Ethical Boardroom Summer 2019 by Ethical Boardroom

Published by Ethical Board Group Limited | www.ethicalboardroom.com

Summer 2019 The TEAM effect in CEO succession

Get to know internal candidates before the transition even begins

Keeping it above board Spotlight on overboarding

Cracking down on directors spreading themselves too thin

Intellectual property within the boardroom

Is IP a director and officer issue?

Insights into human rights

Good reporting can boost performance and assure stakeholders

Subsidiary compliance

Overseeing global entities in a world of rising risks

Remuneration and the impact of the European Shareholder Rights Directive II

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ISSN 205 8- 61 1 6

Ethical Boardroom | Contents

COMMENTARY

Closing the information gap Cue applause for the epic transformation of old-style clubby boards into skilled, independent oversight bodies

Steering investors to a sustainable future Corporate governance, sustainability and long-term investor issues in Europe and beyond

Increased expectations of governance and stewardship Institutional investors hold boards increasingly accountable for company performance and demand greater transparency

A holistic approach While traditional corporate reporting only takes stock of financial performance, integrated reporting reflects long-term value drivers

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MIDDLE EAST

Global News: Middle East Sustainability, gender diversity and foreign investment policy

BOARD LEADERSHIP

The team effect in CEO succession Team fit is an unusual selection criterion for new CEOs but can prove to be a powerful one

The case for sustainable board evaluation Ethical Boardroom chats to Andrew Woodburn, managing partner at Amrop Woodburn Mann

Company culture: expectation v. reality A recent study of supervisory boards in Germany reveals continued development, values and customer focus as areas for improvement

Leveraging the value of female directors Why do women directors regularly receive lower peer evaluations than men? The truth is, it has little to do with performance

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Contents | Ethical Boardroom

The six secrets of longevity Key elements provide a powerful stimulus to future growth and survival

Getting your ducks in a row for the next CEO The need to be prepared is urgent, and the time is now

AFRICA

Global News: Africa Board reshuffle, female CEOs and a controversial appointment

BOARD GOVERNANCE

Corporate governance through an internal audit lens We must transform to keep pace and we must do it now

Managing subsidiary compliance Overseeing global entities in a world of rising risks

Four global entity management trends to watch A landscape of robust economic growth and a surge in global deal activity should leave organisations feeling optimistic

CONTENTS 32

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Parent company liability When does parental control become too much? IP within the boardroom Is intellectual property a director and officer issue?

Remuneration and the Shareholder Rights Directive The impact of the European SRD II on companiesâ&#x20AC;&#x2122; AGM remuneration votes will vary widely across Europe

Executive compensation: metrics and correlation analysis It is important to consider several perspectives when identifying or confirming incentive plan performance measures

EUROPE

Global News: Europe Gender parity, takeover bid` and executive remuneration

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Summer 2019 | Ethical Boardroom 5

90 ACTIVISM & ENGAGEMENT

The German activism climate Investors have proven that shareholder activism can thrive in Germany

Spotlight on overboarding Policies, changing board profiles and shareholder activism could lead to fewer board commitments worldwide

Fit for duty The evolving roles and responsibilities of directors in the age of shareholder activism

Effective shareholder engagement What shareholders can learn from companies that have implemented successful change

The new rules on remuneration The Shareholder Rights Directive II and its implications for executive pay disclosure

ASIA & PACIFIC

Global News: Asia Pacific Ethical investing, gender diversity and corporate governance

REGULATORY & COMPLIANCE

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German businesses: Itâ&#x20AC;&#x2122;s time to take action How companies can minimise risk by implementing a tax compliance management system

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Building a sustainable approach to tax governance Companies should treat tax as a corporate governance matter and focus on risk and compliance

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Playing by the rule of law Compliance in context â&#x20AC;&#x201C; we all have a responsibility to pay attention to potential risks

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Unexplained wealth orders: A reality check Can the UK stay open for overseas investment if it ramps up its anti-money laundering measures?

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Embedding a sense of accountability The importance of awareness and education in achieving an ethical ethos

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Human rights: Reporting insights Good reporting will help companies assure their stakeholders that they are meeting responsibilities

NORTH AMERICA

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Global News: North America Executive neglect, ESG disclosure and gender diversity

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THE EB 2019 CORPORATE GOVERNANCE AWARDS

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Inroduction & Winners list We reveal the 2019 Americas and Caribbean Award winners

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10 Principles of corporate governance Republic Financial Holdings reveals its statement of corporate governance practices

LATIN AMERICA & CARIBBEAN

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Reinforcing the need for diversity in Latin America’s boardrooms A look at the progress and dynamics at play in five countries

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Breaking the remuneration taboo Why it is ‘politically correct’ to talk about a board’s remuneration

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Global News: Latin America & Caribbean Corruption, investors, corporate responsibility and good governance

TECHNOLOGY

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Focussing on ESG How can a board governance software manage ESG programmes efficiently?

Summer 2019 | Ethical Boardroom 7

Ethical Boardroom | Foreword

FirstGroup and its investor revolt

Welcome to the Summer 2019 edition of Ethical Boardroom magazine Over the past year, Scottishbased bus and rail operator FirstGroup has been under attack from its largest investor, New York-based hedge fund Coast Capital Management, which wants sweeping changes to the board.

One of the main objections from Coast, which owns a 10 per cent stake in FirstGroup, is the company’s governance structure, specifically the composition of the board and what it sees as a ‘lack of experience’. In its hard-fought campaign, Coast has also pushed for a break-up of FirstGroup, proposing a sale of its US bus business and an escape from Britain’s unsettled rail industry.

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The activist fund won the backing of FirstGroup’s second and third largest shareholders Columbia Threadneedle and Schroders for its campaign but failed in its attempt to unseat half the board and replace them with its own nominees to implement the break-up plans. Prior to the vote in June – where FirstGroup defeated the attempts to oust six board members, including the chief executive and chairman – the rail operator slammed Coast as ‘an opportunistic, self-interested player that is only focussed on short-term gains’. However, despite seeing off the coup, chairman Wolfhart Hauser agreed he would step down from the company in July. FirstGroup has insisted that its ‘formal and rigorous process to select a new chair’ is well underway, overseen by senior independent director David Robbie in his interim chairman role. But attempts at peace talks again recently ended in

acrimony with Coast angry at the pace of plans to find a replacement for Hauser and the war of words appear destined to rumble on. The rise in the popularity and public visibility of shareholder activism has led some analysts to speculate that it could lead to a gradual reduction in the number of board positions taken on by directors. According to Olshan, a leading law firm to shareholder activists in the US, directors who have personally been on the receiving end of an activist campaign and experienced the spike in working hours required to respond to the activist are beginning to think twice about taking on additional board positions out of fear of being spread too thin. Turn to page 80 of this issue to read more on this topic. Also in this issue (page 76), we hear from Amadeus Moeser at law firm Sidley Austin LLP, on shareholder activism in Germany and Arthur B. Crozier (page 86) discusses being ‘fit for duty’ and the evolving roles and responsibilities of directors.

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Contributors List | Ethical Boardroom

OUR THANKS TO THIS ISSUE’S CONTRIBUTING WRITERS AMADEUS MOESER Associate Corporate/Private Equity at Sidley Austin LLP

MORTEN BENNEDSEN & BRIAN HENRY Morten is the Academic Director of the Wendel International Centre for Family Enterprise at INSEAD. Brian is a PhD Research Fellow, INSEAD

TORBEN FISCHER & SANDRA SÖBBING Torben is a Forensic, Risk & Compliance Partner in the Hamburg office. Sandra is Tax Advisory Partner in the Frankfurt Main office, BDO AG Wirtschaftsprüfungsgesellschaft

ANDRÉS BERNAL & CATALINA ROJAS Both Partners at Governance Consultants S.A

DAVID MORGAN Managing Director of PKF Integrity

ANNE-SOPHIE BLOUIN Senior Director of Executive Compensation, Willis Towers Watson

DAVID GRACIE Head of Global Entity Management Services, KPMG in the UK PATRICK HAGGERTY & JOHN SINKULAR Both are Partners at Pay Governance LLC

PAOLA PEROTTI CEO and Managing Partner, GO Investment Partners LLP

RICHARD F. CHAMBERS President and CEO, The Institute of Internal Auditors

TOM JOHNSON Chief Executive Officer, Abernathy MacGregor

GREGORY PRICE Tax partner at Macfarlanes LLP

ROBERT CLARK Manager, Legal Research at TRACE

KEVIN KALINICH & KRISTIN KRAEGER Kevin is the Global Collaboration Leader, Intangible Assets Solutions, and Kristin is the Managing Director, National Directors & Officers and Fiduciary Product/Practice Leader, Financial Services Group, Aon Risk Solutions

ARTHUR B. CROZIER Chairman of Innisfree M&A Incorporated and Lake Isle M&A Incorporated STEPHEN DAVIS Associate Director of the Harvard Law School Programs on Corporate Governance and Institutional Investors ALFREDO ENRIONE, DONNA FINLEY & GORDON ALLAN Alfredo is the founder and director of the Corporate Governance Centre at ESE Business School in Chile. Donna and Gordon are managing partner and senior associate at Finley and Associates KIMBERLY ERRIAH-ALI Group General Counsel and Corporate Secretary, Republic Bank Limited and Republic Financial Holdings Limited ANJA FIEDLER Managing Director, Denison Consulting

RICHARD KARMEL Managing Partner of Mazars’ London office JONATHAN LABREY Chief Strategy Officer, IIRC MARC DE LEYRITZ, JENS-THOMAS PIETRALLA & JAMES ROOME Consultants at Russell Reynolds Associates CRISTINA MANTEROLA Principal and Member, Egon Zehnder’s Diversity & Inclusion Council CHARLES MAYO, CHRIS OWEN & ADAM BRISTOW Charles and Chris are Partners and Adam is a Supervising Associate at Simmons & Simmons LLP London

ADRIENNE MONLEY Head of Investment Stewardship — Europe, The Vanguard Group

ANDREA RATZENBERGER VP of Sales & Marketing, Sherpany ANTONIO SOLER Vice President and Head of Global Services, CT Corporation CRISTINA UNGUREANU Head of Corporate Governance, Eurizon Capital DANIELE VITALE Corporate Governance Manager, Georgeson, London GEORGE VOLOSHIN Head of Paris Office at Aperio Intelligence Ltd STEVE WOLOSKY, ANDREW FREEDMAN AND RON S. BERENBLAT Partners at Olshan Frome Wolosky’s Shareholder Activism Group ANDREW WOODBURN Managing Partner at Amrop Woodburn Mann, South Africa and a Member of the Amrop Global Executive Board

EDITOR Claire Woffenden DEPUTY EDITOR Spencer Cameron EXECUTIVE EDITOR Miles Hamilton-Scott ART DIRECTOR Chris Swales CHIEF SUB Sue Scott HEAD OF ONLINE DEVELOPMENT Solomon Vaughan ONLINE DEVELOPMENT Georgina King, Rosemary Anderson SUBSCRIPTIONS MANAGER Lucinda Green MARKETING MANAGER Vivian Sinclair CIRCULATION MANAGER Benjamin Murray HEAD OF SALES Guy Miller PRODUCTION EDITORS Dominic White VIDEO EDITOR Frederick Carver VIDEO PRODUCTION Tom Barkley BUSINESS DEVELOPMENT Michael Brown, James Walters, Henry Smart ASSOCIATE PRODUCER Lea Jakobiak HEAD OF ACCOUNTS Penelope Shaw PUBLISHER Loreto Carcamo Ethical Board Group Ltd ● Ethical Boardroom Magazine ● 51 Philpot Street ● London E1 2JH ● S/B: +44 (0)207 183 6735 ● ISSN 2058-6116 www.ethicalboardroom.com ● Ethical Boardroom ● twitter.com/ethicalboard Designed by Yorkshire Creative Media | www.yorkshirecreativemedia.co.uk. Printed in the UK by Cambrian Printers. Images by www.istockphoto.com All information contained in this publication has been obtained from sources the proprietors believe to be correct, however no legal liability can be accepted for any errors. No part of this publication can be reproduced without prior consent from the publisher.

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Summer 2019 | Ethical Boardroom 9

Commentary | Board Performance

Stephen Davis

Associate Director of the Harvard Law School Programs on Corporate Governance and Institutional Investors

Cue applause for the epic transformation of old-style clubby boards into skilled, independent oversight bodies

Closing the information gap It wasn’t long ago that Lord Boothby could describe a corporate director’s job this way: “No effort of any kind is called for. You go to a meeting once a month in a car supplied by the company. You look both grave and sage and, on two occasions, say ‘I agree’, say ‘I don’t think so’ once and, if all goes well”, you get a hefty annual fee. Those days are mostly gone – though not entirely. Board meetings at Nissan Motor under (now-ousted) chief Carlos Ghosn met for an average of 19 minutes, according to a

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special committee investigation, just about enough time for directors to slip in their ‘I agree’ on each agenda item before adjourning. But at most companies, thanks chiefly to years of shareholder pressure, crony is out, professional is in. We would expect such new-style boards to advance performance, oversight, risk management, ethical behaviour and alignment with investor interests. After all, those are the outcomes for which advocates of change were fighting for so long. But there turns out to be one inconvenient hitch, which is becoming ever more evident: the independent board model isn’t truly workable, at least not without a crucial reboot. Here’s the problem – the one many of those most deeply involved in the system,

directors themselves, admit to privately but rarely concede publicly: as much as they try, there isn’t enough help for boards to handle their responsibilities effectively. Directors are part-time, often with other demanding jobs, and meet somewhere between eight and 12 times a year as board members of a specific company. These directors are charged with representing shareholder interests in testing, approving and monitoring corporate strategy; hiring, paying, supervising and – if necessary – firing top management; and ensuring that a vast array of risks and opportunities are optimally managed. Set aside for now that sclerosis in board composition – the ‘pale, male and stale’ syndrome – is likely to contribute to directors missing capacity

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Board Performance | Commentary to handle decisions. Progress on diversity is under way, albeit too slowly. But progress is stalled across markets on efforts to correct another fundamental flaw in governance architecture: directors must handle their duties at the short end of a massive information imbalance. Management has a virtual continuous monopoly on data and insights on how the company performs. Even where directors call in outside advisors, for instance for transaction, remuneration, or director selection advice or the audit, agents’ ulterior loyalty may be to executives rather than to shareholders. By definition, board directors and company executives do not always share the same perspectives or interests. So policing conflicts requires robust director vigilance. Generally, a one-sided disparity gives management a routine advantage in influencing what independent directors discuss and decide. Cementing the information imbalance is the fact that the typical company board has no everyday dedicated staff. Instead, directors rely on an executive – usually a company secretary or general counsel – who is accountable to and works for management. These officers are often the silent heroes of corporate life, as they attend to multiple, sometimes conflicting, constituencies and do so with high ethics and professionalism. But make no mistake: they are not employed by and for the board. Indeed, outside observers would find it hard to fathom how companies go to such lengths to recruit great independent directors – only to make them largely dependent for help on the team they are supposed to oversee. To be sure, a handful of firms have introduced variations on independent board staff. AIG, after the financial crisis, separated its secretaries, naming one for the board and another for the

corporation. BP, in the wake of the with shareholder interests? Indeed, would Deepwater Horizon oil spill in the Gulf you hire someone under these conditions of Mexico, expanded the board’s own and expect an optimal outcome? If the secretariat to oversee central BP as well answer is no, then perhaps the time has as subsidiaries. Most recently, Nissan, come for directors, shareholders, and in efforts to recover from the Ghosn others to acknowledge that an empowered affair, declared that it would establish a board means an information-equipped dedicated office of the board.1 But beyond board. Without that feature, at many these, few companies have equipped their companies, directors will continue to directors with permanent, exclusive staff. push uphill in shepherding long-term Moreover, most corporate governance performance as well as ethical and codes around the world still only advocate responsible corporate behaviour. that directors tap independent advice in There are worthy arguments against special circumstances rather than as a independent board staffing, of course. permanent feature. It could be costly and therefore an Of course, one cohort of directors option only for large companies; it could does have regular access to rich stoke friction with counterparts in the back-office analysis that is separate from management team; it could wind up still management: board members nominated being reliant on management. But think by activist hedge funds. Activists may of a spectrum of options rather than a – and often do – share what they know one-size-fits-all template to address the with other directors. But where they challenge. For instance, a board could serve, there is a double information gap: go all in by assembling an independent management and activist-named directors secretariat group, such as at BP. Or it could can draw on deep wells of information have outside advisors, such as financial while garden-variety non-executives are experts, lawyers, or compensation analysts left dependent on either camp. The result is on retainer at the call of the board chair a troubling irony: without dedicated help, or lead director. Solutions should be independent boards are outgunned by right-sized for each company. activists, some of whom are short term, Shareholders can play a role, first, by and by executive teams that directors are routinely probing in their engagements elected by shareholders to oversee. with companies how the board furnishes Making matters worse, the itself with ongoing information muscle. lack of dedicated staff has Investor stewardship proven no impediment to the Directors are professionals can then ever-rising tide of guidance responses and, trapped in a vice assess calling on corporate where answers are of mounting directors to do more, unpersuasive or smarter. A recent report expectations and unambitious, champion from FCLT Global is as good more effective boardscant resources. an example as any. The empowerment options. Long-term Habits of a Highly Policymakers, for their Would you hire Effective Board rightly part, can beef up corporate someone under recommends that corporate governance codes with directors spend more time on these conditions a comply-or-explain strategy and communicate principle calling on boards and expect an more. But it omits mention to regularly disclose how optimal outcome? they satisfy the need for of independent staff to help make that happen. Directors ongoing, independent are trapped in a vice of mounting information. Codes can also include expectations and scant resources. new-crafted guidance on the different So, it is right to ask: in our current models by which independent board staffing governance architecture, can might be achieved, depending on the outside directors meaningfully company’s size, ownership and risk profile. oversee and counsel Market participants can be proud executives in alignment of having assembled the pieces of a well-functioning system of checks and balances in boardrooms. Independent information is what is now evidently missing, and it is a piece with the prospect of unlocking board potential. Giving directors the tools they need represents ‘governance 2.0’, the reboot to move boards from crony to professional to successful. 1 The author was one of two outside advisors to the Nissan Special Committee for Improving Governance.

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Summer 2019 | Ethical Boardroom 11

Commentary | Investment Stewardship LOOKING AHEAD Sustainability has an important place alongside profitability

Steering investors to a sustainable future Working at one of the world’s largest asset managers and meeting with the board directors and senior managers of some of the world’s leading companies is a great opportunity to better understand their corporate governance practices and to understand how those may or may not align with long-term shareholders’ interests.

In the last proxy year, we engaged with more than 700 companies and voted on just over 160,000 vote proposals. Our funds invest in more than 2,000 companies across 27 countries in Europe. Each market approaches corporate governance a little bit differently. In Germany, for example, employee 12 Ethical Boardroom | Summer 2019

Corporate governance, sustainability and long-term investor issues in Europe and beyond Adrienne Monley

Head of Investment Stewardship — Europe, The Vanguard Group representatives sit on a company’s board; in France, there are quotas regarding female representation on boards. While local norms and regulations may differ from country to country, we still believe that, no matter where we’re invested, good corporate governance is important for driving long-term value.

Shift to the long term

In the last five years, interest in the corporate governance practices of public

companies has been fast growing. This is especially true in Europe, where individuals and institutions alike are keen to ensure their investments in public companies are being managed well and in support of their long-term financial objectives. Despite this, globally, we see the challenge for companies to balance the demands of short-term investors with long-term value creation. Against this backdrop, policymakers in the European Union, the UK and countries across Europe are actively exploring how they can support longer-term behaviour in markets – both by companies and their investors. The European Commission’s approach to sustainable finance is a good example. The Sustainable Finance Proposals seek to enhance the integration of environmental, social and governance (ESG) factors into the financial markets. The revised UK Stewardship Code also takes an

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Investment Stewardship | Commentary interest in long-term sustainability matters through an investment stewardship lens.

Passive investors, not passive owners

Our stewardship team in London has noticed some key differences and similarities between approaches to corporate governance in the US and Europe. We’ve been surprised to meet a number of European companies who have never spoken with their long-term index investors, perhaps assuming that index investors don’t care about a company’s performance reporting, or corporate governance. In the US, engagement with index-oriented investors is more common – perhaps due to the historic success of index strategies, which are often a component of US retirement plans. In Europe, index investing is still on the rise and engagement with index-oriented investors is a newer practice for some companies. As a result, we often have more foundational conversations when first meeting with companies and discuss how our approach to investment stewardship may differ from that of active managers. You could describe index investors as structurally permanent shareholders. After all, they invest in a company as long as it features in the index being tracked. At Vanguard, we start with the premise that our funds will invest in a company forever. This extreme long-term view drives our approach to investment stewardship. We focus on how a company’s corporate governance practices will support sustainable value creation over the course of years and decades – not months and quarters.

A materiality-driven approach to ESG

As we are a long-term orientated investor, working to ensure our investments are sustainable, we look at ESG topics through a materiality lens. When analysing issues, we consider whether and where they may materially affect the company’s financial performance. The Sustainability Accounting Standards Board’s (SASB) materiality map provides good guidance on sustainability issues that could affect either the financial or operating performance of companies on an industry basis. We see a strong focus in Europe on the potential financial implications of sustainability issues. However, not all companies take the same approach regarding ESG and materiality. There is a risk that investors and companies can spend too much time on non-material issues than on those driving long-term value.

Sustainability in Europe

Factors affecting material sustainability can www.ethicalboardroom.com

take different forms across industries and geographies. It depends on relevant competitive forces, regulation, government action, consumer demand and preferences, and social and environmental considerations. For example, in the oil and gas industry, management of the physical, regulatory and reputational risks associated with greenhouse gas emissions is a key sustainability concern, whereas in the consumer goods sector, supply chain management and product quality and safety are likely more important. For a company to grow its value over the long term and for investors to achieve their long-term objectives, deliberate attention to and oversight of material risks is crucial. In the last year, sustainability has been a key theme in many of our engagements. In our experience, European companies are willing to discuss and disclose their approach to these issues, including topics drawing wide public interest, such as climate risk. In addition, many companies actively communicate with stakeholders – such as employee groups, non-governmental organisations, academics and others – on sustainability matters.

Across Europe, we see companies taking steps towards greater transparency on sustainability issues, which we support — particularly when focussed on practices relevant to long-term value creation Across Europe, we see companies taking steps towards greater transparency on sustainability issues, which we support – particularly when focussed on practices relevant to long-term value creation. This increasing comfort with transparency isn’t surprising, as many countries and companies in Europe have joined in the aspirations of the Paris Agreement, support the UN Sustainable Development Goals or align with similar objectives. Even companies in industries not usually associated with sustainability, or directly linked with climate risks, appear to be taking interest.

Good governance means good communication

Still, at the heart of long-term sustainability are good corporate governance practices and, importantly, the responsibilities of boards of directors. Today, investors expect boards to understand and oversee material risks that may affect the company’s

future, including matters such as cyber or data risk, climate risk and human capital management. In turn, companies are being asked to communicate about and disclose their relevant risks in a way that is clear and useful to investors. This is a critical priority for investors who must understand the issues affecting their portfolio companies and appropriately value them in the market. We encourage companies to consider applying sensible frameworks, such as SASB for overarching material risks and the Task Force on Climate-related Financial Disclosures (TCFD) for more specific climate risks. Although we already see some companies embracing enhanced reporting on material risk topics, adoption is not yet consistent around the world. Globally, the TCFD has more than 500 supporters, representing a combined market capitalisation of more than $7.8trillion. These include 457 companies and 56 other organisations, such as industry associations and governments. Although the SASB standards were only recently released – in November 2018 – a rapidly growing number of companies have already adopted the standards. According to the organisation, there are currently 69 companies publishing SASB-aligned reporting while hundreds more reference SASB in relation to how they consider materiality. Industry initiatives across the globe are seeking to improve corporate governance and investor stewardship with similar sights on the long term. They range from governance and stewardship principles (such as the UK Stewardship Code, US Investor Stewardship Group and the global Principles for Responsible Investment) to enhanced corporate reporting standards (including SASB and the TCFD). This growing focus on the long term across the investment value chain is encouraging. Ultimately, if investors, companies and policymakers can broadly align around shared long-term objectives, we have a powerful opportunity to adopt common standards. This article is directed at professional investors in the UK and should not be distributed to, or relied upon by retail investors. This article is designed for use by and is directed only at persons resident in the UK. It is for informational purposes only and is not a recommendation or solicitation to buy or sell investments. The value of investments and the income from them, may fall or rise and investors may get back less than they invested. The opinions expressed in this article are those of the author and may not be representative of Vanguard Asset Management, Limited. Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority. Summer 2019 | Ethical Boardroom 13

Commentary | Corporate Governance

Increased expectations of governance and stewardship Institutional investors hold boards increasingly accountable for company performance and demand greater transparency

The past two to three years have been extremely important for strengthening the relationship between investors and companies.

