whose boards they have been asked to consider joining. This exercise would include researching the company’s current and future risks and performance, as well as the effectiveness of the board and its culture. 

"Given the hugely increased exposure to personal liability that the new Companies Act imposes on directors, I can’t stress enough the importance of informing yourself about how the company is run and what risks it faces,” Natesan comments. "For example, consider the position of people who joined the boards of construction companies after the World Cup but before reports of collusion came to the fore. It’s an extreme example, but prospective directors can’t take anything for granted. While there’s no guarantee one will uncover all problems, the time to investigate is before one joins the board!” 

Natesan is a member of the IoDSA’s Corporate Governance Network, which recently launched a guide to help companies and prospective directors conduct an effective and comprehensive due diligence exercise. The paper contains comprehensive sample questions that both companies and prospective directors should consider. 

"The paper is intended to be a highly practical guide that provides a starting point for companies and individuals to construct their own due diligence exercises, not a checklist,” Natesan concludes. "It can also be tailored to meet the needs of trusts, parastatals and other entities with boards.” 

If a director does not perform his/her duties properly they can be removed by shareholder or the board under the Companies Act. This is in order to hold them accountable to those who
invest in the company. As a governance principle, directors retire on a rotation basis and on rotation they can make themselves available for re-election. This process prevents a situation where directors become entrenched in their positions. 

Fees to directors are paid based on the number of meetings plus a retainer. It needs to be kept in mind that a director attends 4/5/6 board meetings in a year. To only rely on these for a sound understanding of the company is utterly foolish. Much homework is required between meetings to stay abreast of what is happening in the industry and also to attain the requisite knowledge of the company and its operations - hence the retainer.