We have seen increased interest and constructive effort for company and shareholder engagement, particularly around ESG topics; and more activist investor intervention when shareholder engagement was absent or when the trust between investors and companies was weak. We have seen the definition of corporate governance get broader and broader. While at the beginning it was seen as a way of enabling shareholders to be assured that their investments were being properly looked after, (i.e. the focus on internal controls and audit), the definition now talks about corporate governance – together with sustainability – being a means of fostering long-term growth and trust in business, contributing to more inclusive societies. 14 Ethical Boardroom | Summer 2019

Cristina Ungureanu

Head of Corporate Governance, Eurizon Capital The concept of stewardship is aligned with corporate governance and sustainability and needs to be applied both ways: investors and companies. It is about looking at the long-term interests of the business. As steward investors, we have started to look past short-term profit, while expecting companies to take a longer term view of the health and sustainability of their business. We continue to seek more communication and engagement around several priorities: overseeing competitive strategy in a world of disruption and convergence; enhancing risk management; navigating the dynamic geopolitical and regulatory environment; optimising long-term capital allocation strategies; embracing the workforce of the future; and strengthening board composition through strategic alignment.

New challenges, linked to new opportunities, have started to emerge – related to culture, social impact, disclosure and risks, and, with these, new responsibilities have been amplified for both investors and companies aligned.

Culture: an opportunity

Investors increasingly see the management of corporate culture as a critical element in the long-term sustainability of companies. A board’s involvement in corporate culture entails two things: understanding and shaping the forces that drive behaviour within their organisation, and making themselves aware of their company’s social footprint. In recent years, we have been talking about tone at the top when discussing board oversight and risk management. But now investors are asking boards: what is the tone at the bottom, what is the company culture, and are there any risks that stakeholders are taking www.ethicalboardroom.com

Corporate Governance | Commentary that would put the company itself at risk? These are all new and challenging topics for leadership teams. Investors recognise that an organisation’s chosen metrics of performance can affect organisational culture, values and behaviour. But we also acknowledge that the ‘quality’ of any organisation’s culture can affect the choice of performance metrics; it is a symbiotic relationship.

Remuneration: an opportunity

Remuneration is still a topic at the top of the investor agenda as the rewards landscape evolves. Investors will expect a complete change in approach by companies to one where remuneration is in tune with the company values and responsibilities to its wider stakeholders and societies in which it operates. Investors now expect to see ‘intangibles’, such as ESG, strong corporate culture and values, reflected in pay awards to executives. For long, investors did not want discretion in pay, while now expecting to see ‘intangible’ aspects, such as ESG, corporate culture and values reflected in the awards to executives. Discretionary pay and long-term incentives payments should not be used as a mechanism for increasing total remuneration. Instead, companies are expected to start from the principle that exceptional pay should only be for exceptional performance. Remuneration committees are expected to play a more active role in encouraging greater rigour around remuneration practices and overseeing the policy from a wider perspective. Investors also expect to see committees interacting with the human resources, risk and sustainability functions of the corporations as they show more consideration towards human capital and stakeholders’ interests.

Disclosure: an opportunity

Investors are seeking information that provides the confidence that management and boards of the investee companies are thinking long term. Our interest in more disclosure and interaction arises from the desire for improved performance, both from a financial perspective and in terms of overall corporate governance. It is important not only that the board members are fully informed, but also that they can demonstrate to others that they are. Investors need to have comfort that the board has explored the full spectrum of risks the organisation has faced, that the right information has been supplied and the right questions asked. For example, human capital management, increasingly seen by investors as material to long-term performance and risk mitigation, is also an important aspect of integrated www.ethicalboardroom.com

business reporting that unifies financial and non-financial risk disclosures. Investors have also acknowledged that climate change represents a significant economic shift following the Paris Agreement and we are growing impatient with companies that are not adequately disclosing how a two-degree Celsius future impacts their business, and how they will navigate the related risks and opportunities. Boards and senior management should ensure that climate risks are incorporated into strategic decision-making and that appropriate consideration is given to the need for disclosure of relevant financial-related risks.

global customer base and to reduce the risk of boards losing their connection with society as a whole when discussing issues like remuneration and social concerns. Investors start seeing the value of a board succession procedure that enables potential candidates to be assessed on the basis of whether they would move the board closer to that ideal. In this context, board self-evaluation is an important tool to promote board succession. By looking at its strengths, a board can gain a better understanding of where it is currently putting its energy and determine if it has the right balance to deal with the issues and strategic concerns its organisation is facing. Risk management: On the other hand, investors themselves an opportunity also play an important role in ensuring The disruptive forces that are bringing that boards are built for the future and about a rethink of strategy are also are the right fit for each company’s rapidly changing the risk landscape and strategy. We look to the evaluation process pushing companies to reconsider their as an indication of board succession approach to risk. In order to sustain practices and governance proficiency. growth and performance beyond 2020, We expect boards to be transparent and companies need to apply a more balanced, proactive about the evaluation processes, agile and integrated approach to enterprise to communicate and use the results. risk management. For example, in Italy, the practice Boards will need to confirm that (recommended also by the Italian Corporate management gives appropriate Governance Code) of current boards consideration to managing risk/return issuing guidelines on future board trade-offs to drive value creation. composition allows boards to measure Boards are expected to apply a nuanced and adjust their composition and strategy, approach to risk management to while investors are able to gain confidence support the realisation of in the board’s preparedness opportunities associated with Aside from for the future, getting a sense strategic risk-taking while of its evolution. the concept of minimising exposure to preventable and external ‘independence’, Change in mindset To achieve the opportunities risks, including ESG-related. investors are of a sustainable future, Board composition: investors and companies increasingly an opportunity are expected to have a scrutinising Companies are responding change in mindset – be more the ‘diversity’ to all this by undergoing a forward-looking and place strategic rethink, while attention to the substance of company boards are increasingly rather than the form. boards coming under pressure This all requires a long-term from both the market and perspective on the purpose of regulators in terms of effectiveness and each company, its finance, culture, values accountability. and corporate governance. By weaving a Investors continue to see boards’ role as healthy corporate culture and governance decisive in ensuring that new challenges into the business model, companies are and expectations on how companies meet not just contributing to the overall success them are valorised and ensure they are of their own business but also creating effective and focussed on protecting the an environment on which investors can long-term sustainability of the business. rely. Investors can leverage this through Board composition is fundamental stewardship; thus both companies and to ensure board effectiveness. Aside investors are geared to create sustained from the importance of the concept of growth in the economy. ‘independence’, which is paramount for As long-term investors, collectively investors contributing to the submission we need to think differently, because of candidates to the board, investors are addressing sustainability aspects such increasingly scrutinising the ‘diversity’ of as culture and values, human capital or company boards. A board with members climate change, is not only about what from diverse backgrounds is more likely you stop doing but, more importantly, to reflect the concerns of an increasingly it is about what you start doing. Summer 2019 | Ethical Boardroom 15

Commentary | Integrated Reporting

A holistic approach While traditional corporate reporting only takes stock of financial performance, integrated reporting reflects long-term value drivers Jonathan Labrey

Chief Strategy Officer, IIRC

The role of an accountant has evolved over recent years. As Richard Chambers, president and CEO of the Institute of Internal Auditors phrased it at the International Integrated Reporting Council’s global conference in London this year, accountants used to be referred to as the ‘bean counters’, but nowadays they are responsible for nurturing, growing and protecting ‘the bean’ throughout its life. 16 Ethical Boardroom | Summer 2019

As such, accountants increasingly provide strategic insights over the value creation chain of the organisation, recognising and promoting the vital importance of a whole range of resources and relationships needed for an organisation to realise its long-term purpose. At the International Integrated Reporting Council (IIRC), we have categorised these resources and relationships as six capitals that the organisation uses and effects to create value. They include financial, manufactured, human, social and relationship, intellectual, and natural.

Given the growing responsibility for understanding how the different strands of the business contribute to the strategy and the success of the business model, accountants naturally take on an important role when it comes to ethical issues – setting the standard for the organisation to live up to and providing leadership over the reporting process to identify any inappropriate or misleading business practices. Vital for the sustainable development and financial stability of the organisation, this evolution in the role of an accountant has led them to develop their expertise beyond the figures. www.ethicalboardroom.com

Integrated Reporting| Commentary

ETHICS ARE A PRECIOUS RESOURCE Integrated reporting helps conserve it

Importance of transparency

Of course, there will always be cases of fraud and corruption in organisations, whichever country they are based in and however tight the regulatory environment is. However, transparency is key to mitigating the extent to which these happen. It isn’t a cliché to say that shedding light is often the best disinfectant. And yet, slips in ethical behaviour – in my experience – all too often happen, not because of a desire to con or cheat the system, but because of mistakes in analysing the past and forecasting the future performance of the organisation – and because of a lack of ownership or oversight of the real drivers of value within an organisation. Companies need to get better at developing, more robust information and then channelling this information for effective decision-making through embedding a strategic, holistic approach to doing business. To do this effectively, it is important to understand the materiality of the data that is collected – to understand how it impacts the ability of the organisation to create value in the short, medium or long term. Whether it is data about the organisation’s intellectual capital, or its www.ethicalboardroom.com

use of carbon, when management is presented with data, it is vital that they understand why this information is material, whether it presents a risk or opportunity and what it means for the long-term viability of the organisation. All too often, organisations produce streams and streams of data – but never stop to analyse why they are collating it or what its effect is. At the IIRC, we encourage organisations to break down silos and embed governance systems that mean management are across all of this information, understand its relevance, and can use it to communicate with investors and other key stakeholders, as well as to inform their own decisions. As a result, individuals are less likely to make mistakes in their analysis and forecasting. And when individuals have a solid grasp of the information they need, they are less likely to fall into ethical traps where they are scrambling in the dark to get out. Integrated reporting provides the framework for companies to channel this information strategically. The International Integrated Reporting Framework (International <IR>

The main driver for the adoption of integrated reporting has been through the development of corporate governance codes internationally that signpost to the International <IR> Framework as an effective tool for establishing rigorous and effective governance Framework) was developed over a threeyear period by businesses and investors from around the world that implemented and tested its principles so that the result, which was published in December 2013, was a Framework that is grounded in the needs of the market.

<IR> Framework take-up

Fast forward to 2019 and the Framework has been voluntarily adopted by thousands of organisations in countries across the world. Its success has been down to its principlesbased nature – forcing management and the board to really consider issues across the value creation chain that would not have been on the agenda before. In one company we are aware of, it

caused the management team to build a completely new focus for the business as they realised its current business model was far too short term. All too often, boards are so focussed on the finances that they fail to set the right tone at the top across the other capitals the organisation uses. A vital aspect of the International <IR> Framework is the demand for the board to sign off on an integrated report, signalling to key stakeholders that they can put their faith in both the board and the senior management to have installed the very best governance practices. The main driver for the adoption of integrated reporting has been through the development of corporate governance codes internationally that signpost to the International <IR> Framework as an effective tool for establishing rigorous and effective governance. Codes in Japan, Australia, the Netherlands, Malaysia and South Africa – to name just a few – have all led to organisations voluntarily turning to the International <IR> Framework to support not just integrated reporting, but also integrated thinking. In a complex, interconnected and often confusing corporate reporting system, integrated reporting has been singled out by the International Federation of Accountants as the ‘umbrella’ for the corporate reporting system. It is the golden thread that weaves financial, sustainability and governance information together to deliver one holistic story that all stakeholders can access and understand.

Benefits of integrated reporting

Academics have concluded from those adopting integrated reporting that it leads to a lower cost of capital, higher share price performance and a longer term investor base. A range of internal benefits have also been identified, including better engagement from staff who can understand the purpose of the organisation and their role in realising this purpose. However, the real benefits from integrated reporting won’t just be delivered by individual organisations adopting the <IR> Framework. They will be delivered through a system change in the way we think about capital and the way we approach doing business – in broadening our understanding so that finance is put on an equal playing field with the other drivers of value – such as human, intellectual and natural capitals. By embracing this new approach to doing business, organisations will be best placed to drive financial stability and sustainable development through prioritising the long-term needs of the organisation and its key stakeholders. And then, we will have truly used transparency to dull the threat of unethical behaviour. Summer 2019 | Ethical Boardroom 17

Global News Middle East

Dubai regulator targets leaders in Abraaj probe

Diversity Council MENA launch boosts women The Diversity Council, the international inclusion and diversity accelerator, has expanded into the Middle East and North Africa with a focus on strengthening the pipeline of female talents. Founded in Denmark, the key objective of the Diversity Council has been to address the barriers that obstruct the advance of more women to the top level of management. Regional companies, including DP World, GFH Financial Group, Accenture, Headspring Executive Development and the Saudi Industrial Development Fund, aligned as founding partners to launch the diversity accelerator in the region. At its launch in Dubai’s Palm Jumeirah, Tine Arentsen Willumsen, founder of The Diversity Council, said: “This first meeting in Dubai has begun the process of sharing cross-industry know-how on achieving inclusion and gender diversity, with companies committed to leading this important agenda.”

DEWA promotes sustainability in Singapore Dubai Electricity and Water Authority (DEWA) has visited Singapore to promote joint relations and exchange of best global experiences and practices in renewable and clean energy and sustainability. Saeed Mohammed Al Tayer (pictured above), managing director and CEO of DEWA, teamed up with Masagos Zulkifli, Singapore’s Minister of Environment and Water Resources to host the discussions. During his visit, Al Tayer visited the Solar Energy Research Institute of Singapore in the National University of Singapore, which specialises in research and development on applied solar technologies as well as their integration into energy and building systems. The two sides also discussed the production, transportation and distribution of renewable energy, energy efficiency projects and digital transformation.

Saudi Arabia relaxes foreign ownership rules Saudi Arabia has introduced new regulations allowing for broader foreign ownership of publicly traded firms. The Riyadh-based Capital Market Authority has removed maximum or minimum limits on the ownership of listed companies for foreign strategic investors. The limit was previously 49 per cent. To encourage long-term investment and knowledge transfer, foreign strategic

18 Ethical Boardroom | Summer 2019

investors will not be able to sell any of their shares for two years and must be based in a regulatory environment that applies similar standards to Saudi Arabia. The Saudi stock market, which opened to foreign investors in 2015, has seen an upsurge in foreign fund flows since the start of the year due to its inclusion in the emerging markets indexes.

Dubai’s financial services regulator’s investigation into collapsed private equity firm Abraaj is focussing on the firm’s senior management. Abraaj dominated the emerging market’s private equity sector before it collapsed, managing nearly $14billion. The firm entered provisional liquidation last year after running up debts of more than $1billion. The Dubai Financial Services Authority said it is putting its main attention on ‘senior management responsible and persons who may have failed in their responsibility to identify or report irregularities’. Six former Abraaj employees, including founder Arif Naqvi, have been charged with multiple counts of fraud and racketeering.

Qatar regulator bans Guardian Wealth pair

Qatar Financial Center Regulatory Authority (QFCRA) has banned and fined two directors of insurance brokerage company Guardian Wealth Management Qatar (GWMQ). GWMQ was an insurance intermediary firm that sold mainly long-term savings plans in Qatar but is now in liquidation. QFCRA has imposed a penalty of $200,000 each on David Howell and John Hasberry, who were both directors of GWMQ. They are also prohibited from being employed by any authorised firm in the QFC for three years. The regulator has also issued a ‘public censure’ against Vincent Jones, the chairman and independent director of Guardian Wealth for contraventions, including ‘the failure to establish an appropriate corporate governance framework’. Both men say they are innocent and expect to be cleared of any charges.

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Board Leadership | Changing CEOs

Marc de Leyritz, Jens-Thomas Pietralla & James Roome

Consultants at Russell Reynolds Associates

team effect in CEO succession

The

KEEPING IN TOUCH Companies must get to know internal candidates before the CEO transition even begins 20 Ethical Boardroom | Summer 2019

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Changing CEOs | Board Leadership

Managing the CEO succession process is a board’s ultimate responsibility. Beyond risk mitigation, CEO succession planning contributes to the successful governance and management of the company. It also helps inform and align the board on the development of the senior management team. Perhaps not surprisingly, close attention to the succession process proves to be a key differentiator between best-in-class boards and others, according to Russell Reynolds Associates’ recent survey of 750 directors around the globe. In the course of surfacing and evaluating candidates to succeed the current CEO, boards typically consider a wide array of factors: key competencies and experiences, past roles and companies, colleagues’ perceptions, vision of the future and, increasingly, psychological profiles and leadership potential. One factor that often does not get enough attention in the succession process, however, is the impact that the new appointment will have on the rest of the organisation’s senior leadership team. This team effect is less studied and less predictable than other aspects of the CEO transition phase, yet it is an essential variable to understand. The reality is that nearly any CEO transition is likely to have a ripple effect across the organisation’s top leadership. At one extreme, consider a new CEO who is brought in from another organisation to carry out a turnaround or transformation. In this case, it is almost a given that the new CEO will aim to clean house and start afresh with a handpicked leadership team. At the other end of the spectrum, a well-respected member of the current management team who becomes CEO may not intentionally push out colleagues, yet by default, those who were also contending for the CEO title may well decide to look elsewhere for new opportunities. In the middle, team disruption can take on any number of other flavours. Some people leave pre-emptively because they are worried about or frustrated with the new appointee; others become obsolete in a new, severely disrupted environment. All of this turnover is compounded by the fact that decisions about the composition of the new team typically take longer than they should, creating lingering uncertainty both before and after the CEO transition. While boards cannot completely eliminate unwanted turnover among the www.ethicalboardroom.com

Team fit is an unusual selection criterion for new CEOs but can prove to be a powerful one

optimal development plans for the broader executive team and potential options for organisational redesign. These development plans allow the board to get more clarity on the depth of talent among those who currently report to the CEO and encourage measures that strengthen it well ahead senior leadership team during a CEO of a transition. transition, they can mitigate its downside The key starting point for any robust by planning and preparing for it. To start, CEO succession process is to consider the existing CEO and board should pay the company’s long-term strategy: particular attention to the quality and what are the critical opportunities depth of the existing talent bench in the and risks that the company will be facing years leading up to a CEO transition and in the next three to 10 years? In other take steps to strengthen and retain key words, what are the organisation’s members. As the time to select a new CEO near-term needs, and what are the draws near, board members should also longer term ones? In addition to the play out the likely turnover scenarios marketplace perspectives that industry associated with each candidate and decide and financial analysts can provide, how much additional change they are it is critically important for the board comfortable catalysing. The team impact to ask the current CEO and senior is obviously not the only factor to consider leadership team members to reflect on in the selection process but, like any the company’s future challenges. This other factor, it is essential to approach it exercise has two purposes. On one hand, with clarity and thoroughness. After the current leaders can provide first-hand selection, both the board and incumbent observations about the company’s CEO should move quickly to make and opportunities and risks, as well as communicate team decisions to minimise operational strengths and gaps. On the period of uncertainty. the other, they provide unparalleled insight about the dynamics of the current Starting points for success management team and how the group Selecting a new CEO is a complex and is likely to react to various potential multifaceted process. To prepare for the CEO candidates. next CEO transition, board members must A related question is whether, in broad have a deep understanding of the current terms, the organisation requires a CEO organisation and who is a disrupter , who is leadership, but at the ready to make large-scale A thoughtful, same time, align on a changes, or a stabiliser well-conducted common view of the who can maintain what is company’s long-term already in place? A third CEO succession challenges and strategic dimension relates to the process comprises team: to what extent will plans. Considering the fast pace of change, a certain amount it be important to retain the competencies and current senior leaders of transparency experiences a CEO needs compared with bringing for future success may in new leaders with that also has evolve over time – meaning fresh perspective? side benefits that the heir apparent at At any point in its life, an one point in time may not organisation needs a different be the right person to lead the company set of roles to help it evolve into the next once the transition actually occurs. phase of its journey, including a custom In terms of best practices, we advise mix of impact and efficiency and of clients to start the succession process short-term and long-term perspectives. as early as possible and keep it ongoing. Weighing the team Detailed dialogue should start at least When it is time to select a new CEO, two years in advance of an appointment board members will weigh long-term to allow for two or three iterations of strategy against the strengths candidate pools, including in-depth and weaknesses of leading CEO assessments of leading candidates. One candidates. At this point, they should year is too short to allow for more than also incorporate the team effect. baseline assessments. In essence, there are four core A thoughtful, well-conducted CEO scenarios, hinging on the extent to succession process comprises a certain which the organisation must change amount of transparency that also has its strategy and the extent to which side benefits. It helps the board assess the it must change top leadership. best CEO candidate and also illuminates Summer 2019 | Ethical Boardroom 21

Board Leadership | Changing CEOs

CEO SUCCESSION IMPLICATIONS FOR EXECUTIVE TEAM High Need for new strategic direction

If the organisation is in need of a new strategic direction to succeed, and the current executive team capabilities match the short-term turnaround and longer term transformation capabilities required, the best choice would be to strive to hire a CEO whose personality and sense of culture fits into that team. While some turnover will be inevitable, a CEO who fits in can minimise it. However, if the executive team capabilities are not aligned with the needs of the new strategic direction, and reshuffling the team is a requirement, the new CEO should be someone who is more disruptive. He or she should be comfortable and ready to select a new team that can radically change the company in the ensuing three to five years. If there is no need for a drastic change in the strategic direction of the company, and the current executive team’s capabilities, culture and results are strong, then it is best to select a CEO who can fit into the team and help retain and develop existing leaders. If the strategy is strong, but current executive team members are not well suited to deliver it, the new CEO should be a disrupter, ready to change the team while selectively retaining members for continuity (see table above). Regardless of the desired direction for the company and leadership team, it is essential to manage the transition to a new CEO with integrity. On one hand, creating a formal onboarding or transition process for the new CEO that involves multiple stakeholders across the organisation will help smooth the path and increase the odds of success. On the other, the board can minimise the risk

Reshuffle the executive team: New CEO can be a disrupter

Selectively retain the executive team: New CEO to ‘fit into’

Change /selectively retain the executive team: New CEO can be a disrupter

Retain the executive team: New CEO to ‘fit into’

Low Low

Current executive team fit

of excess turnover by ensuring that other team members (including unsuccessful CEO candidates) get rapid and robust feedback about their near-term opportunities and where they fit into future succession plans. In the absence of clarity, many executives assume the worst – or make unrealistic assumptions about what is possible for them to achieve. By encouraging the new CEO to move quickly on team decisions – even ahead of officially taking the role – boards can help minimise the possibility of unwanted turnover or mismatched expectations.

Toward a broader view of succession planning

Team fit is a fairly uncommon selection criterion for new CEOs today but, when used properly, it can be a powerful one. Board members cannot prevent leadership team turnover, but they can help the organisation

High

prepare for it. Part of preparing may involve forecasting who will leave and how best to fill their spots, rethinking organisational structure and casting a net for strong external and internal candidates who could bring fresh perspectives. In addition, as part of the ongoing leadership development process, the board can and should also strategise with the incoming CEO about alternate roles and development opportunities for leaders that the organisation would like to retain. The team effect is just one of many broader variables a board should consider beyond past experiences and proven competencies when selecting a new CEO. By investing the appropriate amount of time and thought in the succession process, board members can look beyond the obvious choices and optimise CEO selection as well as the benefits of the process to the organisation.

SELECTING A NEW CEO Board members can help their organisation prepare better for leadership team turnover 22 Ethical Boardroom | Summer 2019

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Board Leadership | Evaluations

Ethical Boardroom chats to Andrew Woodburn, Managing Partner at Amrop Woodburn Mann EB: What do you see as the current pitfalls of board evaluation? AW: First, let’s take a look at the big picture. Business and global markets are undergoing a profound transition, from a short term, shareholder or mainly commercial focus (or smart boards), to a longer-term, stakeholder focus, (or wise). As we’ve previously argued in this journal, overconfidence, biases, sub-par organisational structures and financial pressures can all lead accomplished leaders with seemingly robust moral compasses to make poor calls. This can cause huge reputational and financial damage, and we’ve seen a host of headline-dominating scandals and resignations in the last few years. In emerging markets, there are even more systemic weakness in governance – firms either don’t buy into the frameworks that may be in place, or actively misuse them. So, we can describe wise board leadership as holistic and ethical. It takes multiple perspectives into account. It’s fundamentally about business – via good governance – earning operating legitimacy. It’s a

matter of sustainability – as summarised by environmental, social and governance (ESG) criteria. Smart boards become wise(r) when they holistically address socio-economic and environmental business dilemmas. They don’t just create and capture vital economic value; they build better organisations. And this is becoming materially more important. A recent survey from Oxford University’s Saïd Business School and Harvard Business School, found that 82 per cent of investment executives now look at a company’s ESG information, spurred by growing client demand or formal mandates. But they face incompatible reporting across firms and a lack of reporting standards.1 Now the question is the extent to which the approach to board evaluation is evolving into an assessment of ‘sustainable board governance’. Here I’d argue that there is a considerable way to go, even in more mature markets that are guided by clear governance codes, such as the UK or South Africa. South Africa’s King IV contains the concept of ‘corporate citizenship’. This embraces non-financial criteria, such as ethics, sustainability and customer care. In short: ‘doing the right thing’ and in a sense ‘bigger’ than ESG criteria. It is for each board to specifically tailor the concept to their individual business. The core issue is how to transcend conformity or box-ticking in board evaluation, To move from a smart to a wise approach. Asking

whether as a board you’re satisfied with sticking to the letter of the codes or also consider the spirit of the codes and strive for a higher level of moral excellence. When you drill this down to an organisation’s attitudes to external board advisory services, these have been a mixture of ‘grudge purchase’ and ‘reflective best practice’ (with a slight emphasis on the former). One-off engagements tend to be standard procedure, sticking to the letter of the codes. So, there needs to be a shift from cost focus to investment focus. And investment is directly proportional to quality of service and rigour of process. Currently, this process typically encompasses assessment in-house, online surveying using basic metrics, perhaps supplemented by face-to-face interviewing and consolidation of the insights. This leads to questions of objectivity and depth. A recent Harvard Law School Forum in conjunction with EY reviewed the most recent proxy statements filed by companies in the 2018 Fortune 100. 2 Only around one in four disclosed using (or considering) an independent third party to facilitate board evaluation at least periodically or combining questionnaires with interviews. There is a fundamental pitfall here. Due to the infrequency of board meetings throughout any given year and the long-term nature of board

Andrew Woodburn

Managing Partner at Amrop Woodburn Mann, South Africa and a Member of the Amrop Global Executive Board.

The case for sustainable board evaluation 24 Ethical Boardroom | Summer 2019

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Evaluations | Board Leadership deliberations, there’s a lack of pull through into consistent improvement over multiple periods when using ad hoc external assessments or self assessments. So, the first recommendation is a multi-year ‘programme’ approach. Global best practice would be to generate a set of engagements involving a depth of reflection across individual and collective performance, board processes and effectiveness, governance developments and strategy contribution and results over the short, medium and long term. A longer view also allows regulators and shareholders to assess the board’s commitment, both to ongoing measurement, and improvements in board practice. EB: What would that programme look like in reality? AW: When you consider financial auditing, for example, auditors often spend five or more years with a client before forced rotation (in some markets). Similarly, I’d argue for a threeto five-year programme, alternating between full board evaluation and online surveying, and including face-to-face interviewing. This should include a succession module at least once every five years (see Figure 1, right).

FIGURE 1: SUSTAINABLE BOARD EVALUATION — A FIVE-YEAR CYCLE $$$ Full face-toface evaluation — board & sub committees

Online survey

Face-to-face evaluation — board KPIs

Online Survey

Year 1

Year 2

Year 3

Year 4

Year 5

Board performance

Strategy

Composition

Governance

Strategy

Governance

Culture

Risk

Structure

Operations

Communication

Corporate citizenship

Selection/ performance management

Check implementation of Year 1 + Year 2 recommendations

Review implementation of Year 1 + Year 2 recommendations

Structure Leadership Ethics Individual member performance

Cooperation with stakeholder groups Business results Check implementation Chair/CEO/CoSec of Year 1-5 performance recommendations

$$$ Full face-toface evaluation — board & sub committees

Governance Risk Operations Corporate citizenship

Structure

Succession module

Leadership

Board Members

+ Overview of 5-year changes + recommendations going forward

C-suite

Ethics

SMART AND WISE BUSINESS LEADERS A meaningful future requires corporate leadership to take moral responsibility www.ethicalboardroom.com

Summer 2019 | Ethical Boardroom 25

Board Leadership | Evaluations EB: What about different markets that face different cultural paradigms – Africa and Germany, for example? AW: This three to five-year cycle is customisable to processes and marketplaces. Organisations must ask whether they need a clear and public board behaviour framework, or only some guidelines? This often depends on the operating country, regulators and bourse compliance in the area of activity. It also stems from the company itself, whether public, private or non-profit. What is clear is that good governance codes certainly support a framework in the minds of investors and directors concerning what best practice is, as agreed by both sides. EB: You mentioned wise leadership. How could you build that into board evaluation? AW: Wise leadership translates into wise decision-making and Amrop has developed a model for this, working with Dr Peter Verhezen, a specialist in governance, ethical leadership and sustainability. We identified three pillars of wise decision-making (see below): Self Leadership – how leaders exercise self-governance; Motivational Drivers – what drives leaders’ choices; and Hygienes – how leaders nourish their decision-making ‘health’.

An Amrop study conducted on the basis of the model found gaps between positive intentions and practice. 3 The concept clearly translates into questions about organisational purpose and, in turn, to core questions about evaluating the functionality of individual board members – and boards as a whole. The starting point is to determine what kind of an organisation the board envisions. At what moral level should it operate? How important are non-financial objectives regarding sustainable performance? How should boards articulate a relevant business case and embed ESG, or even corporate citizenship criteria, in corporate reporting? The following questions could be considered for ‘sustainable’ board evaluation. For example, it’s important to uncover not only strategic proactivity and responsiveness, but also the value that individual board members attribute to sustainability and ESG criteria. Do they consider these vital for a legitimate organisation, or as mere window dressing? Where are the zones of tension (or consensus?). Regarding specific indicators linked to wise decision-making, how exemplary are individual board members and the board as a whole? What measures reinforce ethical standards and protect

these from short-term pressures? How are risk management and opportunism balanced? How does the board maintain its own feedback culture? What value is attributed to personal reflectiveness practices to maximise self-awareness? Finally, when recruiting board members, what criteria are in place to gauge their propensity to make wise decisions? Incorporating such indicators into board evaluation can enable boards to identify areas of improvement or reinforcement in this critical area. Given the current fragile trust in leadership, it’s essential to determine remedial measures vis-à-vis external and internal stakeholders. Space also needs to be reserved on board agendas to address these specific issues. They are quite simply becoming critical to an organisation’s legitimacy to operate. 1 Amel-Zadeh, A., Serafeim, G., (2017), Why and How Investors Use ESG Information: Evidence from a Global Survey, Said Business School, University of Oxford, Harvard Business School. 2Klemash, S., Doyle, R., Smith., J.C., (2018), EY Center for Board Matters, Harvard Law School Forum on Corporate Governance and Financial Regulation. 3Between Q4 2016 and Q1 2017, 363 executives representing all regions of the world and major sectors completed a confidential Amrop survey. 94% held posts at C-suite level or above. 75% of their organisations had an international presence. Several items were drawn from previously validated research and are referenced in the full report (www.amrop.com/insights).

WISE DECISION-MAKING AND STEPPING UP TO SUSTAINABLE PERFORMANCE: KEY FINDINGS FROM THE AMROP STUDY

SELF LEADERSHIP

Leaders are on the path from smart to wise, but missing vital steps and opportunities While leaders are cognitively smart, few reflect on (and learn from) experience or exercise ‘reflection in action’ when facing a problem. Many display high self-confidence — vital for leadership. Fewer systematically stop or adapt a decision given counter-evidence or are held back by risk. They are missing decision-engineering processes — mechanisms to transcend bias are under-used. Often neglected, too, is the involvement of diverse, qualified (and confrontational) stakeholders in decisions, risking groupthink and commitment bias. The moral guiding light is in sight, but often lost in the clouds Leaders value ethics: setting a high moral bar, scrutinising the route to a result, having clear (moral) codes. They display holistic thinking when solving hypothetical dilemmas surrounding profit, planet and people. Yet the majority had faced ethical blockages over the past three years. Overcoming these is 26 Ethical Boardroom | Summer 2019

3 PILLARS OF WISE DECISION-MAKING Focus: Factors within leaders’ scope of control Experience

Reflection Affective intelligence

Cognitive SELF LEADERSHIP intelligence

Leadership Purpose

Career MOTIVATIONAL choices DRIVERS

03 HYGIENES

Feedback-seeking Mindfulness practices

Guiding framework

perhaps not helped by the fact that only around half could easily describe their personal mission or their strengths and weaknesses, or that their values and principles helped them navigate dilemmas.

MOTIVATIONAL DRIVERS

Leaders are driven by service, virtue and entrepreneurship — but not to the point of self-sacrifice Driving these tensions into the epicentre of leaders’ lives by presenting five hypothetical career moves designed to test their key motivators, it was the need for power (prestige, social eminence and superiority) that prevailed. Few saw a position that was designed to appeal purely to ‘wise’

values and demanded a temporary personal sacrifice as a promotion.

HYGIENES

Many leaders are engaging in personal mindfulness practices — but feedback is often skipped Proactive feedback-seeking is vital for self-awareness and self-development, but our research found it far from widespread. ‘Mindfulness’ or ‘reflective’ practices are another important hygiene, supporting awareness and insight and often bringing about a state of ‘flow’. The positive effect on decision-making of walking, the most widely practiced, was far surpassed by a much less common practice amongst the leaders surveyed — meditation. www.ethicalboardroom.com

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Board Leadership | Supervisory Boards

Company culture: expectationvsreality A recent study of supervisory boards in Germany reveals continued development, values and customer focus as areas for improvement Anja Fiedler

Managing Director, Denison Consulting

Recent scandals at a number of German companies triggered many discussions, including the question about the role of supervisory boards. As a matter of fact, a transition or turnaround on Germany’s executive floor has started: more and more, supervisory boards are changing from mere supervisors to co-managers in the background. When companies face economic challenges,

implement far-reaching changes, or a scandal threatens to damage the company’s reputation, this is the supervisory board’s moment to shine as the executive board’s surveillance authority. At this point, what’s needed is best practice. This requires professionalism, professional competence and understanding of both the market as well as the company’s interests. However, how do things actually proceed within supervisory boards? To what extent are the supervisory boards of companies in various sectors part of the company culture? What about their involvement, mission, stability and adaptability? A recent pilot study of about 50 supervisory board members at listed and non-listed German companies, performed by Denison Consulting, a global consulting firm with its European headquarters in Switzerland, reveals the need for improvement among the sparring partners of the executive board and the owners, namely the supervisory board. The Denison model of organisational culture highlights four

key traits that an organisation should master in order to be effective and links organisational culture to organisational performance metrics, such as sales growth, return on equity (ROE), return on investment (ROI), customer satisfaction, innovation, employee satisfaction, quality and more. At the centre of the model are the organisation’s ‘beliefs and assumptions’. These are the deeply held aspects of an organisation’s identity that are often hard to access. The four traits of the Denison model – mission, adaptability, involvement and consistency – measure the behaviours driven by these beliefs and assumptions that create an organisation’s culture. MISSION: Do we know where we are going? ADAPTABILITY: Are we responding to the marketplace/external environment? INVOLVEMENT: Are our people aligned and engaged? CONSISTENCY: Do we have the values, systems and processes in place to create leverage?

MOVING OUT OF THE COMFORT ZONE Effective organisations should foster a shared sense of mission 28 Ethical Boardroom | Summer 2019

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Supervisory Boards | Board Leadership

INTERNAL FOCUS

Denison’s research has demonstrated that effective organisations have high culture scores in all four traits. Thus, effective organisations are likely to have cultures that are adaptive, yet highly consistent and predictable, and that foster high involvement, but do so within the context of a shared sense of mission. This robust model also splits into hemispheres: internal/external and flexible/stable.

INVOLVEMENT + CONSISTENCY An organisation with a strong internal focus is committed to the dynamics of the internal integration of systems, structures and processes. It values its people and prides itself on the quality of its products or services. A strong internal focus has been linked to higher levels of quality and employee satisfaction.

EXTERNAL FOCUS

FLEXIBILITY

ADAPTABILITY + MISSION An organisation with a strong external focus is committed to adapting and changing in response to the external environment. It has a constant eye on the marketplace and a strong sense of where it is headed. A strong external focus typically impacts revenue, sales growth and market share.

ADAPTABILITY + INVOLVEMENT A flexible organisation has the capability to change in response to the environment. Its focus is on its customers and its people. A flexible organisation is typically linked to higher levels of product and service innovation, creativity and a fast response to the changing needs of customers and employees.

STABILITY

MISSION + CONSISTENCY A stable organisation has the capacity to remain focussed and predictable over time. A stable organisation is typically linked to high return on assets, investments and sales growth, as well as strong business operations. The tension between top-down and bottom-up management, represented by the mission and involvement traits, is important for organisations to understand. To be successful, an organisation must be able to link the mission, purpose and goals of the organisation to create a shared sense of ownership, commitment and responsibility for its employees.

There is a lack of clear values and ethical code

While the study showed that participants see great strengths in defining or contributing to the strategy, vision and goals of a company as well as displaying a great degree of cooperation and collaboration as a team, when it comes to taking difficult decisions or to managing and resolving conflict as well as sharing a common perspective, the results also show the clear need for improvement in three specific areas. Measured against today’s demands of management and company culture, company pillars like values, focus on customers or the question of personal development play an important role when it comes to performance. However, these aspects are far from being practically applied in supervisory boards, the impact of which is growing within companies. A third of the study participants say that there is no clear and constant value system, also, more than half state that there is no clear ethical code that assists the supervisory board as an ethical guideline to distinguish between right and wrong. Although a strong value system, integrity, and solid ethical principles in particular are important decision factors when selecting and nominating supervisory board members, these aspects seem to lose relevance when it comes to actual responsibility for a company. The question arises: to what extent could financial results be improved if values and an ethical code were integrated into the work of the supervisory board with more consistency?

The supervisory board should represent the organisation’s fundamental values, exemplify them and help others do the same

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Board Leadership | Supervisory Boards READY FOR CHANGE? The supervisory board needs to look to its own continuous development

This is where stability and consistency are needed. The supervisory board should represent the organisation’s fundamental values, exemplify them and help others do the same. Regular news about misconduct and the resulting negative influence on a company still confirm the discrepancy between expectation and reality.

No investment in continuous development

The same applies when it comes to continuous development. While almost everyone surveyed felt they were well informed by the company and also rate collaboration as being positive, there were discrepancies when it came to the question of ongoing development of skills. Although qualitative interviews after the quantitative study showed that the majority of participants consider onboarding practices and training as satisfactory, more than a third of those surveyed said that there was no investment in the continuous development of the supervisory boards. Can we afford that in a world that changes with increasing speed? Our task is – no matter in what area you are active and what responsibility you have – to first work on your own transformation to even be in a position to guide, supervise or drive a transformation in the company. The study has shown that supervisory boards want more input from the company in this area, while they recognise their own responsibility in the continuous development of skills and competencies. There may be areas where a supervisory board member indeed should take charge of his or her skill building, but geopolitical themes and trends that have an impact on a company’s strategy should 30 Ethical Boardroom | Summer 2019

fast-moving consumer goods industry it is, of course, more difficult for example in the be discussed or presented as part of the B2B segments. However, several qualitative continuous development. interviews provided examples of supervisory boards visiting customers as a group in Lack of understanding industries other than consumer goods. for customer needs Apart from these visits, there are plenty of One of the decisive factors for profitable additional sources of information to deepen growth is external orientation to the the customer understanding, such as market market and the competitive environment research studies that most companies have. while focus on the customer, It is certainly an area that in turn, helps develop needs to be addressed One of the innovations. Although 70 carefully as a supervisory decisive factors per cent of those surveyed board should not interfere consider their reaction to with the responsibilities of the for profitable competition and changes in executive management team. growth is external the business environment as However, the study clearly orientation to a supervisory board to be shows that it is an area that appropriate, only half of should get more attention in the market and them said that there is a supervisory boards, otherwise the competitive deep understanding of the we should ask whether wishes, needs and concerns companies are really certain environment of the customers. Yet how their supervisory boards while focus on the that is a supervisory board are prepared and equipped supposed to develop valid customer, in turn, for the challenges of the strategies without a deep VUCA world, digitalisation, helps develop understanding of customer artificial intelligence, innovations and consumer needs? cyber-security, or traditional Even though it is not in the yet constantly changing supervisory board’s task to seek direct important variables, such as consumer customer contact, there is a need for insights/customer needs? discussion on how to instill and cultivate With the above three areas of necessary customer understanding and focus improvements, it is surprising that 26 per in the board and in the organisation, cent of participants in the study state that in order to fulfil the supervisory board’s the composition of their supervisory board strategic and economic responsibility. is not regularly assessed. And 24 per cent Isn’t it a contradiction to state that the said that their board does not need new reaction to changes in the competitive skills and competencies and therefore environment is appropriate whilst not doesn’t need to change in composition. believing it is necessary to have a deep So, does that mean, that we feel equipped consumer or customer understanding? and are ready to react to market changes, Of course, it depends on the industry as but that these transitions are feasible to whether or not direct customer contact with our existing teams? Or does it mean is possible; while it is relatively easy for a that we simply feel more comfortable supervisory board member to deepen the in sticking to old structures and staying understanding of consumer insights in the in our comfort zone? www.ethicalboardroom.com

ICSA

A WA R D S

2019 H e l p u s re c o g n i s e t h e be s t g o ver n ance pro f es s i ona l s . V i e w the c a t e g o r ie s a n d s u b m i t yo u r nomi na t i o n a t: ic s a . o r g . uk / a w a rds

Board Leadership | Diversity FACES AT THE TOP Treating women as 'one of the boys' in fact can make them feel more excluded

Leveraging the value of female directors Why do women directors regularly receive lower peer evaluations than men? The truth is, it has little to do with performance Alfredo Enrione, Donna Finley & Gordon Allan

Alfredo is the founder and director of the Corporate Governance Centre at ESE Business School in Chile. Donna and Gordon are managing partner and senior associate at Finley and Associates

32 Ethical Boardroom | Summer 2019

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Diversity | Board Leadership

While there is still a lot of room for improvement, corporate boards around the world are finally tackling the gender bias in their composition.

Fortune 100 corporations have increased female director representation from 19.6 per cent in 2011 to 25.7 per cent in 2018. Most noticeably, corporations, such as GM, Viacom and Best Buy, are going beyond the 50 per cent threshold for female board seats, even in countries without mandatory quotas imposed by law, including Norway, Finland and Italy. Yet, a dark secret seldom told – and which the authors have experienced first-hand in different parts of the world – is that female directors tend to receive poorer evaluations than their male peers. However, these lower evaluations have much more to do with board culture and biases than with women's performance per se. This article argues that women directors and board performance overall can be improved by addressing these biases and correcting the misperceptions of gender performance gaps.

The case for more diversity in boards of directors

The pledge for gender equality – understood as equal ease of access to resources and opportunities, including economic participation and decision-making – is probably thousands of years old. Yet, the case for a significant presence of women on corporate boards is much more recent. In fact, it's just a few decades old. Two forces are pushing the agenda for change. The first one, is scientific and evidence-based, which attempts to prove how women on boards have a positive effect on corporate performance, and the second force addresses inequality as an ethical problem and a political issue. The first force could be categorised into three lines of research. One underlines the positive effects of diversity in decisionmaking and group performance. The second addresses how specific feminine traits, like different cognitive abilities and values, improve board and, ultimately, corporate performance. The third builds on specific female behaviours and their influence on board dynamics – for instance, the fact that boards with a larger female presence increase their monitoring and strategising tasks. The second force draws from the ideals of social justice and common sense. After all, men never had to scientifically prove their worth to join corporate boards. If women represent half the population, consumers, workers and – do not forget – voters, it is reasonable and fair that society demands an equitable proportion of those leading and making the calls. These forces are having a gradual but global effect. In just two decades, women www.ethicalboardroom.com

directors increased from non-existent to a visible minority on corporate boards. Pushed by social science, regulations, market forces, activism and common sense, the proportion of women on boards in Europe and North America doubled in less than a decade, reaching approximately 25 per cent. A quarter is indeed a significant proportion, although still far from ‘egalitarian’, notwithstanding the fact that in many parts of the world, such as Latin America, the proportion is still closer to 10 per cent.

A dark secret

After almost two decades of board evaluation experience in different parts of the world, the authors observed a frequent finding. It's a finding that, in most cases, remains hidden and hurts the efficacy of boards and, likely, policy-making: women directors tend to receive lower peer evaluations than their male colleagues. Strikingly, this perceived gap has more to do with culture, perceptions and biases than with actual female performance. Directors’ evaluations are not public in most parts of the world, so there is not sufficient research on the performance of individual directors, and women in particular. Yet, the aforementioned finding is consistent with evidence collected on gender biases in organisations and team dynamics.

It is fundamental to acknowledge that performance expectations of directors’ behaviours, attitudes, styles, values and ways of interaction, have been historically imprinted by male role models Some research, for example, shows that female-led teams perform significantly better than male-led teams. The effect arises from the fact that female leaders emphasise ‘feminine’ qualities, such as collaboration, mentorship and cooperation, which helps team members perform at higher levels. Female leaders also tend to go out of their way to help team members perform better and volunteer for work that goes beyond their role. However, those same female leaders tend to receive lower evaluations by their teammates. A woman leader will tend to focus more on the productivity of the team than on how her peers perceive her own performance. In addition, females tend to give themselves less credit than men in achieving the team’s overall objectives. It is fundamental to acknowledge that performance expectations of directors’ behaviours, attitudes, styles, values and

ways of interaction have been historically imprinted by male role models. Until recently, ‘good’ effective corporate board dynamics, leadership, decision-making and governance had few alternative benchmarks.

What can and should be done: a case study

Consider the case of a North American municipal board, whose job was to oversee the operation of public parking facilities in a city of approximately two million. In 2015, the organisation’s board engaged a third-party facilitator with extensive governance expertise to help it deal with a series of challenges: low director engagement; lack of strategic direction; CEO turnover; and a major lawsuit, among others things. Initially, the facilitator introduced an evaluation process from which a two-year board development plan was created to address overall board performance gaps. Several years later, this evaluation was augmented with annual individual director evaluations. These evaluations were reviewed by the chair with each individual director and, together, they identified ways to improve the director’s contribution. All directors and the CEO evaluated each other, as well as themselves on 20 dimensions. Considering the ‘top notch’ professional credentials of the women directors, the results of the peer evaluations were surprising. Men consistently scored higher than women. Operating in a male-dominated sector, typically prone to gender stereotyping, this board’s data uncovered the directors’ unconscious bias towards its female directors. For example, the head of the governance committee was a female banking executive with several decades of senior finance experience. However, she was rated by her peers to have a financial literacy score of only 57 per cent, compared to her male counterparts who averaged 75 per cent, regardless of having a financial background or not. When compared to a male director with a similar financial background, this female's overall score was 62 per cent compared to his 77 per cent. What was happening? Two key issues were at play: biased perceptions were colouring individuals’ abilities to make objective evaluations of female performance and, at the same time, board culture was negatively impacting the women’s overall performance. The difference in ratings seemed to be related to ‘observed performance’, as a woman’s interactions in a male-dominated group may be less effective than those of a man with similar qualifications, skills, experience and/or abilities. In these cases, the behaviours and biases – either conscious or unconscious – were adversely affecting the women’s perceived and actual performance, and hence the overall effectiveness of the board. Summer 2019 | Ethical Boardroom 33

Board Leadership | Diversity

Tips for action

After years of board evaluation experience, including the case described above, the authors learned several important lessons on how to improve board effectiveness. In particular, that uncovering and tackling gender biases on boards resulted in significant performance improvements. Here are our tips for overcoming bias.

For board chairs

The board chair must recognise that improving board performance is a continuous process, requiring periodic overall board evaluations. However, these evaluations are insufficient on their own. Individual director evaluations are also necessary to uncover the conscious and unconscious biases that hinder the board reaching its full potential. Through the board chair’s leadership both types of evaluations need to be adopted and repeated over multiple cycles. In addition, the chair moderates and sets the tone of board behaviour and has the power – and duty – to influence the directors’ conduct. The chair must ‘make space’ (opportunity and time) for the female directors to share their opinions and ideas to ensure they fully participate. The chair has to call out 'mansplaining' – a tendency for some men to explain something to women in a condescending or patronising way that assumes she has no knowledge of the topic – as inappropriate. A female director’s participation can be encouraged by reinforcing her comments and fostering further exploration (e.g. 'that's an interesting point – let's think more about the implications of that idea'). 34 Ethical Boardroom | Summer 2019

Overall Board Performance

Male Directors

Female Directors

100

90 Performance Scores (%)

■■ Average individual director performance ratings improved (from 75 per cent to 89 per cent) ■■ Women directors improved at almost twice the rate of men after their first evaluation (15 per cent compared with eight per cent) ■■ Overall, the board’s performance improved significatively (virtually doubling its initial performance ratings from 45 per cent to 90 per cent)

OVERALL BOARD AND DIRECTORS PERFORMANCE SCORES 2011-19

84 80

76 71

Cycle #4 2018

2019

45% eight-year improvement

Following an analysis of the data, the facilitator made a point to meet with the male chair to discuss the findings. When the biases towards the female directors was highlighted, the chair was shocked as he believed he was doing a good job by treating all directors the same. He quickly realised that the two genders required different treatment. Desiring to improve the board’s performance and shift the culture, the chair committed to adjusting his behaviour. After five biennial board evaluations and five annual individual director evaluations, the results were significant (see graph, right). They showed:

65 60

59 Introduction of individual director evaluations

50 45 40 2011

Cycle #1 2012

2013

Cycle #2 2014

A third tip for the chair deals with feedback. McKinsey found that women received less feedback than their male counterparts despite asking for informal feedback as often as men do. In the case above, the chair took it upon himself to introduce individual meetings with each director to privately review their specific evaluation results, and, together, identify ways to improve their contributions. In this case, the chair also provided mentorship and support for the female directors, encouraging them to take on ever greater leadership roles. As the literature points out, women tend to work harder and their teams benefit more from their guidance. These actions improve communication and engagement between directors and provide an ‘early warning system’ to emerging issues so that they can be dealt with promptly.

For male directors

Male directors can improve their self-awareness regarding their behaviour, actions, body language and speech. Calling out inappropriate behaviour by other directors and providing specific gender bias training can help to raise awareness of unconscious biases, begin to correct behaviour and move towards shifting the culture. Though treating a female member as ‘one of the boys’ may be meant with the best of intentions, it may create the exact opposite: an environment where women feel excluded or marginalised. Developing self-awareness and making conscious efforts to moderate any stereotypical male behaviours, such as aggressiveness, talking over, (literal) finger-pointing, help to create a more inclusive and productive environment.

For female directors

Women need to go into the boardroom with their eyes open and be aware that their male peers will probably have an unconscious bias

2015

Cycle #3 2016

2017

when evaluating their performance. Women can promote the use of tools like structured evaluations, longitudinal individual performance data, and formal gender equity training to highlight where behaviours need to change. It is recommended that a female director develops strong relationships with the chair for at least two reasons. First, to encourage richer and more frequent feedback on her performance at the board table. Secondly, to create a safe place for her to bring forward potentially inappropriate behaviours by peer directors. In a male-dominated board, a higher pitch of voice and an intonation that rises at the end of a sentence can be unconsciously interpreted as weaker, hesitant and less convincing. Therefore, female directors may benefit from developing a lower pitch in voice and a confident tone when delivering their arguments.

Conclusion

Research and life teach us that men and women are different and the boardroom is no exception. Each gender offers different strengths, traits and values, all of which have a great impact on board performance. This article has addressed a very important, yet very specific, bias. In a world that is valuing diversity to a greater extent, it is important to understand that there are also other dimensions of diversity. Age, race, nationality and gender fluidity will each have their own associated biases that could affect board performance. If boards do not account for the unconscious biases that emerge from these differences, the performance of directors, the board and, ultimately, the organisation will not achieve their true potential. Implementing the right diagnostic tools, such as individual director evaluations, and leading the necessary actions are all in the hands of the chair. www.ethicalboardroom.com

Board Leadership | Family Business

The six secrets of

longevity Key elements provide a powerful stimulus to future growth and survival

BOARD SETS RULES OF ENTRY

Morten Bennedsen & Brian Henry

Morten is the Academic Director of the Wendel International Centre for Family Enterprise at INSEAD. Brian is a PhD Research Fellow, INSEAD

In fact, many languages have idioms for this vicious cycle, such as ‘shirtsleeves to shirtsleeves in three generations’ (American), ‘clogs to clogs in three generations’ (British) and ‘stables to stars to stables’ (Italian). However, the reality is that many family firms do prosper and survive well beyond three generations. Cargill, the Minnesota-based multinational owned by third- and fourth-generation descendants of the founder, is the largest privately held corporation in the United States, posting revenues of $114.7billion and employing 155,000 people in 66 countries. Thierry Hermès (1801-1878) founded his namesake firm as a small leather saddle and harness workshop in Paris in 1837 and 182 years later it is the most admired luxury brand in the world. The Indian Tata Group, one of India’s largest companies, was founded in 1868 by Jamsetji Tata and has remained under the ownership of his descendants ever since.

SECRETS TO OUR SUCCESS Family firms are agile and resilient to sudden changes in their industry marketplace 36 Ethical Boardroom | Summer 2019

Let’s begin with the oldest of the old. Kongoˉ Gumi, a Japanese construction company, was founded in 578 by a Korean immigrant named Shigemitsu Kongoˉ who was skilled in the art and science of building Buddhist temples and other types of religious monuments. Along with two other carpenters from the Korean kingdom of Baekje, Shigemitsu was invited to Yamato (Nara) by Prince Shoˉtoku (574-622) to help build Japan’s first Buddhist temple, the Shitennoˉ-ji, not far from Osaka. Prince Shoˉtoku appointed the son of Shigemitsu Kongoˉ as his official palace carpenter in order to build many other monuments as a means to unify the country around the newly imported religion. Over the next 1,400 years, Kongoˉ Gumi had a hand in building and rebuilding some of Japan’s most famous landmarks, including the stunning Osaka Castle in the 16th century. However, in the 1980s, the 40th family CEO was

There is an often-repeated myth that the wealth gained by a poor but hard-working, first-generation business founder will be squandered by the third generation, and the family once again goes back to being impoverished.

FAMILY LEADERS

NEX T

GEN

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Family Business | Board Leadership concerned about the future viability of the business model and diversified into property investments. His investments were highly leveraged but lost much of their value when the 1990s Asian financial crisis burst the Japanese real estate bubble. In January 2006, Kongoˉ Gumi went into liquidation, having run up arrears of $340million and was taken over by another old Japanese construction company. The story of Kongoˉ Gumi provides important insights into longevity. First, longevity of a family business is easier if it operates in a stable and long-living industry. Second, long-lived family firms have a succession model that works, in this case based mainly on primogeniture. Third, no family firm can take survival for granted; each generation has to create value and fight to deliver the business to the next generation. Fourth, most long-living family businesses that go out of business do so because the business becomes irrelevant or the family leaders make bad business decisions. The experience of Kongoˉ Gumi is not unique. In our collaboration with many of the world’s oldest family firms, we observe that long-lived family business share a lot of common family and business experience. We identify the six key elements of longevity as being:

Business strategies

Agile long-term business strategies that are resilient to global competition and an ever faster changing economy. Long-living family firms are often found in stable, long-living industries, but they demonstrate an uncanny ability to adapt their existing business strategies to new circumstances. Business strategies often feed into the intangible family assets, such as the legacy and history,

and the family and business networks that have been developed over generations, sometimes centuries. Business families fine-tune their strategies from one generation to the next, making those far more resilient to sudden changes in the market place, to shocks in world trade relationships and to downturns in the economy. Each new generation improves on the existing business strategy so that the firm can continue to stand As the apart from its competitors.

which family members know how to join the firm and advance their careers. Often, these criteria include education from top business schools and outside experience in a management position in other firms.

3 Ownership Legal structures that offer incentives

to create firm value and minimise family conflicts. If designed correctly, an ownership model will align the firm’s vision and strategy with the incentives and performance of the business Transitions stakeholders in the firm and family grows Processes that prepare the family. Having a sound in numbers, and engage the next ownership design will prevent generation. Long-living family ownership can owner-managers from getting firms know how to transfer entangled in internal disputes become overly between family members, business from one generation to the next. Historically, especially over sensitive diluted by these family firms have put like dividends. In most the repeated issues in place rules and procedures cultures, parents are keen to to undertake internal family divide wealth equally among division and succession to guide their their offspring. Moreover, distribution succession strategies in a inheritance laws in many of shares to transparent way. These rules countries oblige parents to and procedures were in the divide inheritance equally new family past often based on the right among their heirs. Therefore, members of primogeniture, whereby incentives are always aligned the first-born legitimate son to the specific legal and tax inherits the business. This custom environments for a given country. In was also helped along by adoption or addition to these specific circumstances, arranged marriages. However, today all business families face a blend of many long-living family firms base their biological and social challenges that tend hiring decisions on meritocracy and to get more complicated over time. recruit the most talented and engaged At the most basic level, a business next gens from within the family, family is subject to the power of numbers, independent of birth order or gender. whereby the number of family members In addition, long-living family firms tend to increase over generations. As will often hire professional managers. the business family grows in numbers, More recently, owner-managers entrust ownership can become overly diluted non-family members of their supervisory by the repeated division and distribution boards to define processes and criteria by of shares to new family members.

FAMILY ENTERPRISE: THE SECRET OF LONGEVITY AND RESILIENCE BUSINESS STRATEGY

Out of the six key elements of longevity, which one is the most challenging for your family business and how do you address it?

BUSINESS STRATEGY

TRANSITION

Agile long-term business strategies resilient to global competition and an ever-fasterchanging economy

FAMILY GOVERNANCE FAMILY GOVERNANCE

SIX KEY ELEMENTS OF LONGEVITY

1 Family governance 2 Business strategy planning INNOVATION & ENTREPRENEUR 3 Transition planning -SHIP 4 Ownership design 5 Governance and leadership 6 Innovation and entrepreneurship

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OWNERSHIP

GOVERNANCE & LEADERSHIP

TRANSITION

Structures and processes that prepare and engage the next generation

OWNERSHIP

Structures and processes aiming at keeping family united and engaged

Legal structures that incentivise creation of firm value, minimise family conflicts and are efficient in a given legal context

INNOVATION AND ENTREPRENEURSHIP

GOVERNANCE & LEADERSHIP

Building structures and providing incentives to cope with digitisation, disruption and the Fourth Industrial Revolution

Identifying value creators and building the best supportive structures around them

Summer 2019 | Ethical Boardroom 37

Board Leadership | Family Business Furthermore, the amount of shares for each family member is often determined by the distribution of children across family branches. It is interesting to notice the variety of ownership structures among long-living family firms and the impact that has on wealth. Some firms have a single owner, some have concentrated ownership in the hands of several family members and some have thousands of family owners. Compare Cargill with only about 10 key family owners who own 90 per cent of the company shares to the 375-year old Wendel family business in France with more than 1,200 family members who own 38 per cent of the publicly traded family firm. Most long-living family firms adjust ownership structure every one or two generations to avoid too much dilution in ownership as the family grows. They design dividend policies to balance diverging family interests and the growth requirements of the firm. Furthermore, the ownership structure balances the right incentives for those involved in the management versus those who play a passive role as shareholders.

Standing at the forefront of digitisation, these firms are deeply involved in implementing the latest technology into their traditional production cycles. Family-owned Fabbrica D’Armi Pietro Beretta S.p.A., for example, was founded in 1526, when Bartolomeo Beretta delivered 185 arquebus barrels to the Republic of Venice. For almost five centuries since then, Beretta has focussed on innovation, an absolutely essential ingredient to survive in the armaments business. Beretta now produces the highest quality light calibre firearms dedicated to sport, hunting and shooting contests. It also sells military-grade weapons to the armed forces and the law enforcement sector.

the family tree either gradually over time or through major readjustments once every generation. The most typical forms of redesigning ownership include the transfer of ownership to future generations, the creation of an internal market for trading shares among family members and buying out individual or groups of family members. Some family businesses have opted for a two-board governance structure, consisting of a family shareholder board and a corporate board. This structure allows the corporate board to focus entirely on the business whereas the family board can focus on business and broader family issues.

governance 4 Corporate and leadership

Identifying value creators and building the best supportive structures around these value creators. Many long-lived family firms hope to produce at least one value-enhancing family leader with each passing generation. This family member is expected to lead the firm and the family to the next level. A business family that continually produces the right family members with the right skills and talent sets will prosper, while those families not fortunate enough to produce the right offspring will suffer. Enriching the family tree boils down to the difference between growth and stagnation. Around the valuable family leaders, long-living family firms can build governance structures to provide incentives and take advantage of synergies. Traditionally, these structures were often populated by family members until recently when business families began to recruit non-family professionals into management roles and independent directors onto corporate boards.

and 5 Innovation entrepreneurship

Building structures and providing incentives to cope with digitisation, disruption and the Fourth Industrial Revolution. Technologies, economies and societies are all changing at an ever-increasing pace. Long-living family businesses are not immune to such changes and fully understand the importance of the innovation and keeping alive the spirit of entrepreneurship inherited from their founders. 38 Ethical Boardroom | Summer 2019

SIX ELEMENTS OF LONGEVITY Successful family firms will share similar traits

governance 6 Family Structures and processes aiming

at keeping family united and engaged. Family firms have developed innovative family governance structures and mechanisms to ensure that the family can make critical decisions and resolve conflicts, while preserving their family assets and managing the business on a long-term basis. These structures and mechanisms should be specific to the cultural and institutional environment of the firm, the family and the country. While family governance is a universal concept, the structures and mechanisms will vary. Many business families have a family charter, which is an agreement between family members vis-à-vis their family business. Not a legally binding instrument like a shareholders agreement, a family charter might contain statements of intent about the mission and strategy of the family business. It might also contain statements about the role of the family in providing for the needs of next gens, education in particular. In addition to charters, many old families resort to mechanisms of ownership redistribution that allow them to prune

For family firms, the secrets of longevity are bound up with the outcomes of these six elements, which overlap in time according to the challenges faced by each generation. However, the implementation of these elements will take many different forms, depending on the size, geography and age of the family-run business. Kongoˉ Gumi lasted for 14 centuries and 40 generations of family ownership largely because each new generation could replicate the business model of the previous generation, which was designing, building, restoring and repairing temples and cultural heritage buildings throughout Japan. However, over time the business changed character and, to avoid slow stagnation, Kongoˉ Gumi chose risky investment projects with catastrophic consequences. For younger family businesses, survival beyond the third generation, much less the 40th generation, represents a major challenge. To overcome the odds, to defy the cliché of ‘clogs to clogs in three generations’ and, ultimately, to make success happen, will necessarily involve the close coordination of business and family. To this end, the six elements of longevity can provide a powerful stimulus to future growth and survival. www.ethicalboardroom.com

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Board Leadership | Succession Planning

Getting your ducks

in a row for the next CEO In today’s governance world, a corporate board’s duties are increasingly diverse. From helping determine the strategic course of the company to setting compensation policies to engaging with shareholders, board members are taking on more visible and active roles in managing and protecting a company’s reputation.

As their list of responsibilities continues to grow in size and importance, it is at times surprising that many boards are failing to focus on one of the tasks traditionally regarded as perhaps their most essential duty: CEO succession planning. Succession continues to be a topic of discussion in the boardroom, but how advanced those discussions are can vary greatly and often companies are still unprepared when the top leadership role is vacated. Few events represent a more critical moment for a company than the announcement of a new CEO. Virtually every single stakeholder – from investors to employees to customers to regulators – will watch the announcement closely and make quick value judgements based on both the choice of leader and how they are introduced. Early mistakes are often hard to recover from and any uncertainty only heightens the level of risk across the enterprise. Plan well and

40 Ethical Boardroom | Summer 2019

The need to be prepared is urgent, and the time is now Tom Johnson

Chief Executive Officer, Abernathy MacGregor stakeholders will adapt quickly, allowing the company to focus forward. Even in the case of a sudden and unexpected transition, boards that have planned ahead and chosen the right successor have successfully been able to mollify nervous shareholders, motivate valuable employees and secure customers. Plan poorly and chaos may reign. So, what separates a successful transition from a poor one? There are a few attributes to consider, but it all begins with purposeful planning. Yogi Berra once famously said: “If you don’t know where you are going, you’ll end up someplace else.” Modern-day boards are properly meticulous about many things. They challenge strategy. They dig deep into financial results. They walk the factory and headquarters floors to see for themselves what might be working and what is not. They think about talent, but sometimes unevenly. It’s difficult to introduce the concept of developing CEO-level talent when the CEO is also present. Who wants to talk openly about possible replacements for the person in the room? This can be particularly true

when there’s no obvious or immediate need for a change. For example, during periods where a CEO has just been appointed, or a company has a young, dynamic CEO with a seemingly long road in front of them, or when an established CEO with a successful track record is at the helm and the business is performing well. Who wants to think about serious succession planning then? But that is exactly when the conversation needs to happen. A good board isn’t afraid to both recognise and publicly advocate for the development of top-level talent and a good CEO isn’t threatened by a succession plan being put into place. High-performing talent is an increasingly important commodity and one that can effectively separate one competitor from another. To properly nourish that talent, rising star employees need to know the company not only values them but is also cultivating them for leadership. Not every employee will get the top job, but recognising and rewarding talent fosters creativity, ensures stability and leaves boards with sometimes multiple good potential candidates to choose from. I work with one board that successfully executed a seamless transition a few years ago. The longtime CEO stepped aside and ceded control to a trusted lieutenant whose internal and external profile had been gradually increasing over the previous couple of years. Investors were excited because the new CEO brought new energy and ideas after a few years of lacklustre growth and employees were excited to see one of their own moved into the top seat. But the

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Succession Planning | Board Leadership

new CEO and the board were savvy enough to realise they had a problem: the bench behind the new CEO was thin and unknown. So, the board, with the new CEO’s support, immediately embarked on a methodical programme to evaluate and promote talent across the organisation. Now, at each board meeting two to three executives present updates on their business plans to the board, many of them for the first time. Each executive is offered access to outside consultants to learn how to think and speak about their roles strategically and, ultimately, prepare to present to the board. The CEO spends time with each of them, pushing them on strategy, and the board likewise works hard to have dinners and other less formal meetings to get to know them all better. The result has been not only enhanced board awareness about the level of talent within the organisation, but increased confidence among a growing group of rising executives who know they are an important part of the company’s future.

Know where you are going, and you will end up where you want to be

Any sophisticated board member knows; however, it is not that simple. Planned transitions are one thing. When a successful CEO decides it is time to step aside, it is usually done with an extraordinary amount of advance thought and planning. Each constituency can be contemplated and planned for and expected questions can be proactively addressed and answered. There are always surprises along the way, of course, but it is easier to react when you are working with a known commodity. Many CEO transitions, however, are not quite that simple. The sudden CEO departure is the most difficult. Whether because of death, illness or unexpected tragedy, poor performance, or because a

CEO suddenly jumps ship for another remediation programmes or, in some opportunity, abruptly removing a known cases, even a surprise transition, if quantity for a mostly unknown one can deemed necessary. be a traumatic event for everyone involved. Recently, I worked with a company that Strategies, priorities and results can all was producing solid, but not spectacular change unexpectedly and quickly. Suddenly, results. The CEO was a known commodity expectations need to be reset. Financial and particularly well liked among the metrics that seemed all but certain before regulators who played a heavy hand in may now be in question. A strategy that had overseeing the industry. But within the resonated internally and externally may shareholder base, there was a growing now be in flux. And the image of a company unease. The CEO’s stated strategy was may now need to be rebuilt. Ultimately, somewhat unusual and starting to show those all may prove to be positive changes, cracks. Concerns about risk were beginning but in a moment where they are relative to seep through. Top talent had been unknowns, risk and uncertainty can rule allowed to leave and a potential acquisition the day. When investors, employees and candidate had walked away, in part because customers have bought the other company’s into a certain person and board was uncomfortable Whether because strategy, which then about putting their of death, illness or suddenly disappear company under the without a pre-ordained unexpected tragedy, CEO’s domain. Our board plan in place, confidence, quickly realised a change poor performance, valuation and results needed to be made, but usually wane. its options were limited. or because a CEO The good news is many There was no time or suddenly jumps board members are ability to quietly recruit ship for another increasingly acutely from the outside, but aware of these factors and the internal candidate opportunity, abruptly effective succession pool had also decidedly removing a known planning is once again thinned. The board also becoming a top priority quantity for a mostly recognised that any in many boardrooms of would signal unknown one can be transition companies I advise. One to employees a significant factor that is helping a traumatic event for change in strategy, as well is the modern requiring a good deal of everyone involved board member is actively patience and dedication. engaged in overseeing the During their deliberations, operations of the companies in which the board lamented having let so many they serve. For instance, one direct result of strong candidates leave the company at increased shareholder, employee and even times when that didn’t seem like a crisis. customer engagement at the board level is that board members have the opportunity to personally uncover a problem with leadership that then can be evaluated and discussed at an early stage. These insights can help identify weaknesses or holes in the management chain and even at the CEO level, which can lead to effective

A NATURAL PROGRESSION Succession planning should be part of a company’s daily routine

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Summer 2019 | Ethical Boardroom 41

Board Leadership | Succession Planning The board had a vigorous debate around several possible solutions, ranging from hiring an executive coach to seeking a merger partner, but ultimately settled on a CEO switch because the business still, at its core, held a lot of promise. Without the conversations they were having with various stakeholders, the issues that led to the change likely would not have boiled to the surface until a real problem occurred. The transition was not entirely seamless; a board

CEO transition when the time comes, even with external candidates. If investors, customers, employees and regulators have faith in the talent at the company and that they are remaining in place and supporting the new CEO, the anxiety and risk that often occurs around these transitions can drop significantly. There are many ways to showcase that talent, among them conferences, investor calls and meetings, investor day

a company effectively guard against talent bleed? After all, it’s one thing to run an effective talent development programme, with all the time, energy and resources that requires, but if top executives keep leaving to take the top job elsewhere, is that the desired result? This is where companies and the boards grappling with these issues need to understand and stay true to the company’s culture. It is one thing to set up programmes

PAVING THE WAY Organisations must groom potential CEOs well ahead of time

member with solid industry experience was temporarily put at the helm while a search firm was hired to find a permanent CEO and there were questions for a while as to what the strategy would be and whether some remaining critical talent would stay. But the board’s decisive action encouraged investors and customers and employees likewise expressed relief in the change, allowing the company to get through a bumpy few weeks. Today, the board, with the new CEO’s cooperation, is developing strategies to not only build a bench of talent underneath the CEO, but also find ways to showcase that management depth. Talent development is standard practice in any organisation and is a critical component to succession planning, but many organisations lose sight of the importance of highlighting that talent not just internally but externally, too. Finding ways to showcase the bench behind the CEO can not only provide further confidence in a corporation’s ability to execute on its strategic plan, but it can greatly smooth a 42 Ethical Boardroom | Summer 2019

presentations and media interviews. Any strategy to do so should be well thought through and regularly evaluated to measure effectiveness. There likewise needs to be a feedback loop with core audiences to make sure the talent is getting recognised and to pick up on any concerns they have early. There are risks, of course. When promoted talent leaves, it can cause some concerns. But having a deep bench means there is always someone to fill the void. Knowing that talent will stay in place and continue to execute has become a core to success in any CEO transition, so boards should work constantly to make sure that talent is in place and being properly developed. The succession planning programme can lead to some interesting debates in the boardroom. Is the company effectively recruiting and cultivating diverse talent across the organisation, which many stakeholders are now demanding to see? What areas of the business should future leaders be exposed to for them to continue to ascend within the organisation? How can

Knowing that talent will stay in place and continue to execute has become a core to success in any CEO transition, so boards should work constantly to make sure that talent is in place and being properly developed to develop talent and it is another to truly be engaged in them as a board. Top talent seeks out challenges and opportunities. Promising executives want to work in organisations where their skills are not only respected, but where they are challenged to help make the enterprise better. That kind of culture can keep talent in place and create a dynamic environment where CEO succession planning is encouraged and is not a taboo topic. Everyone is driving toward the same goal – helping the organisation succeed. To get there, you need to challenge assumptions and introduce new ways of thinking. The risk of not doing so can oftentimes be damaging but done properly organisations will continue to thrive and grow, even when a new leader takes the helm. www.ethicalboardroom.com

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Global News Africa Tributes to Safaricom’s Bob Collymore

Former Eskom CEO in solar deal A company owned by former Eskom acting CEO Matshela Koko, has been granted a licence to produce solar energy in Zimbabwe. Matshela Energy will build a solar plant that is expected to produce 100MW of electricity in a bid to ease Zimbabwe’s electricity supply crisis that has led to outages lasting up to 18 hours. Koko resigned from state-owned power utility Eskom in 2018 when the company was in the process of instituting a disciplinary hearing against him.

Matshela Energy will invest $250million into a solar power plant in Gwanda, with project works set to begin next month. Zimbabwe’s Energy Minister Fortune Chasi, in an interview with Business Day, said: “What is important about this deal is that Matshela Energy has the requisite expertise in energy, given its experience in South Africa. We need investors in our country, more so in energy because we are in a crisis.”

Bob Collymore, the chief executive of east Africa’s largest and most profitable mobile company Safaricom, has died following a two-year battle with cancer. The Guyana-born British and Kenyan national, who was appointed CEO in 2010, was praised for promoting gender equality at Safaricom, where almost 50 per cent of staff are women. He was also lauded for championing transparency in corporate governance and became the first CEO in Kenya to declare his wealth, urging other industry leaders to do the same. Chief justice and president of the Supreme Court of Kenya, David Maraga, said in tribute: “In his death we have lost a towering symbol of excellence in corporate governance."

Reuel Khoza takes

Naspers South Africa the helm at PIC announces female CEO

ADM Energy unveils board shake-up Oil and gas investing company ADM Energy, which has its asset base in Nigeria, has appointed Osamede Okhomina as its new chief executive. Okhomina takes over from Stefan Olivier, who stepped down as CEO in June but will remain on the company’s board. ADM Energy, formerly MX Oil, also appointed His Highness Sheikh Ahmed Bin Dalmook Al Maktoum as its new president in June. Okhomina said: “Our strategy will be to build on our existing asset base in Nigeria and target other attractive investment opportunities in the oil and gas sector, primarily in west Africa, that we feel will bring significant value to ADM Energy shareholders as we grow the company.”

44 Ethical Boardroom | Summer 2019

Phuthi Mahanyele-Dabengwa (pictured below), the newly appointed CEO of South African tech conglomerate Naspers, is the only black woman to run a Johannesburg Stock Exchange-listed top 40 company. Naspers has appointed Mahanyele-Dabengwa – the company’s first female and first black chief executive – to direct its business and daily interests in South Africa. Mahanyele-Dabengwa will also oversee Naspers Labs, a social impact and skills acquisition initiative for South Africa’s unemployed youth. Bob van Dijk, group CEO of Naspers, said: “Phuthi is a seasoned leader with a strong track record of achievement throughout her career. Her significant investor and board experience across varied sectors, makes Phuthi the perfect match for this important role at Naspers.”

South Africa’s Public Investment Corporation (above) has appointed Reuel Khoza as the pension fund’s first non-political chairman. PIC is Africa’s biggest fund manager and the largest investor in the Johannesburg stock market. Khoza replaces former Deputy Finance Minister Mondli Gungubele as chair of the PIC board, marking the first time the head has been chosen from outside the ranks of the ruling African National Congress. In March, PIC suspended its acting CEO, Matshepo More, over alleged interference in an inquiry into impropriety at the $139billion fund. Khoza said: “The first thing is to restore stability, but simultaneously we are on the search for a permanent CEO.”

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Board Governance | Auditing

Corporate governance through an internal audit lens We must transform to keep pace and we must do it now Richard F. Chambers

President and CEO, The Institute of Internal Auditors

When a major retailer’s point-of-sale (POS) system was hacked during the holiday season, exposing tens of millions of payment card credentials and customer records, people were shocked to eventually learn how the cyber hackers had entered the system: via the stolen credentials of a supplier that had been accessing the retailer’s network through an external vendor portal. That data breach raised a host of governance-related issues, including the need for extensive supply chain vetting and proper security controls around remote access to digital networks. A more basic concern was related to company culture: the cost of silos within an organisation. When the head of operations had a new facilities system installed in a couple of the retailer’s stores, according to media reports, nobody would have expected that he also should have been an expert in cybersecurity. Nor would most people have expected the head of information security 46 Ethical Boardroom | Summer 2019

to be aware that operations had purchased the new system, especially one that could be programmed from outside the network. I asked Larry Harrington, former chief audit executive at Raytheon Corp. and Aetna, his thoughts on the issue: “The operations guy wasn’t thinking of it from a cyber standpoint, and the cyber folks had no idea what the operations folks were doing. So, these silos ended up getting them into trouble. Internal audit cuts across all of those organizations, and one of our roles is the ability to bring people together.” It’s a key reason why a board’s audit committee should want a strong, well-resourced internal audit function in place. “We see it all,” Harrington said. “When you do that, you create greater relationships, greater partnerships, and greater transparency.” In preparing audit plans, internal auditors will typically talk to people in every department of a company, getting a thorough understanding of significant

projects each department is working on and the risks and opportunities they may pose. The data breach at the retailer, as well as at a host of other companies over the past several years, also underscores the need for ongoing evaluation of directors’ skillsets to ensure the board is equipped to address evolving risks that can easily disrupt a company’s business strategy or harm its reputation. A new survey of more than 360 directors by the EY Center for Board Matters and Corporate Board Member finds that less than half those polled (48 per cent) are confident their boards have the appropriate resources, including board education and internal and external tools, to move their companies forward in the current era of digital disruption. During his last 10 years at Raytheon, Harrington’s team would spend a little www.ethicalboardroom.com

Auditing | Board Governance ADDING VALUE AS AN AUDITOR Internal audit can provide significant insight to a board

acquisition than an intricate blending of two companies’ businesses. “I said we’re going to have to insert ourselves. We’re going to have to change a few things because they don’t run their business the way we’re used to running it and it’s just going to cause frustration and difficulty down the road,” Anderson recalled. “That’s the kind of thing you can do as an internal auditor. You can look at the [business] structures. You can look at the culture of what’s going on,” he said.

Fighting fraud and corruption

time of each audit, no matter the business unit, trying to understand the culture in that organisation, he said. Over a period of time, his team was able to tell how well the vision at the top of the company was being communicated all the way down and how well feedback was making its way back up to senior management. “We could start to see, business by business or function by function, do we have the kind of leaders who stood for what the company really believed in and wanted to have happen,” he said. Internal audit has valuable insights to offer the board when it comes to how aspects of company culture apply when considering risks and opportunities. Conferring with internal audit during the due diligence period on a pending acquisition, for example, can end up www.ethicalboardroom.com

saving a company a lot of time, money and effort by preventing a cultural mismatch, says another former chief audit executive, Doug Anderson. Anderson recalled that, early in the due diligence period for an acquisition that one company was considering, he and other business leaders visited the target company’s headquarters to meet with the executive leadership team. “My job was to sniff around and look at governance,” he said. “Basically, I realised there was something here that’s going to be an issue as we go down the road. Nobody else was thinking that way. They were all thinking about liabilities and product growth.” Anderson said his focus as an internal auditor was on the history of the board. He looked at board minutes and footnotes on other documents ‘to get a picture and a feeling for how the upper echelon ran the company. How do they look at things? How do they structure things?’. The deal the company was contemplating was less a simple

A central aspect of corporate governance is having a programme in place to prevent or combat corruption and fraud. This is often a greater challenge when a company has operations in remote geographic regions where local cultural customs can cloud employees’ commitment to a code of ethical conduct. Some companies have come under investigation after their employees in far-off parts of the world resorted to less-than-legal means to secure government permits for business operations, after being told it’s a normal way of doing business in that country. Lauren Cunningham, director of research at the Neel Corporate Governance Center at the University of Tennessee at Knoxville, explains: “In some situations, boards are asking the internal audit group to either do cultural surveys to better understand how culture does differ across geographic locations, or boards are asking internal audit to go in and do field testing. This isn’t the type of testing you can do in two days. You really have to stop and get to know the people and really understand the culture that’s going on around you.” Summer 2019 | Ethical Boardroom 47

Board Governance | Auditing Cunningham and Terry Neal, director One of the things the CAE should be telling of the Neel Corporate Governance Center, the chair of the audit committee is what have been interviewing chief audit internal audit isn’t doing, or what’s being executives about how companies evaluate postponed until a later time because it lacks their corporate governance programmes, as the resources. Anderson said that opens a part of a partnership with The Institute of ‘rich discussion’ with the audit committee Internal Auditors (IIA) to gauge the health about what internal audit should be focussing of corporate governance among publicly on, given the resources it has available. held companies in the United States. Anderson told me that, when he used to Insight gained from chief audit executives present his annual plan and give quarterly (CAEs) is crucial, because internal audit is updates to the audit committee, he would usually in a better position to ensure good ‘talk about how the risks are changing and governance when the chief audit executive how my audit plan was changing’. In the is invited to participate in a company’s more robust discussions at the start of the strategic planning process, Harrington said. “By listening to strategies being put together, you learn what the company’s strengths and weaknesses are, what its opportunities and threats are,” he told me. “You start to think as you listen: ‘Where might I add value as an auditor?’ You’re also able to add insight and foresight to the strategy.” One thing that can help internal audit earn a seat at the table is a sense of responsibility to report not only the negative things with the board’s audit committee, but also the areas within the company that are demonstrating leadership and innovation. The chief audit executive is able to create added value by recommending to the board how to leverage the strengths of thriving business units in other areas of the company that are not doing as well, Harrington said. Adding such value demands adequate resources. But there is no simple rule for allocating resources to internal audit. Instead, resources should One of the be based on the kind and level things the of risk the business is facing and on a determination of the CAE should capabilities of internal audit to be telling address those risks. the chair of Boards typically don’t have enough information to do the audit their jobs properly, and they committee is generally get most, if not all, of their information from what internal the executive team. That audit isn’t means the information will be only from senior doing, or he would present for five management’s perspective. what’s being year, to seven minutes and leave “You need someone who can postponed the rest of the time allotted look at the information in an for discussion. He’d start the objective way and determine if until a later conversation by asking the the right information is going time because committee members if they to the board,” Anderson said. believed he had identified the “And is it the full information? it lacks the proper risks, or whether there Does it deal with all aspects of resources were some he wasn’t giving that topic? And are there things enough attention to. you’re not looking at?” Key to strong governance is access by Yet, in IIA’s 2019 Pulse of Internal the chief audit executive to the chair of the Audit survey, 57 per cent of chief audit audit committee. “One CAE said that, if executives reported they rarely or never they didn’t have that level of access, they discuss with the board or management probably wouldn’t want that job,” Neal said. the accuracy, completeness, timeliness, Internal auditors also see board truthfulness and transparency of independence and the way in which board information going to the board. 48 Ethical Boardroom | Summer 2019

members are selected as essential aspects of governance in a company. Academic research finds that nominating committees still rely on the CEO or other board members to identify an initial pool of candidates for an open board seat, while fewer than 20 per cent use a search firm, Cunningham said. “That’s telling,” she said. “I don’t think there’s much outreach that goes into continually creating those initial pools. I think it’s more built on senior management’s and the board’s personal and professional networks.” One research study that examined selection of board members found that interviewees prioritise ‘chemistry and comfort’ with other board members and the CEO as the key goals when recruiting directors, Cunningham said. “As I was reading that, I thought to myself, ‘then how does anyone ever stand up to challenge the CEO and senior management?’ If they’re all worried about being nice to each other and having chemistry, I don’t know how you’re ever going to have a tough conversation.” Anderson agrees that senior management has too much influence in the selection of directors, but he thinks they should be able to offer suggestions. A more effective way to recruit new members is to hire a reputable professional search firm that will study and report on the dynamics among current board members and suggest candidates based on who they know and who is available in the marketplace. One of Cunningham’s and Neal’s findings from their research as part of the partnership with The IIA is that, despite CAEs’ access to diverse parts of the company and knowledge of both business and governance, “they’re not often being tapped to actually go in and do rigorous evaluations around full aspects of governance”, Cunningham said. Their interviews with CAEs suggest that the reason may be that it’s not a priority for the allocation of resources to the internal audit function. That appears to be confirmed by IIA’s 2019 Pulse survey, which found a very low allocation of time in the audit plan to governance and culture (3.8 per cent on average), compared with higher time priorities, such as financial reporting (14.5 per cent), compliance/regulatory (15.5 per cent) and operational (16.4 per cent). CAEs believe they have more to offer in evaluating the quality of company-wide governance programmes. Cunningham said she thinks they could help the board decide whether the board itself, senior management, and the company’s culture are effective. But that would require buy-in from senior management and the board, which would mean both would have to be open to criticism. Where a board and senior management team genuinely wants to know how they can do better, she said: “I think CAEs can help.” www.ethicalboardroom.com

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BEYOND THE BOARD Keeping track of all entities and subsidaries is becoming far trickier

Managing subsidiary compliance Overseeing global entities in a world of rising risks David Gracie

Head of Global Entity Management Services, KPMG in the UK

In today’s increasingly complex business environment, it has become more imperative than ever for corporations to have clear oversight and control of their subsidiaries around the world. The risks of non-compliance are increasing, with a growing threat of fines and regulatory censure, while directors face greater personal responsibility.

As operations become more globalised, group headquarters’ risks are becoming further and further distanced from the companies that carry out the day-to-day business. At the same time, legal entities are multiplying and corporate structures are becoming more complex. As a result, 50 Ethical Boardroom | Summer 2019

establishing and maintaining a clear picture of a group’s legal entities, their business function and risk profile is becoming increasingly difficult. And things will not get any easier as economic disrupters such as the threat of trade wars from the US, Brexit in the EU and the OECD’s global anti-tax avoidance initiatives start playing out around the world. We are also seeing regulators not only issuing new rules but also taking a harder line with existing ones, together with an increasing number of stakeholders that are demanding more transparency and accountability. This has translated into higher risks and increased associated costs of corporate governance failure. It has also reinforced the need for robust corporate governance frameworks at every level. At the same time, risks are rising on a personal level for company directors. With increasing globalisation comes the need for directors to be appointed to multiple boards across the globe. Being aware of local expectations and risks is key. The penalties for non-compliance are becoming stiffer in many parts of the world, so organisations have a duty towards their

directors to ensure they don’t fall foul of them on a personal level. All of these factors mean that Global Entity Management (GEM) has become an ever more crucial part of general counsel and corporate secretariat’s roles. At KPMG, we have an extensive and experienced team of GEM professionals who work with businesses to manage their subsidiary compliance programmes. With coverage in more than 140 countries, KPMG’s integrated teams operate using a multi-disciplinary approach that leverages subject matter experts in major business centres, across virtually every industry, to deliver tailored advice and services to our clients.

Centralised v. decentralised models

But what is the most effective way of managing your entities and subsidiaries around the world? In practice, there are two basic approaches: a centralised model or a decentralised one. Under both models, a balance is needed between control from the top and freedom at the bottom. The difference is largely one of where that balance lies. www.ethicalboardroom.com

Advertorial | Board Governance pro-active board that can respond quickly to local conditions. The challenge here is to ensure that subsidiaries take into account group governance policies and feedback sufficient information to enable their activity to be monitored and, where necessary, corrections made Which model should be chosen depends on various factors, such as the size and composition of the group and its constituent entities, including its business sector, the functions performed by the various entities and the maturity of the group’s existing corporate governance model. In fact, it is not necessarily a question of choosing between one model or the other, but a question of which elements are appropriate for the given group. The result should be a model tailored to the group’s actual circumstances. Finding the right balance may not be easy but it can make the difference between success and failure. Problems can arise where too much control is concentrated at the level of the parent board, which may also have tax implications. But insufficient levels of oversight also create problems. This is true not only for the general well-being and efficiency of the subsidiary’s business but also from the point of view of legal liability. In practice, we are finding a growing trend towards the centralised model, given the rising regulatory risks and pressures around the world. This is a model that We are seeing regulators our GEM service is not only issuing new well-placed to support, given that KPMG has rules but taking a harder ■■ A centralised teams around the world line with existing ones, model is who can liaise with characterised together with an increasing the central GEM team by a strong helping to manage a number of stakeholders parent company company’s compliance that are demanding board with and advise them on largely passive practical, relevant local more transparency boards at issues and conditions and accountability subsidiary level, that need to be taken focussed on into account. regulatory compliance and day-to-day Global world, local customs decision-making and reporting. This Having an understanding of local variations results in more direct control and a in practice remains an essential part of clearer division of responsibilities, but doing business, no matter how much the it also risks fettering local initiative, world is globalising in terms of corporate stifling motivation and slowing down governance standards. There remain some decision-making. Under such a model, interesting quirks of local practice, such as: clear and relevant information flows back to the parent board as an essential ■■ China: The traditional requirement part of the governance framework, to sign official documentation with a in particular, if local conditions are black fountain pen is still in place today. to be properly taken into account Failure to do so could result in a contract ■■ A decentralised model means being deemed invalid. At KPMG, we have empowering subsidiary boards so that created a signature requirements checklist they have the freedom to develop their to help our clients around the world business in a way that makes sense from ■■ India: There is a growing requirement a local perspective, without unnecessary for corporations to prove that their or irrelevant interference from the parent Indian operations are genuinely staffed board. This results in a more agile, www.ethicalboardroom.com

and active on the ground by taking photos of the director(s) inside and outside the office ■■ Ultimate beneficial ownership: Rules are increasingly being adopted around the world requiring businesses to show where ultimate ownership of subsidiaries resides. In the EU, the fourth Anti-Money Laundering (AML) Directive requires member states to set up registers of the ultimate beneficial owners of legal entities. However, even though the deadline to implement the 4th AML Directive was 26 June 2017, debates are still ongoing about how the Directive should be implemented and there are variations in national practice. The Netherlands and Italy, for example, are yet to implement the UBO requirement, given that a fifth AML Directive is expected soon. It is important, therefore, that businesses understand the exact requirements in different countries. Meanwhile, similar requirements have been coming into force in other jurisdictions around the world, such as Canada, Hong Kong, Singapore and the Caribbean KPMG’s GEM teams can provide businesses with the up-to-date local insight they need to ensure that they are in compliance with regulatory requirements in the territories in which they operate.

KPMG’s GEM approach

Through KPMG’s global network, we strive to adopt a consistent approach, providing oversight and control across global structures, delivered in an effective and client-centric way. We bring our clients a dedicated project manager who is the central point of contact on all engagement matters. The project manager liaises with KPMG’s compliance, tax and legal experts around the world to manage compliance on our clients’ behalf. We charge competitive fixed fees, providing certainty of the budget from the outset. Through our GEM services, clients will reap a number of further significant benefits: ■■ Centralised: Through our centralised model, in which we access the KPMG network around the world, clients no longer have to deal with the coordination of multiple parties, reducing time and cost ■■ Multi-disciplinary: As part of KPMG’s multi-disciplinary environment, clients benefit from the integration of services and teams combining wider areas of compliance, such as tax and statutory accounting ■■ Local expertise: Our global network of corporate secretarial specialists and legal advisors provides the local expertise to support the central project manager in the delivery of in-country requirements Summer 2019 | Ethical Boardroom 51

Board Governance | Advertorial ■■ Technology-enabled: Accurate and robust data management is a key requirement for any organisation. We utilise market-leading entity management software and process management technology. We can maintain and update clients’ existing systems, or provide them with access to market-leading entity management platforms to manage corporate information and track global compliance. This will provide online storage of corporate information and records, and centralise data for quick access when working on any internal project. Through our services, clients have the potential to maintain accurate corporate information, access it instantly, and easily run company The need to manage reports and produce subsidiary compliance group structure charts

KPMG’s GEM services

We provide a wide variety of solutions to support businesses and help bring them greater control and peace of mind:

around the world is becoming ever more pressing. Corporate structures are becoming more complex at the same time as the regulatory bar is rising and governance failures are more severely punished

■■ Core annual service: Our core annual service is designed to ensure the routine corporate compliance matters that entities face each year are addressed in an efficient and consistent manner. We provide support with ongoing compliance requirements, such as annual approvals, statutory registers and filings. We also provide regular written updates on key changes to corporate secretarial law and practice to cover your global footprint ■■ Health check: The KPMG corporate health check provides a snapshot of the current status of compliance for an organisation’s entities, delivered in a uniform report. We assess the compliance status of entities, covering such issues as director appointments, shareholdings and corporate records. The health check can be particularly useful if a business is considering making structure changes, is about to undertake a sale or acquisition, or has found gaps in compliance and wants a deeper assessment ■■ Incorporation services: From a single entity to a regional expansion plan, branch offices to companies, KPMG can assist in the incorporation of new entities into an organisation’s structure. With access to specialists across the globe, we can provide a checklist of requirements for incorporation of a new entity, manage a step plan from approval to completion, 52 Ethical Boardroom | Summer 2019

and assist with post-incorporation work where required, such as business licenses and registrations ■ Transactional and ad-hoc filing support: KPMG can provide flexible support for one-off filings or projects, to relieve the burden on internal teams. This could involve providing assistance with restructuring projects, capital adjustments, dissolutions, share transfers and director changes. We can also support ad-hoc filings, such as changes of company name, change of financial year-end, constitutional document updates and updates to registers on ultimate beneficial ownership ■■ Directors’ responsibilities: With directors’ personal liability rising in today’s governance environment, ensuring that individuals know and understand their responsibilities has become an increasing priority for organisations. We have developed a comprehensive, country-specific guide to directors’ responsibility and risk that gives an overview of core duties and requirements in different jurisdictions that can be used by directors themselves and as a tool for in-house legal teams providing support ■■ Corporate governance support: While assisting with administrative support for corporate secretarial matters, we can provide guidance on wider corporate governance issues. KPMG member firms provide regular forums for company secretaries to discuss key issues facing them in their role and focussed topic

TAKING CONTROL KPMG offers a range of tools to help companies manage their subsidiaries

group meetings, such as governance frameworks, corporate culture and the evolving use of technology

Time to act?

As we have seen, the need to manage subsidiary compliance around the world is becoming ever more pressing. Corporate structures are becoming more complex at the same time as the regulatory bar is rising and governance failures are more severely punished. Increasing numbers of organisations are taking steps to embed strong and consistent governance across their operations by taking a more centralised approach. Robust global entity management has become an essential part of doing business today. Our GEM service, as part of KPMG’s Legal Services offering, leverages the full strength of KPMG to bring an integrated, fully packaged solution covering all aspects of law and seamless coordination with specialists from related fields, such as tax and pensions. If you would like to discuss any aspect of KPMG’s GEM services, or have a query about any aspect of managing subsidiary corporate compliance today, please do not hesitate to contact us.

KPMG – London 15 Canada Square, Canary Wharf London E14 5GL +44 (0)20 7694 3537 david.gracie@kpmg.co.uk www.home.kpmg/uk www.ethicalboardroom.com

At Citco GSGS we work in partnership with our multinational clients to deliver single-source and market-leading governance services. Our infrastructure solution, which combines an experienced central team and a bespoken technology platform, ensures that clients meet their complex regulatory compliance obligations.

Global Subsidiary Governance Services (GSGS) Governing subsidiaries in an international environment is intrinsically complicated and can often be a logistical challenge for many organizations. If not planned and managed correctly, this can also funnel financial resources and time away from the more strategic areas of an organization’s core business.

■

We consider Citco to be one of our strategic suppliers Global Telecommunication company

Citco does go the extra mile when providing services to us Multinational pharmaceutical company

FIND OUT MORE

For further information on how we can assist you, please contact our Global Subsidiary Governance Services team at GSGS@citco.com. Citco DISCLAIMER: The information contained in this document is marketing material and for informational purposes only. The information contained in this document is presented without any warranty or representation as to its accuracy or completeness and all implied representations or warranties of any kind are hereby disclaimed. Recipients of this document, whether clients or otherwise, should not act or refrain from acting on the basis of any information included in this document without seeking appropriate professional advice. The provision of the information contained in this document does not establish any express or implied duty or obligation between Citco and any recipient and neither Citco nor any of its shareholders, members, directors, principals or personnel shall be responsible or liable for results arising from the use or reliance of the information contained in this document including, without limitation, any loss (whether direct, indirect, in contract, tort or otherwise) arising from any decision made or action taken by any party in reliance upon the information contained in this document. The Citco Group Limited is the indirect parent of a network of independent companies. The Citco Group Limited provides no client services. Such services are provided solely by the independent companies within the Citco group of companies (hereinafter, the ìCitco group of companiesî) in their respective geographic areas. The Citco Group Limited and the Citco group of companies are legally distinct and separate entities. They are not, and nothing contained herein shall be construed to place these entities in the relationship of agents, partners or joint venturers. Neither Citco Group Limited nor any individual company within the Citco group of companies has any authority (actual, apparent, implied or otherwise) to obligate or bind The Citco Group Limited in any manner whatsoever. © The Citco Group Limited, July 2019

Board Governance | Managing Entities

Global entity management trends to watch

A landscape of robust economic growth and a surge in global deal activity should leave organisations feeling optimistic An increase in global activity has led many organisations to step up efforts to address multinational legal, regulatory and contractual compliance. Expanding global regulations and a heightened focus on multi-jurisdictional scrutiny and transparency have raised the compliance stakes.

While today’s professionals may understand the importance of proactively managing their legal entities, it’s not uncommon to see global organisations struggle to effectively handle legal entity and corporate compliance tasks, particularly at the local level. The reason for this is simple: global regulations are changing in fundamental ways and at an accelerated pace.

Data protection laws drive expanded regulatory responsibilities

Global entity management presents notable challenges that are applicable to almost any organisation. Laws and regulations often vary widely between jurisdictions and the global regulatory landscape is eternally dynamic. New laws are passed and existing laws are expanded, amended or repealed on a near-constant basis. Know your customer (KYC) laws are one example of a rapidly evolving set of policies. These security regulations serve as a critical tool for preventing money laundering, bribery and other financial crimes. Changes to data protection laws worldwide (the EU’s General Data Protection Regulation [GDPR] and Canada’s Personal Information Protection and Electronic Documents Act [PIPEDA], for example) have also been keeping compliance officers busy. GDPR rules mean that businesses must make major adjustments to the way they gather, store and manage personal data. These laws were once the sole province of tightly regulated organisations and jurisdictions. That’s changed and the expansion of KYC and other compliance mechanisms has grown to include multiple jurisdictions and many types of non-regulated entities. As another example, companies in the Cayman Islands are now required by law to adhere to international standards and commitments when maintaining and filing beneficial ownership data. These commitments include policies designed to prevent money laundering, tax evasion and terrorism financing. These laws were adopted with the goal of facilitating better information exchange between Cayman Islands’ 54 Ethical Boardroom | Summer 2019

Antonio Soler

Vice President and Head of Global Services, CT Corporation entities and global regulatory and tax authorities. Failure to file beneficial ownership information can lead to a company being struck off the register or having its assets vested with the government, as well as facing additional financial sanctions.

Heightened risk of enforcement and penalties drives new business requirements

The old ways of doing business are quickly changing, particularly in the arena of global enforcement. Multinational firms can find themselves a target of enhanced compliance enforcement, as foreign tax authorities have learned that it is often easier to collect penalty and interest payments from larger organisations. Some foreign tax authorities have created dedicated teams that specialise in pursuing action against legal entities of the foreign direct investment variety. As enforcement activity has increased, so have penalties for non-compliance. Common risks of non-compliance in all regulated industries include admonition notices, financial penalties, ceding supervision and control to local authorities and even shutting down the business. Such sanctions can lead to serious financial or operational harm while also opening an organisation to reputational damage. Individual criminal liability is also a possibility. Consider the following scenario. Most US firms name senior management as directors of overseas entities. Assume that a director is situated in a country with a punitive posture toward non-compliance (Brazil, France, Italy etc). If that organisation has a delinquent tax issue that hasn’t been resolved locally, the director may be arrested when entering the country – even if that director had no prior knowledge of the non-compliance. Even more troubling, the director may have their own personal assets seized, under some circumstances. For senior management staff who are acclimated to operating behind the veil of US corporate culture, this kind of introduction to an overseas posting is very close to a nightmare scenario. This type of extreme action is rare and doesn’t happen in every country, but organisations should still take steps to prevent any corporate non-compliance issues that can trigger an enforcement penalty. www.ethicalboardroom.com

Managing Entities | Board Governance

WORKING SAFELY IN MULTIPLE REGIONS The key to reducing risk lies in real-time data, scalable tech and on-the-ground service

www.ethicalboardroom.com

Summer 2019 | Ethical Boardroom 55

Board Governance | Managing Entities

Why real-time data and insights are critical

The solution to this problem, thankfully, is straightforward – more control and Data has become the lifeblood of almost visibility into global compliance obligations. every modern organisation, and almost Technology plays a key role in providing this every department within an organisation control, visibility and scalability. is itching for greater reporting that Still, the appropriate tech is half of the provides access to actionable information. equation. A combination of technology, Master data management, or an updated service and content is the true killer app for central repository of documents and managing compliance. The process of staying data, is a prerequisite for keeping various compliant is evolving into more of a strategic organisational functions working partnership scenario, as organisations seek synergistically. trusted partners to help manage compliance This synergy is especially critical between demands. These trusted partners can offer tax and legal departments, as facilitating flexible, customised solutions that are smooth and open collaboration between purpose-built to support an organisation’s these two departments is key unique needs, wherever they for staying compliant. Adding Integrating the operate. new global entities to the mix Organisations are also latest entity can make existing processes seeking trusted partners who management more cumbersome. can provide true, on-the-ground Integrating the latest entity expertise and support. As local software into management software into conditions change at a rapid compliance management is the compliance pace, it’s essential that a partner key driver for delivering results management is can provide timely updates quickly and efficiently. The the critical context the key driver and right software solutions can necessary to understand and provide insight into corporate react to these local changes. for delivering structures for each jurisdiction; services, combined with results quickly These furnish accurate, real-time data a scalable technology solution for departmental use and foster and efficiently that provides central visibility collaboration with executives and helps ensure compliance at on business strategy, risk aversion, mergers the local level, are the key. This solution must and acquisitions, and so on. also cover all points in the entity lifecycle, incorporation, to ongoing annual Pairing technology with expertise from compliance demands and any situational helps mitigate corporate compliance needs arising unexpectedly. compliance risk and reduce costs. Working with a partner that can provide It is incumbent upon organisations an integrated compliance solution that expanding overseas, who may work with merges technology and expertise, can lower multiple providers, to maintain visibility costs, introduce greater flexibility and allow into what’s happening in every region, organisations to access a broader pool of with every provider. This is no small task. talented global workers. Local advisors Complex legal and regulatory regimes, multiand service providers play an integral territory agreements, the varying quality role in creating new legal entities, recruiting of data and language issues can all make and training both senior managers managing this process quite challenging. It and operational staff and supporting also opens the organisation up to significant administrative functions. It should also be non-compliance enforcement risks. noted that an outsourced solution can work

FOUR GLOBAL ENTITY MANAGEMENT TRENDS TO WATCH OUT FOR 1. Data protection laws drive expanded regulatory responsibilities

2. Heightened risk of enforcement and penalties drives new business requirements

as a complement to existing internal compliance operations. Overall, with the right strategic partner in place, today’s organisations can boost their bottom line while also introducing greater efficiencies and productivity. The key is finding a partner who offers not only the technology, but also the critical expertise. Before global services are integrated, however, legal departments need to improve internal processes and determine the optimal technology to implement. The right software solution can create significant new efficiencies by automating many non-essential or low-value tasks and providing an opportunity to reduce workloads. In many cases, finding this solution means working with a trusted outside partner – one who can help promote efficiency and standardisation while also allowing the legal department to demonstrate its value across the organisation.

The future of global entity management

Non-compliance presents certain risks for organisations, including reputational harm, financial penalties, personal liability and administrative dissolution. In order to avoid these traps, it’s essential to stay vigilant when pursuing global expansion by anticipating common compliance issues before they arise. Ultimately, the right partner should employ a triple-level approach: content, technology and service. One or two of these elements is not sufficient. Just as a triangle is dependent on having three connected planes, an optimal regulatory compliance partnership relies on having these three components in place. Global compliance management may be growing more complex by the day. But the right partner, which delivers on content, technology and service, can help organisations become more efficient, minimise compliance risks and focus on the core business mission, all without being distracted by lingering compliance issues.

THE THREE COMPONENTS FOR SUCCESS

Scalable solution with visibility to help ensure compliance

On-the-ground expertise on a local level

Technology Service

4. Pairing technology with expertise helps mitigate corporate compliance risk and reduces costs

56 Ethical Boardroom | Summer 2019

3. Real-time data and insights are critical

Real-time data to keep your organisation working synergistically

Content

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Board Governance | Subsidiaries

PARENT COMPANY LIABILITY When does parental control become too much? Charles Mayo, Chris Owen & Adam Bristow

Charles and Chris are Partners and Adam is a Supervising Associate at Simmons & Simmons LLP London

UK-headquartered multinational companies face the increased risk that non-UK claimants may be able to bring claims against them in the English courts for the overseas acts of their non-UK subsidiaries. There is an increasing trend for these claims, particularly in relation to environmental and human rights issues.

The English Supreme Court recently gave judgment in Vedanta Resources PLC and another v Lungowe and others [2019] UKSC 20. The case confirmed that a duty of care can exist between a parent company and third parties affected by the operations of its subsidiaries. The case adds pressure to multinationals to manage risks effectively across their corporate groups and supply chains. A failure to mitigate these risks could create legal liability for multinational parent companies, result in litigation and cause significant harm to the reputation and brand of the wider corporate group.

The cases

Vedanta is one of three recent and high-profile jurisdictional cases â&#x20AC;&#x201C; all of them procedural decisions of the English courts about whether they have 58 Ethical Boardroom | Summer 2019

jurisdiction to hear a claim. All three have been decided at appeal level; Vedanta is the first of the three cases to reach the Supreme Court (the highest appellate court in England and Wales). The jurisdictional rules and analysis applied by the courts are outside the scope of this article. But the crucial point is that for the purpose of confirming jurisdiction in these cases the courts have had to grapple with, and answer, the question of whether or not there is at least an arguable duty of care between an Englishdomiciled parent company and third parties affected by the acts of an overseas subsidiary of the parent, such that a claim can proceed to a full substantive trial on the merits in the English courts.

Vedanta

In the Vedanta case, 1,826 Zambian villagers brought proceedings in the English courts against Vedanta Resources Plc, a UK incorporated parent company and Konkola Copper Mines Plc (KCM), its Zambian subsidiary, claiming that waste discharged from a copper mine owned and operated by KCM had polluted the local waterways, causing personal injury as well as damage to property and loss of income. In 2016, the High Court held that the claimants could bring their case in England, even though the alleged harm occurred in Zambia, where both the claimants and KCM are domiciled. This

LIABILITY OF A UK PARENT Courts have taken a harder look at the governance process at multinationals

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Subsidiaries | Board Governance decision was upheld on appeal by the Court of Appeal in October 2017 and again by the Supreme Court which gave its decision in April of this year. The Supreme Court judgment means that the claim can now proceed to a full substantive trial.

Shell and Unilever

In 2018 two similar cases were heard by the English Court of Appeal. The cases involved: ■■ Royal Dutch Shell Plc (Shell) – two Nigerian communities are claiming against Shell and its Nigerian subsidiary, Shell Petroleum Development Company of Nigeria Ltd (SPDC), a joint venture with Nigerian shareholders and the Nigerian government, for oil spills from SPDC-operated pipelines ■■ Unilever PLC (Unilever) – 218 Kenyan nationals are claiming against Unilever and its Kenyan subsidiary Unilever Tea Kenya Limited, the owner of a tea plantation in Kenya, at which the claimants allegedly suffered ethnic violence at the hands of third-party criminals In both cases the Court of Appeal concluded that there was not an arguable duty of care, in contrast to Vedanta.

The Supreme Court’s decision in Vedanta: key points

The Supreme Court confirmed that there was nothing legally novel about the parent/subsidiary relationship that requires a special test or set of factors for deciding parent company liability for the acts or omissions of a subsidiary. The key test for parent liability will be one of corporate control: did the parent company have superior knowledge and expertise regarding, and control over, the subsidiary’s operations? As this was a jurisdictional challenge and not a full trial on the merits, the Supreme Court held that the claimants needed only to show that a duty of care was ‘arguable’, which meant persuading the judge that a sufficient level of intervention by Vedanta in the conduct of operations at the mine may be demonstrable at trial, after full disclosure of the relevant internal documents of Vedanta and KCM, and of communications passing between them. The Supreme Court refused to be drawn on setting prescriptive principles or an exhaustive list of factors and circumstances in which an arguable parent company duty of care might arise, pointing out the futility of confining the court’s inquiry too narrowly. Given the typical complexity of modern corporate structures, and that there is no limit to the models of management and control used within multinational groups of companies, the www.ethicalboardroom.com

Supreme Court emphasised that the existence of parent company duties of care is a question of fact in each specific case. These comments will no doubt be of concern to multinationals wishing to understand in exactly what circumstances a parent company might attract liability for its subsidiaries’ activities. In fact, the Supreme Court rejected the Court of Appeal’s attempts in the Shell and Unilever cases to categorise or in any way prescribe the circumstances in which a parent will owe a duty of care to persons affected by a subsidiary: ■■ The Supreme Court cast doubt on the suggestion of the Court of Appeal in the Shell case that, as a general limiting principle, a parent company could never incur a duty of care for the activities of a subsidiary simply by establishing group-wide policies and expecting the management of each subsidiary to comply with them ■■ The Supreme Court expressed reluctance to shoehorn all cases of parental liability into specific categories of the kind suggested by the Court of Appeal in the Unilever case. These two categories were: (i) where the parent has in substance taken over the management of the relevant activity of the subsidiary in place of or jointly with the subsidiary’s own management; and (ii) where the parent has given relevant advice to the subsidiary about how it should manage a particular risk Instead, the Supreme Court simply clarified the factors that might support establishing a parent company duty of care in specific circumstances.

The case for establishing parental liability in Vedanta

Although Vedanta did not have material control of the mine’s operations, the Supreme Court held that the claimants’ case on Vedanta’s duty of care was arguable. The claimants had identified multiple circumstances that indicated that Vedanta had superior knowledge and expertise regarding, and control over, KCM’s operations. In particular, Vedanta had: ■■ Published a public sustainability report, which stressed that the oversight of all Vedanta’s subsidiaries rests with the board of Vedanta itself and made express reference to the particular problems at the mine in Zambia ■■ Entered into a management and shareholders’ agreement by which Vedanta had a contractual obligation to provide KCM with various support and supervisory functions Summer 2019 | Ethical Boardroom 59

Board Governance | Subsidiaries ■■ Provided detailed and specific health and safety and environmental training across the Vedanta group ■■ Provided extensive financial support for KCM ■■ Made various public statements regarding its commitment to address environmental risks and technical shortcomings in KCM’s mining infrastructure ■■ Exercised a high degree of control over KCM’s operational affairs The Supreme Court weighed up these various factors to decide whether the alleged duty of care was reasonably arguable. The Supreme Court noted that Vedanta’s assertion in published materials of its own assumption of responsibility over the activities of KCM and the operations of the mine was particularly damning. So too, according to the Supreme Court, was the fact that Vedanta had not simply laid down proper standards of environmental control over the activities of its subsidiaries and, in particular, over the operations at the mine, but that it had gone further by implementing those standards through training, monitoring and enforcement.

What are the implications for UK parent companies?

The Vedanta case represents a clear widening of the circumstances in which a parent company could be said to owe a direct duty of care to people affected by the operations of a subsidiary. The Court of Appeal in Shell and Unilever tried to frame specific categories of corporate management, control and advice that will or won’t be deemed to create parent company liability; the Supreme Court rejected those attempts. It is likely that the factors identified by the Supreme Court will be heavily relied on by claimants in future cases in an attempt to establish parent company liability. But don’t panic if any of these factors are familiar to you and your company: the existence of similar factors in another corporate group, in relation to a different claim, is not necessarily determinative. The English courts take a holistic view – no single factor or combination of factors will determine the existence of a parent company duty of care, rather the totality of circumstances surrounding the parent company’s relationship with its subsidiary and its role in the specific operations of its subsidiary giving rise to the claim in issue will be relevant. The Vedanta case therefore raises inevitable concerns about whether or not multinational companies are structured and operating in a way that could give rise to parent company liability. It is, of course, impractical to restructure an entire corporate group in reaction to a single case. In any event, the fact-specific and non-prescriptive guidance of the Supreme Court prevents any certainty that 60 Ethical Boardroom | Summer 2019

particular structures would necessarily avoid findings of parent company liability. Nevertheless, a rule of thumb for parent companies seeking to avoid liability for the operations of their subsidiaries is that they should, where practicable, seek to maintain clear operational division between their activities and the activities of their subsidiaries. There are various ways in which the risk of a finding of parent company liability could, depending on the circumstances, be avoided: ■■ Strong subsidiary governance whereby directors of local subsidiaries exercise independent judgment and the board of a subsidiary controls its direction (this is less straightforward for businesses organised by activity or region than for businesses organised by legal entity) ■■ Drafting public statements and reports to avoid any implication of parent company responsibility for the individual application by subsidiaries of relevant, group-wide standards ■■ Considering which framework policies are in place and how they are communicated, monitored and enforced – in particular, parent companies should take care not to take responsibility for the individual implementation of those policies by their subsidiaries at a local level

responsibility of the subsidiary. A policy does not automatically establish parental liability over outcomes which are not within that parent company’s control. It would be a bitter irony if the English courts’ willingness to hear claims against English-domiciled parent companies for the operations of their overseas subsidiaries indirectly led to reduced engagement by these companies with human rights, environmental and/or HSSE concerns.

Looking forward

This Supreme Court decision makes clear that parent companies/multinationals can have liability for the overseas operations of their subsidiaries. Although this is a decision turning on the specific facts of the Vedanta case, those facts are by no means unique: we anticipate that this decision is likely to encourage equivalent claims to be brought. The date of the substantive trial of Vedanta has not yet been listed. The Supreme Court has recently refused the claimants’ application for permission to appeal the Court of Appeal judgment in the Unilever case. This is the end of the line for the claimants in that case. The claimants in the Shell case have recently been granted permission to appeal the Court of Appeal judgment in their case to the Supreme Court. A The Vedanta case decision on that application Even these measures expected shortly. represents a clear isAccordingly, present some challenges this area of law for parent company boards is far from settled and will widening of the exercising normal group to be the subject circumstances in continue oversight, where compliance of intense scrutiny. The failures of one group company which a parent Vedanta, Shell and Unilever adversely affect the group. cases are highly fact-specific company could and are only responding to Conflict between be said to owe a jurisdictional challenges at parental liability direct duty of care this stage. The appeal of the and business and courts to overseas to people affected English human rights? claimants is ultimately likely A question for by the operations to depend on how their multinationals will be their claims are treated, and of a subsidiary approach to implementing whether an actual (rather group-wide policies, for than merely arguable) parent instance about Modern Slavery or Pillar II of company duty of care is established, once the UN Guiding Principles on Business and these parent company liability cases are Human Rights (UNGPs), which provides a considered on their merits. framework for businesses to prevent and A major concern expressed by corporates address negative human rights impacts. has been the perceived risk of a floodgates The UNGPs are currently voluntary and moment if parent company liability to companies may be deterred from taking third parties is established in any of steps to respect human rights because of a these cases. Conversely, a number of human perceived risk of parent company liability. rights activists and specialist claimant However, there is clearly a tension here: firms have advocated for a generous there is no better solution for avoiding application of the law: as a matter of public parent company liability than ensuring policy, why shouldn’t multinational parent that risks are effectively mitigated through companies be held to account for the appropriate on-going due diligence and operations of their subsidiaries, they say, company-level grievance mechanisms. And, particularly where justice is hard to obtain careful drafting can produce policies that in the country where their subsidiary, which make it clear that the implementation, has caused the alleged harm, is located? administration and standard of care Will a full trial in the Vedanta case be that imposed by those policies are the sole floodgates moment? Only time will tell. www.ethicalboardroom.com

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Board Governance | Intellectual Property

IP within the boardroom

Is intellectual property a director and officer issue? Kevin Kalinich & Kristin Kraeger

Kevin is the Global Collaboration Leader, Intangible Assets Solutions, and Kristin is the Managing Director, National Directors & Officers and Fiduciary Product/Practice Leader, Financial Services Group, Aon Risk Solutions

62 Ethical Boardroom | Summer 2019

www.ethicalboardroom.com

Intellectual Property | Board Governance

In July 2019, Apple agreed to purchase most of Intel’s modem internet of things (IoT) business for $1billion, which includes 17,000 wireless technology patents.

Performance

The announcement is the latest in a trend of increasing investments in intangible assets, including disruptive technology, such as 5G, machine learning, artificial intelligence, robotics, cloud computing, IoT/connectedness, quantum computing, big data/predictive analytics and blockchain/distributed ledger. The evolution to intangible asset focus is rapid and spans nearly all industries, geographies and size organisations.1 However, intellectual property ideas are not new. As far back as 1926, the inventor Nikola Tesla, said: “When wireless is perfectly applied the whole earth will be converted into a huge brain, which in fact it is, all things being particles of a real and rhythmic whole. We shall be able to communicate with one another instantly, irrespective of distance. Not only this, but through television and telephony we shall see and hear one another as perfectly as though we were face to face, despite intervening distances of thousands of miles; and the instruments through which we shall be able to do this will be amazingly simple compared with our present telephone. A man will be able to carry one in his vest pocket.” What is new is that there is greater pressure on organisations to figure out how to allocate resources and measure intangible investment, returns and risk exposures.2 In today’s economy, the value provided by intangible assets must be captured in enterprise valuation. Organisations have to expand the range of data sources and techniques they use in valuation and develop methodologies that are suitable to the intangible asset being valued for more reliable valuation results. Such methodologies provide new perspectives on various cost, market and income approaches and can be integrated with an analysis of non-GAAP (generally accepted accounting principles) key performance indicators and other conceptual frameworks.3 Identifying and valuing intangible assets is critical, not only in an active management framework, but also in investing (i.e. insurance protection to backstop a loan based on intellectual property collateral) and quantitative modelling in passive strategies that rely on financial statements use nding dema t s o M use uality High q ing fin Redellectual inte roperty p y use qualit m iu Med

use Low quality

Time www.ethicalboardroom.com

data and that may need adjustments for comparability. On 22 May 2019, Moody’s rating agency downgraded to ‘negative’ the outlook for Equifax due to Equifax’s lack of adequate cyber resiliency that resulted in a loss in excess of $1billion.4 Apple and Equifax are not alone. There are all sorts of significant intangible asset stories in the headlines, for example: ■■ Uber’s self-driving truck subsidiary, Otto, was accused of stealing trade secrets from Google’s autonomous driving subsidiary, Waymo, and settled in February 2018 by providing Google with a $245million equity stake in Uber, all while maintaining its innocence5 ■■ AstroTurf, maker of synthetic grass products, filed for bankruptcy protection in 2016 after a $30million patent infringement loss to rival product manufacturer Tarkett6 ■■ Kraft Heinz, which combined Kraft Foods and H.J. Heinz in a 2015 merger, wrote down its assets by $15.4billion on 21 February 2019, including $7.1billion of goodwill and $8.3billion in intangible assets (the merger put a $47.8billion value on intangible assets) ■■ McDonald’s lost its European Union trademark registration for BIG MAC pursuant to a January 2019 decision by the European Union Intellectual Property Office ■■ D&O insurer was not obligated under a policy exclusion in its directors and officers’ liability insurance policy to defend a travel agency charged with misappropriating trade data, says a federal district court7 ■■ After an Amazon health startup was accused of trade secrets theft, a Massachusetts federal judge ruled on 22 February 2019 that a former employee of UnitedHealth unit Optum Inc. could continue his role with the company Berkshire Hathaway Inc and JP Morgan Chase after a ruling that Optum had not shown the two companies were likely to be rivals anytime soon8 This paper will focus on a subset of intangible assets: intellectual property.

Who is responsible for valuation, strategy and risk management of intellectual property?

Ultimately, the board of directors is responsible for the valuation, strategy and risk management of any and all issues that could be sufficiently material to investors that they may be required to be disclosed in public securities filings. How much information is vital to investors depends a lot on who is defining what information is material and what is immaterial. Generally, according to the US Securities and Exchange Commission, information is material if it ‘limits the information required to those matters to which there is a substantial likelihood that a reasonable investor would attach importance in determining whether to purchase the security registered’. Summer 2019 | Ethical Boardroom 63

Board Governance | Intellectual Property In the US, directors are held to standards precipitously, finally followed by a lawsuit of fiduciary duty, loyalty and care, with alleging the company should have disclosed the business judgement rule as a defence the negative operational event earlier. Each of against many allegations of wrongdoing. the above listed intellectual property ‘event’ Irah H. Donner in Fiduciary Duties of could fall into this category. IPOs are another Directors When Managing Intellectual common premise in the event-driven Property, says: "The law covering corporate litigation involves mismanagement – director duties pertaining to management corporate mismanagement in connection of intellectual property assets is evolving, with the company’s business operations. making it important for Whether the allegations directors to remain to intellectual Many organisations relate up-to-date on any and all property valuation, strategy become paralysed changes in management or risk management; they procedures and best almost always claim any because of the lack practices. Generally, courts previous statements the of valuation and treat intellectual property company made relating assets like any other accounting standards to the alleged operational corporate asset, which problem were misleading with respect to means directors must for failing to disclose the intangible assets approach intellectual event. Those statements property with the same due could be, among other sources, care as they would any other asset."9 a part of the risk factors the companies The ability to demonstrate that directors describe in their financial statements or have appropriately discharged their duties statements made by management in public often dictates the ability to successfully press releases, analyst or investor forums. rebut claims made against such individuals. Any statements are fair game for inclusion Outside of the US, the standard to which in an event-driven complaint, particularly corporate leaders are held in many cases statements following the disclosure of is higher. For example, in a recent case, the event. Post-event statements will be The Hague Court held individual directors held out by plaintiffs as a presumption liable for a company’s trademark and of mismanagement – meaning bad news copyright infringement.10 must equal bad behaviour. A new age is dawning on the nature of class It remains to be seen what the success action securities litigation. Today, companies rate will be with this new style of class and their directors and officers face myriad action securities litigation. Regardless, and allegations from an active plaintiffs’ bar, rightfully so, corporations and their directors claiming corporate mismanagement and officers will undoubtedly look to their following a negative event in connection with directors and officers (D&O) policies to the company’s operations. Commonly dubbed backstop the cost of defending the litigation, ‘event-driven’ litigation, this new rendition either through a successful dismissal or of securities litigation results when a settlement. It is paramount that today’s press-worthy event happens (think cyber vintage of D&O policy has the expansive breach, sexual harassment allegation, or coverage offering, especially on terms that products that cause cancer), the ‘Street’ will be tested by event-driven litigation, reacts and the company’s stock price falls such as: broad definitions of derivative

Tibotec-Virco CVA v. Rompaey

Voss v. Sutardja

Riddell, Inc v. Schutt Sports, inc.

■ Shareholders of Tibotec ■ Marvell Technology was ■ Schutt Sports was found (corporation that is a charged with $1.17billion in guilty of patent minority shareholder of patent damages that were infringement and the Therapy Edge) brought an awarded to Carnegie Mellon company was ordered to pay action against Rompaey, who University in regards to $20.4million in lost profits is a director of Therapy Edge semiconductor patents damages and $5million in reasonable royalties ■ Rompaey approved the ■ Shareholders alleged damages to Riddell sale of valuable IP owned Marvell’s directors breached by Therapy Edge fiduciary responsibility ■ Schutt Sports had to file for Chapter 11 bankruptcy in the ■ Shareholders complained ■ The plaintiffs sued for US Bankruptcy Court in an that Rompaey breached director’s failure to stop attempt to smooth business his duty of care and failed production of products operations while figuring to take reasonable steps found to willfully infringe out a restructuring plan to maximise shareholder on a competitor’s patents value when selling these ■ Directors of Schutt could valuable assets be held responsible for infringement case and ■ The case was eventually ultimately causing the settled, but still highlights a company to file for director breaching fiducuary Chapter 11 bankruptcy responsibility with IP 64 Ethical Boardroom | Summer 2019

demands and loss, narrow conduct exclusion and severability provisions, less ridged reporting requirements and flexibility for defence arrangements.

What can directors and officers do?

The first step is to become educated on intellectual property issues relative to other material issues via an IP audit in order to develop informed strategies: ■■ Identify what IP you own and use ■■ Determine your IP’s usefulness, whether it is enforceable, and whether it conflicts with any third-party IP rights ■■ Conduct an IP valuation While intangible assets are increasing in value and potential loss exposure compared to tangible assets, such as equipment and structures from fires and weather, organisations are failing to keep up with maximising and protecting the value of intangible assets.11 Despite the greater average potential loss to information assets of $1.08billion compared with $795million in property, plant and equipment, the latter has much higher insurance coverage (60 per cent versus 16 per cent). Although few companies have a trade secret theft insurance policy and/or a patent liability policy, by having a greater understanding of the value of their intangible assets compared to their tangible assets, organisations will adjust their allocation of resources accordingly to insure what’s most valuable to them – their intangible assets12 (see the Investment in Intellectual Property Products chart, opposite). Investment in intellectual property now represents 33.41 per cent of total US gross domestic investment in 2018, up from 30.95 per cent at year-end 2012. Over the same period, investments in structures as a percentage of total US gross private domestic investment have remained flat, while investments in equipment have fallen (see the Investment in Intellectual Property Products chart, opposite). Many organisations become paralysed because of the lack of valuation and accounting standards with respect to intangible assets. Others restrict strategy and risk management decisions to those assets and risks modelled via 25 years of actuarial benchmarking, which is not available with respect to innovative intangible assets, such as intellectual property. Nate Silver, in The Signal and The Noise, sums it up well “The most calamitous failures of prediction usually have a lot in common. We focus on those signals that tell a story about the world as we would like it to be, not how it really is. We ignore the risks that are hardest to measure, even when they pose the greatest threats to our well-being. We make www.ethicalboardroom.com

Intellectual Property | Board Governance

INVESTMENT IN INTELLECTUAL PROPERTY PRODUCTS 1000 938.0

950

US ($) billions

900

852.0

850

805.5

800 750 700 650

726.4

691.9

759.2

655.7

600 550 500

2012 2013 2014 2015 2016 2017 2018 Source: US Bureau of Economic Analysis, Table 1.1.5; last revised October 2018

US GROSS DOMESTIC INVESTMENT (PER CENT OF TOTAL) 50% 40% 30% 20% 10% 0%

2012

2013 2014 2015 2016 2017 2018 ■ Structures ■ Equipment ■ Intellectual property products Source: US Bureau of Economic Analysis, Table 1.1.5 last revised October 2018

COST-BENEFIT OF POSSIBLE INTELLECTUAL PROPERTY SOLUTION STRATEGY

RISK

Competitive landscape IP benchmarking Buy-side assessment Enterprise value creation Intelligent Portfolio® Build Pruning Strategic acquisition IP governance IP best practices Trade secret consulting

approximations and assumptions about the world that are much cruder than we realise. We abhor uncertainty, even when it is an irreducible part of the problem we are trying to solve.” The key for directors and officers is to become informed with the most accurate, comprehensive and in-context information, given an organisation’s unique circumstances. Corporate development IP strategy IP valuation C-suite IP M&A IP risk solutions

General counsel

IP department/ IP attorneys

www.ethicalboardroom.com

VALUATION

IP liability Collateral protection Theft of trade secrets IP litigation transfer IP-related tax indemnity IP reps & warranties Source code diligence Design around consulting IP litigation expert witness

IP stack valuation M&A sell-side & buy-side Asset-backed lending Value articulation to markets IP-related transfer pricing IP transaction intermediation IP as an asset class consulting Total cost of risk assessment IP claim management

It is possible to model the potential upside and downside of intellectual property valuation, strategy and risk management. As more data is collected for the models, the models improve. Collaboration between the key stakeholders is critical. Furthermore, the board should consider the cost-benefit analysis of each possible intellectual property solution. High-value intangible assets that are proprietary and confidential to an Risk department/ organisation include trade risk managers secrets and unpublished IP liability patent applications.13 Trade secret theft If such information is Risk assessment leaked, deleted or used risk by a competitor there would be material negative consequences,14 such as loss of

market share, reputational damage,15 loss of customers and business partners, diminishment of advantage and the time and expense associated with incident response. The board and management must create a culture from top down that protects the company’s intellectual property, including corporate policies, training and enforcement regarding: A. Use of company technology B. Restricted access to computer systems and data C. Prohibitions of unlicensed software D. Copyrighted materials E. Social media F. Use of company email (no outside media) G. Why the C-Suite and IP Should Talk16 Intellectual property rights, including patents, trade secrets, copyrights, trademarks and service marks can provide a substantial competitive advantage if properly valued, protected and exploited. In fact, proper valuation, strategy and risk management of intellectual property results in increased profitability and market capitalisation while lowering the total cost of risk. Making informed decisions with the most accurate, comprehensive and in-context information, will go a long way to satisfying the board of directors’ duties with respect to intellectual property issues. 1 “Capitalism Without Capital: The Rise of the Intangible Economy.” Jonathan Haskil and Stian Westlake (Princeton University Press 2018) 2What Ideas Are Worth: The Value of Intellectual Capital and Intangible Assets in the American Economy. Kevin Hassett and Robert Shapiro (Sonecon 2011). www.sonecon.com/docs/studies/Value_of_ Intellectual_ Capital_in_American_Economy.pdf 3The Intangible Valuation Renaissance: Five Methods https://blogs.cfainstitute.org/ investor/2019/01/11/a-renaissance-in-intangible-valuationfive-methods/ 4Equifax May 13, 2019, 8-K: https://www.sec. gov/Archives/edgar/data/33185/000003318519000014/ exhibit99120190331.htm 5https://www.newyorker.com/ magazine/2018/10/22/did-uber-steal- googles-intellectualproperty 6ttps://www.wsj.com/articles/astroturf-files-forbankruptcy-protection-1467219617 7Benjamin & Brothers LLC v. Scottsdale Indemnity Co. https://www. businessinsurance. com/article/20190321/NEWS06/912327424/Scottsdalewins-in-directors-and-officers-litigation-based-onintellectual-property 8https://www.wsj.com/articles/ unitedhealth-employee-cleared-to-join-health-venture-ofamazon-berkshire-jpmorgan-11550859259 9Irah H. Donner, Fiduciary Duties of Directors When Managing Intellectual Property, 14 Nw. J. Tech. & Intell. Prop. 203 (2016). https:// scholarlycommons.law.northwestern.edu/njtip/vol14/iss2/3 10 Novomatic cs v. Bluemay Enterprises NV. 27 June 2018 (ECLI: NL:RBDHA: 2018:7746). 11Understanding the Strategy, Valuation and Risk of Intangible Assets: https://www.aon. com/thought-leadership/ponemoninstitutereport2019. jsp; 122019 Intangible Assets Financial Statement Impact Comparison Report: https://www.aon.com/forms/2019/ strategy-valuation-and-risk-of-intangible-assets.jsp 13It’s Time to Prepare for the IP Monetization Revolution. (2019 January 21). https://www.iam-media.com/law-policy/ip-monetisationteeters-brink-disruption. 14IP Operations Are Facing Increased Risk and Growing Demands. https://clarivate.com/ wp-content/uploads/2018/06/IP-Operations-Trends-Report. pdf 15Reputation Risk in the Cyber Age: The Impact on Shareholder Value. Pentland Analytics. https://www.aon. com/getmedia/2882e8b3- 2aa0-4726-9efa-005af9176496/ Aon-Pentland-Analytics-Reputation-Report-2018-07-18.pdf 16 https://gowlingwlg.com/en/insightsresources/articles/2019/ why-the-c-suite-and-ip-team-should-talk/

Summer 2019 | Ethical Boardroom 65

Board Governance | EU Directive STANDARDISED FRAMEWORK The revised SRD addresses remuneration reporting and shareholder votes in Europe

REMUNERATION AND THE SHAREHOLDER RIGHTS DIRECTIVE The impact of the European SRD II on companies’ AGM remuneration votes will vary widely across Europe Daniele Vitale

Corporate Governance Manager, Georgeson, London

66 Ethical Boardroom | Summer 2019

The transposition of the revised Shareholder Rights Directive into the national legislation of EU member states is expected to bring about a standardised framework in a number of areas, ranging from executive remuneration to related party transactions across Europe.

When it comes to executive remuneration, the revised EU Shareholder Rights Directive is aimed at encouraging a

higher standardised level of disclosure and greater accountability over directors’ pay. Once the requirements are implemented via member states’ national legislation, minimum standards of shareholder say-on-pay will be implemented across the continent. In particular, the revised Shareholder Rights Directive provides that shareholders will be entitled to express their views through two different votes: a forward-looking vote on a company’s remuneration policy, which lays down the framework for the award of remuneration to directors, and a retrospective vote on the remuneration report describing the www.ethicalboardroom.com

EU Directive | Board Governance remuneration that has been granted to directors in the past year. A number of EU member states had already put into place national regulations covering executive remuneration before the revised Shareholder Rights Directive was rolled out. Some of these overlap with the Directive, specifically the UK’s three-year binding vote on remuneration policy, which sits alongside its long-standing annual advisory vote on remuneration policy. Elsewhere, notably in Germany and the Netherlands, states are still behind the times in terms of shareholder say on pay. While in both of these laggard markets it’s true that companies are to some extent required to obtain approval for their remuneration policy, a shareholder vote is usually only required when a change in the executive remuneration policy is envisaged. In particular, the current German Corporate Governance Kodex (under revision at the time of writing) provides that companies should hold a non-binding vote on remuneration policy at regular intervals or in cases where there has been a notable change. In the Netherlands, legislation only requires companies to put executive remuneration to a vote if there has been a material change in the policy. As a consequence, a discrete number of companies have not had a shareholder vote on executive remuneration for many years. The general consensus is therefore that, especially in Germany and the Netherlands, national law implementing the revised Shareholder Rights Directive will require significant adjustments on the part of companies, as investors – who are accustomed to largely ignoring executive remuneration practices when no vote is involved – will ‘discover’ practices that they have long stopped tolerating in other markets where all companies already put their remuneration up for some sort of annual vote.

A pan-European regulatory framework

Pursuant to the provisions of the revised Shareholder Rights Directive, the vote on a company’s remuneration policy can be either advisory or binding, depending on the member state’s implementation of the directive requirement. A remuneration policy will need to be submitted to a shareholder vote at least every four years and, in any case, after any material change is made to it. The remuneration policy will need to include, among other things, a description of all the components of fixed and variable remuneration, including bonuses and other benefits, which may be awarded to directors while also indicating their relative portion in a clear and understandable way. www.ethicalboardroom.com

Where a company awards variable remuneration, the remuneration policy shall set clear, comprehensive and varied criteria for such an award. If the award is share-based, the policy should also specify the vesting periods and, where applicable, the retention periods of shares after vesting. The company should indicate the financial and non-financial performance criteria, including, where appropriate, criteria relating to corporate social responsibility, and explain how they contribute to the overall business strategy and the methods to be applied to determine to what extent the performance criteria have been fulfilled. The policy should specify information on any deferral periods and on the possibility for the company to reclaim variable remuneration. Further, the policy should contain information relating to the duration of contracts or arrangements with directors and the applicable notice periods, the main characteristics of supplementary pension or early retirement schemes, and the terms of the termination and payments linked to termination.

The remuneration policy will need to include, among other things, a description of all the components of fixed and variable remuneration, including bonuses and other benefits, which may be awarded to directors while also indicating their relative portion in a clear and understandable way The remuneration policy should explain the decision-making process followed for its determination, review and implementation, including measures to avoid or manage conflicts of interests and, where applicable, the role of the remuneration committee or other committees concerned. Where the policy is revised, it should describe and explain all significant changes and how it takes into account the votes. As for the remuneration report, this shall include a comprehensive overview of remuneration (including all benefits in whatever form) awarded or due during the most recent year to each individual director. The report shall also include the total remuneration of each individual director split into component parts (fixed and variable, and their relative proportion); information on the application of the

performance criteria; the annual change in remuneration in relation to the performance of the company and the change of employee remuneration over the last five financial years; remuneration deriving from undertaking within the same group of companies; the number of equity instruments granted or offered and the main conditions for their exercise; information on applicable claw-back provisions; and, lastly, information on any deviation from the implementation of the remuneration policy. The European Commission has run a consultation on guidelines that are aimed at harmonising companies’ annual disclosure for directors’ remuneration. The consultation ended on 21 March 2019 but no indication of when a final draft of the guidelines will be published has been provided by the European Commission yet.

Germany

Currently, in Germany there is no mandatory requirement for annual shareholder approval on executive compensation. As stated previously, national regulation provides that shareholders may only vote on the remuneration system on a regular basis or where a notable change is implemented. The draft law for the implementation of the revised Shareholder Rights Directive is expected to bring about a number of notable changes. In compliance with the German corporate law and governance structure, the draft implementing law (published on 11 October 2018) sets forth different rules for the remuneration of the management board and that of supervisory board members. According to the provisions of the draft implementing law, the supervisory board members’ remuneration is to be determined by the shareholders at the AGM while the remuneration of the management board members is to be determined by the supervisory board in compliance with the policy which shall be submitted to a shareholder advisory vote once every four years. As per the remuneration report, shareholders will be entitled to express an advisory vote every year and the draft implementing law provides that the supervisory board and the management board are jointly responsible for its drafting. It is currently envisaged that the remuneration report must contain retrospective information on the remuneration of both the supervisory members and management board members individually as well as information regarding the ratio of the average remuneration of directors compared to that of employees over a five year period. Summer 2019 | Ethical Boardroom 67

Board Governance | EU Directive Looking at current practice in Germany, it is notable that from 2010 to 2019, fewer than 100 votes on remuneration were undertaken in the DAX 30 index. Germany’s situation as a latecomer in terms of giving shareholders a say with regard to the remuneration of directors is even more striking when we consider that in the 2019 AGM season only four DAX 30 companies submitted a remuneration system to their shareholders for a vote. Some investors have argued that a gradual introduction of voluntary voting over remuneration matters would have helped to smooth the transition towards a more

Among the most notable features of the draft implementing law, is that it requires there not only that the vote on the remuneration policy be binding but that the remuneration must be adopted with a qualified majority of 75 per cent of the votes cast (unless otherwise provided by the articles of association). Such a high threshold for approval of the remuneration policy is likely to set Dutch companies on a learning curve to implement international best practice standards of remuneration to ensure their policies are approved with very comfortable majorities in the years to come.

Conclusion

TRANSPARENCY FOR INSTITUTIONAL INVESTORS German and Dutch companies will confront unseen challenges on their remuneration votes in 2020

developed shareholder franchise on remuneration of directors. As things stand, it is now clear that German companies will potentially be in for a rude awakening when shareholders are given a vote on their pay unless they swiftly get up to date with international standards of executive remuneration prior to the next AGM season.

Netherlands

In the Netherlands, national law implementing the provisions of the revised Shareholder Rights Directive is currently going through parliament. At the time of writing, the current draft implementing law provides that a binding shareholder vote shall be put forward at least every four years and this provision will be applicable both to the remuneration policy of the management board members and that of the supervisory board members (or to non-executive directors where the company has a unitary board structure). 68 Ethical Boardroom | Summer 2019

an advisory retrospective vote on the remuneration awarded to individual directors is put forward as a stand-alone item at each AGM. As provided for in the revised Shareholder Rights Directive, it is envisaged that the remuneration report includes information about the total amount of remuneration split down to component parts; that the compliance of the actual remuneration within the framework set out by the policy approved by shareholders; the annual changes in remuneration compared with the company performance; and the development of employees’ pay as well as information on any recovery provisions and deviations from the policy. As member states implement the provisions set forth in the revised Shareholder Rights Directive for remuneration of executives, best practice for remuneration of executives becomes more and more institutionalised. Moreover, since the introduction of the first annual remuneration votes (many major European markets had already introduced some form of annual remuneration votes: 2002 in the UK, 2010 in Spain, 2011 in Italy and 2013 in France and Switzerland), the demands of proxy advisors and institutional investors have steadily increased, both in terms of transparency and best practices, to which the companies in these markets have had to respond with significant improvements. While France was granted a grace period during the first year of introduction of the new remuneration votes (in 2014

Among the most notable features of the draft implementing law, is that it requires that not only the vote on the remuneration policy be binding but also that the remuneration must be adopted with a qualified majority of 75 per cent of the votes cast Furthermore, a greater involvement of the work councils is also envisaged. In particular, it is provided that, before a remuneration policy is put on the agenda for a shareholder vote, the work councils will have the right to provide their advice on the remuneration arrangements set out in the policy and that any deviation from the work councils’ advice will need to be addressed. In addition, where the supervisory board of a company is entrusted with setting up the remuneration policy of the management board members and such supervisory board has a remuneration committee, the work councils’ representative shall be part of the committee. Lastly, it is envisaged that the policy must include a statement highlighting how the same policy is aligned with the company’s values and identity as well as its mission. The draft implementing law provides that

remuneration resolutions garnered an average of 92 per cent across the board), this seems less likely to happen for Germany and the Netherlands – the two most prominent markets still lagging behind in terms of executive remuneration votes may have to swiftly adapt to the new reality. As both the proxy advisors’ and investor-specific guidelines have become stricter and stricter on remuneration, German and Dutch companies will be forced to prepare for unseen challenges from investors and proxy advisors. The two markets will need to come to terms with the new requirements, not just through national implementation of the revised Shareholder Rights Directive but also by the investor community and its own sophisticated and ever-developing approach to executive remuneration. www.ethicalboardroom.com

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Board Governance | Incentives

Executive compensation: metrics and correlation analysis The selection of appropriate incentive metrics is a critical decision for compensation committees and management teams. While a company’s business plan and strategy should be the primary factor when selecting incentive plan measures, most companies consider many other factors. This article discusses:

It is important to consider several perspectives when identifying or confirming incentive plan performance measures

■■ The factors that companies consider when selecting incentive metrics ■■ A detailed discussion of one these factors – the role of correlation analysis in assessing the relationship of incentive metrics and a company’s total shareholder return

long-term incentives, particularly the performance measures and goals, are intended to directly connect employees to the company’s business strategy. Given this criticality, it is imperative to be specific and clear in selecting and defining incentive plan performance measures. While there are many measures that are important for a company to monitor, companies typically find the best design – to maximise motivation and line of sight to drive results – limits the number of measures to less than five (the preference is

Factors that many companies consider when selecting incentive metrics Incentives are the core element of the executive pay programme. Short- and

70 Ethical Boardroom | Summer 2019

Patrick Haggerty & John Sinkular Both are Partners at Pay Governance LLC

often two or three measures in each plan, but practices vary by industry, business situation and other factors). In selecting performance measures, companies consider the factors detailed below. 1. Business strategy 6. Correlation 2. Peer market with TSR practice Factors used to determine incentive metrics 3. Analyst 5. Investor commentary feedback 4. Proxy advisor firms

Business strategy Focussing on business strategy is the starting point for incentive measure selection. Long-range business strategies can provide basis for selecting long-term incentive goals while annual operating plans provide basis for www.ethicalboardroom.com

Incentives | Board Governance UTILISING CLEAR FINANCIAL METRICS Companies use a number of different strategies to set performance goals

will help gauge the importance of potential types of incentive metrics and the specific measures used by directly comparable companies. This step includes understanding which specific measures are most heavily scrutinised by key analysts, particularly with companies at a similar stage in their life cycle (e.g. high-growth, repositioning, etc). Undertaking this review will ensure selected measures are reasonable relative to analysts’ areas of focus and the specific target goals are appropriate if the company provides investor guidance, recognising that metric definitions are often customised to focus on continuing operations or otherwise adjusted to ensure accountability, and guidance is often provided as a range. advisory firms 4 Proxy For US publicly traded companies, the two

leading proxy advisory firms test a company’s financial performance and total shareholder return (TSR) relative to other companies. These ‘tests’ focus on generally accepted accounting principles (GAAP) financial metrics, such as return on assets, return on equity, return on invested capital and earnings before interest, tax, depreciation and amortisation (EBITDA).

selecting goals for annual incentive plans. The incentive metrics should relate to key measures of success as defined by the board and management team. For publicly traded companies, the metrics should align with messages provided in the company’s investor presentations and internal communication of performance. For private companies, the metrics should align with the company’s internal communication of performance.

Short- and long-term incentives, particularly the performance measures and goals, are intended to directly connect employees to the company’s business strategy

Reviewing peer and broader market practices helps identify which performance measures are common, including the types and mix of measures, and the overall incentive plan design structures used by other companies. While this assessment should be secondary to aligning with the company’s business strategy, it does provide information related to trends and potential ideas that companies should consider. In addition to which incentive metrics peers use, other related design information can be gathered and reviewed, including: weighting of metrics, definition of metrics, adjustments made to metrics, year-overyear changes to actual incentive goals, and performance range of actual incentive goals.

The comparator groups used by the proxy advisory firms may vary from the company’s pay peer group and, if these differences our significant, it is often useful to simulate the proxy advisory firms’ likely views on pay-performance alignment. The proxy advisory firms’ views regarding incentive metrics have evolved and will likely continue to be adjusted in the future. Companies should understand how their incentive metrics relate to the proxy advisory firms’ likely views and provide clear proxy disclosure regarding the company’s rationale and application of metrics. For companies that use metrics that advisory firms test against, it is important to understand differences in GAAP versus non-GAAP to minimise surprises. For example, it would be embarrassing if a company paid out incentive for outperforming return on invested capital (ROIC) – e.g. above the 75th percentile – when a proxy advisory firm’s test indicated ROIC performance is in the bottom quartile on a relative basis.

commentary 3 Analyst Identifying what areas of financial

feedback 5 Investor We expect to see continued dialogue

group and broader 2 Peer market practices

statements that key analysts are focussed on www.ethicalboardroom.com

about executive compensation between

company representatives and major investors. These discussions are more likely to occur when companies have been receiving relatively lower say-on-pay vote support from shareholders or during periods of significant change. When dedicated discussions about the executive officer pay programmes occur, typically, the top human resources and investor relations executives will lead the discussion about executive compensation with investors. Depending on the situation, the lead director and chair of compensation committee will also participate. A major part of these discussions is often about incentive design/metric, goals and pay-for-performance alignment. Investors often have specific metrics they want to see for incentive plans, as well as the underlying focus on recent total shareholder returns – both absolute and relative to a relevant comparator group. However, if management has clear rationale for specific incentive metrics, investors are generally supportive. Having a defined process for goal setting as summarised above is helpful when meeting with investors. correlation analysis. 6 TSR TSR correlation analysis assesses the

historical relationship between financial metrics and TSR. This analysis answers the important question – what incentive metrics historically have positively correlated with TSR? As detailed below, this type of analysis is intended to provide a directional perspective and not a definitive answer. However, TSR correlation analysis can indicate which incentive metrics: ■■ Have historically had the strongest correlation to value creation (for the company and peers) ■■ Are the most volatile ■■ Are reasonable relative to key value drivers and metrics used by companies in similar businesses

Role of TSR correlation analysis

TSR correlation analysis assesses the historical relationship between financial metrics and TSR. This can be measured using a company’s own history (internal perspective) and a peer set (external perspective). These analyses assess the degree to which one variable (i.e. TSR) is affected by changes in a second variable (i.e. the chosen financial performance metric) over time. By examining rolling three- and five-year periods over the past decade, we have identified financial measures that have a relatively strong positive correlation to TSR changes. However, since there are many company-specific and macroeconomic factors that impact performance over time, these analyses are intended to provide a directional perspective and not a definitive answer. Summer 2019 | Ethical Boardroom 71

Board Governance | Incentives To provide context, we analysed 50 large industrial companies and found that the strongest TSR correlations were observed for return on invested capital and two margin metrics. For a set of 50 service companies, we found that revenue growth had the strongest correlation with TSR, followed closely by gross profit, margin and return on assets measures.

Key inputs

There are several key inputs to define when conducting TSR correlation analyses. For purposes of these illustrative analyses, we applied the following inputs: ■■ Measures Sample of financial performance measures spanning the income statement, balance sheet, and cash flow statement. If a standardised database is used, the financial measure definitions will often vary from the specific incentive plan measures used by a company ■■ Comparisons Change in dollar amounts for income statement measures and the absolute margin or return for other measures (the per cent change may also be analysed) ■■ Time period Three- and five-year rolling time periods over 10 years ■■ Correlation strength Relatively stronger correlations were highlighted at greater than or equal to 25 per cent, reflecting the wide range of companies that comprise the two data sets. We note that in smaller data sets of similar companies, correlations of near or greater than 50 per cent have been observed

Example output

The charts above illustrate the correlation of various financial metrics to TSR over three- and five-year periods. Metrics with correlations of greater than or equal to 25 per cent are highlighted. Financial performance data reflect standardised definitions provided by S&P Capital IQ (they have not been customised or adjusted).

Using TSR correlation analysis

TSR correlation analysis provides companies with another perspective as they confirm or reevaluate the appropriateness of their incentive plan performance measures. For example, assume a company in the service industry uses the following incentive metrics: FOR SHORT-TERM 3-YEAR INCENTIVES: CORRELATION ■■ Revenue (50% weight) 41% ■■ EPS (50% weight) 5% FOR LONG-TERM INCENTIVES ■■ Gross profit margin (50% weight) -10% ■■ Return on assets (50% weight) 30% While these performance measures may be aligned with the company’s business plan 72 Ethical Boardroom | Summer 2019

TABLE A: INDUSTRIAL COMPANY CORRELATION ANALYSIS (50 COMPANIES) Category

Metric Revenue growth Gross profit growth Sales/earnings Earnings from operations growth Basic EPS growth Margin

Gross profit margin Operating income margin Net income margin

Return on assets Return on equity Return/capital Return on invested capital Unlevered cash flow growth

50 manufacturing companies Three-year Five-year 25% 25% 23% 23% 23% 23% 21% 21% 21% 36% 33%

23% 34% 34%

23% 18% 37% 13%

17% 20% 32% 13%

TABLE B: SERVICE COMPANY CORRELATION ANALYSIS (50 COMPANIES) Category

Metric Revenue growth Gross profit growth Sales/earnings Earnings from operations growth Basic EPS growth Margin

Gross profit margin Operating income margin Net income margin

Return on assets Return on equity Return/capital Return on invested capital Unlevered cash flow growth and strategy, EPS and gross profit margin are not correlated with TSR based on historical relationships. Due to certain limitations, including the use of historical data at various points in time and the uniqueness of individual companies in a given peer set, TSR correlation analysis should be considered directional. A general correlation analysis, as illustrated herein, is a starting point. As a next step, a company may decide that further refinement is warranted in order to determine the most appropriate form of the metric to be used. In the end, companies should select incentive plan performance measures that best align to their business strategy to drive long-term shareholder value.

Putting it all together

There are many factors to consider in developing and administering a well-designed executive compensation programme. At the core, executive compensation has its foundation on incentive compensation opportunities – annual and long-term incentives – that provide a direct connection to the relevant metrics. In today’s say-on-pay environment, with a substantial potential negative impact on vote outcomes if proxy advisory firms perceive there is misalignment in pay-performance or underlying subpar designs, it is critical for companies to have the utmost confidence in their plan designs.

50 Service Companies Three-year Five-year 41% 39% 30% 26% 3% 15% 5% 4% -10% 31% 30%

-7% 28% 28%

23% 3% 15% 1%

32% 5% 11% 16%

While public companies have as a priority to increase total company value over time, there is typically a disconnect in using stock price or total shareholder return as the primary incentive metric. Yes, stock price and TSR are important. However, they are outputs of management’s execution of the strategy and the markets’ perceptions thereof, not a tangible day-to-day operating plan for the management team. While most companies readily note their business is unique – this observation may be more accurate now in today’s highly competitive, technology- and innovation-driven business models, game-changing challenges and opportunities that are prevalent. The result is the need for nuance, considering various tradeoffs, to arrive at the best designs for a particular company, not a ‘one size fits all’. Companies with a long-term perspective and other astute companies review a wide range of inputs, including recent past, current and future projections for the industry, relevant direct peers and the company itself, to help determine their performance metrics for the new incentive cycles. Correlation analysis should be one of these perspectives that is, at least, periodically, reviewed. In the end, the company’s strategy, near-term realities and other internal factors should be the primary drivers in selecting the appropriate incentive metrics. www.ethicalboardroom.com

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Global News Europe Santander prepares for CEO court battle Banking boss under Spanish bank Santander has said it has acted with ‘total transparency’ and ‘followed rigorous standards of corporate governance’ in its decision to reverse its plan to hire a new CEO. Just months after announcing Italian banker Andrea Orcel (pictured here with Ana Patricia Botin, Santander group executive chairman) as its new CEO, Santander said he would no longer be joining due to the ‘unacceptable’ costs associated in compensating him for past remuneration at his former employer UBS. Orcel, the former head of UBS’s investment bank, is now suing Santander and demanding that it either make him CEO or pay damages of €100million. Santander’s secretary general, Jaime Perez Renovales, told shareholders that the bank will defend its position in court and will act ‘with total force to prove before the courts that the conditions were not met for [Orcel’s] contract to be effective’.

Orange boss cleared over payout scandal Orange chief executive Stéphane Richard (right) has been cleared of any wrongdoing in a long-running fraud case by the Paris Criminal Court. He was cleared by Paris judges in a scandal related to his role at the Finance Ministry in a €404million arbitration payout a decade ago. At that time, Richard was chief of staff for Finance Minister Christine Lagarde, who was found guilty of negligence in 2016 for creating the circumstances for the payout and then not challenging it. The acquittal of Richard, on trial for complicity in fraud, cements his position at the head of France’s largest communications group, where he has been CEO since 2011.

European financial services push for gender parity Women hold just over a third of positions on the boards of the largest banks and financial services companies in Europe, according to a study. The 2019 Corporate Women Directors International (CWDI) Report focusses on women board directors in 104 banks, insurance and mortgage companies in the 2018 Fortune Global 500 ranking of the largest in the world. Among the top 10 companies with the highest percentage of women directors are two insurance firms that have achieved 50-50 male-female representation on their boards — AXA, headquartered in France, and Achmea, based in the Netherlands. French companies dominate the listings with six companies averaging 44.6 per cent women-held board seats. According to CWDI, the higher numbers in Europe, compared to the rest of the world, reflect the success of quotas designed to increase women’s access to board positions.

74 Ethical Boardroom | Summer 2019

fire for pay ‘attack’

Bill Winters, the American chief executive of British multinational bank Standard Chartered, has been accused of ‘undermining corporate governance’ for his recent attack on the company’s shareholders. Winters called investors ‘immature’ after almost 40 per cent of Standard Chartered’s shareholders declined to back the lender’s new remuneration policy at its annual meeting in May. “Picking on individual pension arrangements… and suggesting that there is some big issue there is immature and unhelpful,” Winters told the Financial Times. In response, Neville White, head of responsible investment policy and research at EdenTree Investment Management, told FT.com that: “When Mr Winters called shareholders ‘immature’ for their opposition to executive remuneration, he transgressed a fundamental principle of accountability. “Mr Winters is sadly diminished by his intervention; it is never wise to attack the providers of capital for exercising shareholder democracy.”

Metro recommends investors reject takeover bid Germany’s wholesale cash-and-carry group Metro has warned shareholders not to accept a takeover offer by EP Global Commerce, owned by Czech and Slovak investors. EP Global Commerce already owns 17.5 per cent of Metro and has the option to buy another 15.2 per cent from German holding company Haniel. But Metro CEO Olaf Koch said the price offered by EPGC is ‘inadequate as it substantially undervalues Metro’. He said that after reviewing the offer’s further conditions, the group ‘recommends our shareholders not to accept the offer’. Once one of the world’s biggest retailers with businesses stretching from electronics to department stores, Metro has struggled since splitting off from its Ceconomy electronics arm two years ago.

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Activism & Engagement | Germany

The German activism climate Investors have proven that shareholder activism can thrive in Germany Amadeus Moeser

Associate Corporate/Private Equity at Sidley Austin LLP

The cosy years for executives of German public companies are over. Shareholder activism has become a major and permanent phenomenon in the German corporate landscape. An increasing number of predominantly foreign activists have been shaking up German boardrooms over the last years. Activists have been studying the German market and have become familiar with the legal framework and cultural idiosyncrasies. In light of countless corporate scandals in recent years and developments such as a cultural shift towards increased shareholder engagement, a new shareholder structure that is increasingly geared towards (passive) foreign funds, as well as new legal developments, Germany offers better opportunities and a more favourable environment for activists than some years ago. Activists in Germany are becoming more confident and aggressive, targeting some of the largest and most prominent German companies, such as Deutsche Bank, Bayer, ThyssenKrupp, SAP and Volkswagen. Even companies previously considered immune from activist campaigns have begun to feel pressure. Europe’s largest economy looks set to become a new hot spot for activists in the coming years. Scandals, such as Volkswagen’s emissions scandal and the fraud probe into alleged accounting irregularities at Wirecard; poor or at least unpopular management decisions, such as the $63billion acquisition of Monsanto by 76 Ethical Boardroom | Summer 2019

Bayer; long-serving periods of executives; excessive remuneration packages and opaque management bonus schemes – these have made German companies vulnerable and more exposed to activist attacks. In addition, German executives have ignored crucial governance trends. The relevance of environmental, social and governance (ESG) does not seem to have found its way into many boardrooms yet and in some ESG areas, German companies are lagging far behind. A good example is the lack of diversity in German boardrooms. Only 13.9 per cent of the executives in the DAX are women (27 out of 194) and in the MDAX the number is only 10.2 per cent (26 out of 254). These numbers are particularly noteworthy against the background that the largest asset managers, including BlackRock, Vanguard and StateStreet, have long since included diversity in their voting policy, knowing that ESG-issues are value drivers. As a consequence of the aforementioned, stock market prices have fallen significantly during the last years. One

Companies previously considered immune from activist campaigns have begun to feel pressure. Europe’s largest economy looks set to become a new hot spot for activists in the coming years extreme example is Bayer, which has seen its share price plunge more than 40 per cent since June 2018, when the acquisition of Monsanto was closed. These circumstances have been the impetus for a cultural change in corporate Germany. Unsurprisingly, the cultural change did not originate in the boardrooms, but was largely driven by shareholders. Shareholders have grown tired of poor management decisions, a lack of transparency, poor shareholder communication and value destruction

and have lost confidence in many management teams. Retail investors, institutional investors and shareholder associations are becoming louder and more critical. Shareholders are demanding better governance and are increasingly willing to articulate their concerns via the press, through direct conversations with the management or in their voting behaviour at annual general meetings. This was impressively illustrated by the Bayer annual general meeting in April 2019 where, for the first time, shareholders delivered a vote of no confidence to the management of a DAX-listed company. In some cases, even anchor shareholders have turned their backs on the management. In the ThyssenKrupp case, the anchor shareholder called the engagement of Elliott Management ‘a great opportunity’. Activists are benefiting greatly from this development as shareholders are more receptive to activist ideas and increasingly willing to support those ideas. The days of compromises and consensus-oriented corporate culture in Germany seem to be over.

Shareholders get vocal

The shareholder structure in Germany has changed drastically in recent years. There is a much higher proportion of foreign institutional investors. Those investors have started to become increasingly interested in governance and operational matters. They are supporting activist endeavours and are becoming more vocal. It is to be expected that institutional investors, which have been passive until now, will become active themselves and assert their own claims in the invested www.ethicalboardroom.com

Germany | Activism & Engagement

DRIVING CORPORATE CULTURAL CHANGE Shareholders in Germany are vocal and demanding better governance www.ethicalboardroom.com

company. The influence of proxy advisors is also increasing. They, too, are becoming more critical and increasingly willing to support activists. As a result, it has become easier for activists to collect the votes/ proxies necessary to enforce their demands. A recent trend in Germany has been to target conglomerates. While some German conglomerates, such as Bayer, Daimler or Volkswagen, spun off certain divisions and established holding company structures in an attempt to pre-empt activists. Others like Bilfinger, E.ON and ThyssenKrupp have been pressured by activists to separate from divisions. There are still enough conglomerates in Germany that are just waiting to be taken apart by activists. Recent years have also seen a dramatic increase in high-profile, public shortselling campaigns. The rise of taking private deals in Germany is also a very interesting development for activists. While purchase prices for private M&A-transactions have reached record levels, stock market prices have fallen significantly. As a result, taking-private deals have become popular again. Equipped with vast amounts of capital, private equity firms are looking for new, attractive investment opportunities and are increasingly targeting public companies. It is to be expected that activists will take advantage of this trend. Recent M&A-related activist campaigns, in particular M&A-arbitrage, where activists take advantage of scenarios where their stake is (at least partly) needed to allow a takeover to succeed or to implement certain corporate measures, have been very successful and profitable. In Germany, there are far-reaching minority rights, which can constitute a serious source of annoyance for management. Holding one single share entitles the owner to attend, speak and vote at general meetings, request certain information at a shareholdersâ&#x20AC;&#x2122; meeting, file countermotions before and at a general meeting and file proposals regarding the election of supervisory board members. Holding shares representing five per cent or â&#x201A;Ź500,000 of registered capital entitles the owner to request that a shareholdersâ&#x20AC;&#x2122; meeting is convened or to request an amendment to the agenda of the general meeting (e.g. removal of members of the supervisory board, vote of no confidence regarding members of the management board). Summer 2019 | Ethical Boardroom 77

Activism & Engagement | Germany Holding 10 per cent or €1million of registered capital allows the shareholder to request an individual vote on the discharge of management and/or supervisory board members. In addition to statutory law, the German Corporate Governance Code (DCGK) contains recommendations based on international standards for the best practice of corporate governance that can also be useful for activists to exert pressure on the target. The DCGK is not mandatory, but deviations need to be explained and disclosed. On the other hand, activists are subject to extensive disclosure obligations that require investors to disclose shareholdings in listed companies to the company itself and the Federal Financial Supervisory Authority (BaFin) should the voting interest exceed certain thresholds. When crossing a 10 per cent threshold, investors are also required to inform the company of the aims they intend to pursue with the investment, whether they plan to acquire further voting rights within the next 12 months, exert influence on the management’s composition, or seek changes in the capital structure and whether the investment serves the implementation of strategic objectives. In the course of preparation for a proxy contest, activists are hampered by some peculiarities of the German legal framework. For example, unlike in the US, where the shareholders have a right to identify information of all other shareholders by inspecting the company register, in Germany the activist can only demand to inspect the participants list of the last annual general meeting. The collection of proxies is therefore regularly done publicly in Germany. Activists must also keep an eye on the rules regarding acting in concert while soliciting proxies.

Starting a proxy fight

In the US, one of the primary strategies used by activists to influence companies in which they have invested is to initiate a proxy contest for representation on a company’s board of directors. In Germany, a two-tiered board structure consisting of a management board (Vorstand) and a supervisory board (Aufsichtsrat) is mandatory for listed companies. The management board runs the company independently and has the sole authority over a whole range of issues where neither the annual general meeting nor the supervisory board may interfere (shareholders cannot instruct the management board in corporate structure matters, such as the sale of divisions or subsidiaries, a share buyback programme or a special dividend payout). Shareholders do not have direct influence on the composition of the management board in Germany. However, the idea that the two-tier board system would shield German boardrooms against activists was more than naïve. The members of the management board are appointed and 78 Ethical Boardroom | Summer 2019

removed by the supervisory board, whose members are in turn elected by the shareholders’ meeting with a simple majority.2 The legal protection of the management board is also undermined by the new level of aggressiveness used by activists in Germany. The ThyssenKrupp case of 2018 is a remarkable example of the more aggressive US-style activist situation German boardrooms will have to get used to. As a result of their campaign, the involved activists had the CEO and the chairman of the supervisory board removed within just 10 days. In addition, activists can pressurise

There have been legal developments that activists can use to their advantage. The law implementing the revised Shareholder Rights Directive contains interesting innovations individual executive board members by being able to influence executive board remuneration through their influence on the supervisory board. Nevertheless, direct influence on the management board seems less and less necessary. Due to the countless scandals and failures of German management teams, supervisory boards are much more active in their role as controlling bodies than they were just a few years ago. German supervisory boards have become increasingly powerful just as the management boards have lost influence; the traditional model of the management board as the sole decision-maker no longer applies to the same extent. Supervisory board members are also becoming increasingly present in the media. While settlement agreements are possible in Germany, they do not offer the same scope of action as in the US. Agreements between the supervisory board and shareholders on the dismissal of management board members or management board compensation are conceivable. However, settlement agreements in Germany have to be in the best interest of the company and comply with the principle of equal treatment of all shareholders. If an activist shareholder negotiates an economic

advantage, this agreement must be made public and the other shareholders must benefit equally. There have also been legal developments that activists can use to their advantage. The law implementing the revised Shareholder Rights Directive (SRD II)– expected to come into force in fall 2019 – contains interesting innovations for activists. The provisions regarding say-on-pay are of particular relevance. Activists are given a useful and not-to-be-underestimated instrument to put the management board under pressure before the annual general meeting. In the future, it will be mandatory for the annual general meeting to pass a resolution approving a remuneration policy for the management board for each material change, and at the very least every four years. The say-on-pay is no longer optional, but obligatory. The draft law provides that the resolution of the general meeting on the remuneration policy is to be of a purely recommendatory nature and does not create any rights or obligations. But even if the say-on-pay vote is not binding, it still sends a strong signal. It could have a de facto binding character, because the supervisory board – which decides on the remuneration of the management board – will hardly be able to completely ignore a clear vote of the shareholders. In recent years, the position of activists has also been strengthened by the German Federal Court of Justice (BGH). Of particular importance is a ruling of September 2018 in which the BGH commented on the interpretation of the characteristic of the ‘individual case’ in the context of acting in concert.1 Activists will now be able to influence supervisory board elections by entering into agreements with other activists/shareholders to coordinate their voting behaviour without attribution of their votes (consequently, no additional voting rights notifications or the obligation to launch a mandatory offer will be triggered). The environment for activists in Germany has never been better. Investments in the largest German companies show that activists are becoming increasingly sophisticated and confident. Activists’ emphasis on ESG issues and their alignment with the interests of other shareholders have improved their standing. The general perception of activists has changed fundamentally. Being perceived as aggressive and more confrontational is no longer a taboo in Germany. Many of the activists’ demands are now actively supported by other shareholders. Activists seem to be fully aware of the new climate in Germany and well-prepared to take advantage of it. The coming years are going to be very interesting for German boardrooms. 1 German Federal Court of Justice, 25 September 2018, (II ZR 190/17) 2 Something different may apply to companies subject to co-determination regulations. Depending on the number of the company’s employees, a certain amount of supervisory board members are determined by the company’s employees.

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Raymond James Activism Response & Contested Situations Practice

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One of the only middle market investment banking firms currently offering this type of support, Raymond James partners with companies to help them prepare for and respond to activist investors and other contested matters. Our Activism Response & Contested Situations practice leverages extensive knowledge of the latest developments affecting activist strategies and institutional investors and provides expertise in four key areas: • Activism Preparedness and Response • Contested M&A • Shareholder Engagement • Corporate Governance Matters We offer the critical advice and resources your company needs to proactively develop the right response plan and team. Reach out to learn more. Duncan Herrington, CFA Managing Director, Head of Activism Response & Contested Situations New York +1.212.856.4382 raymondjames.com/shareholderactivism duncan.herrington@raymondjames.com © 2019 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC 19-ECMMA-0088 KF 1/19

Activism & Engagement | Board Directors

Spotlight on overboarding Policies, changing board profiles and shareholder activism could lead to fewer board commitments worldwide Steve Wolosky, Andrew Freedman and Ron S. Berenblat Partners at Olshan Frome Wolosky’s Shareholder Activism Group

A series of global corporate governance developments is making directors who typically serve on multiple boards less attractive to companies and suppressing the appetites of directors themselves to take on additional board positions. As a result, we expect to see a slow but steady decrease in the number of boards on which individual directors serve around the world. We believe a trend of directors serving on fewer boards will emerge over the coming years as proxy advisory firms and institutional shareholders continue to implement internal voting guidelines with respect to ‘overboarding’ and regulatory organisations roll out new rules and regulations restricting or discouraging service on multiple boards. We also believe this trend could be fuelled by the gradual decrease in demand for directors who typically serve on multiple boards due to the recent explosion of interest in more diverse directors and a growing preference for directors with specific expertise in highly specialised fields. Finally, we believe directors are scaling back on their board commitments in anticipation of heavier time constraints and added investor

80 Ethical Boardroom | Summer 2019

scrutiny with the globalisation of shareholder activism. Widespread attention to the issue of overboarded directors, or directors who serve on too many boards, began in the early 2000s in response to concerns raised by investors and academics that ‘busier’ directors do not have enough time to effectively discharge their duties to the detriment of stakeholders. These concerns spawned numerous studies, digging into various areas of the topic of overboardedness. including the consequences of serving on too many boards, the number of directorships an individual may hold before he or she becomes in danger of being overcommitted and correlations between directors holding multiple board seats and poor company performance. There are also schools of thought challenging the proposition that overboarded directors are detrimental to companies as over-simplistic and arguing that any determination as to a director’s time commitments should be considered on a case-by-case basis. While the merits of this debate are outside the scope of this article, it is quite clear, at least in the US, that the leading proxy advisory firms, the top three index

HOW MUCH IS TOO MUCH? There are concerns that having directorships in different companies can impact commitment and effectiveness

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Board Directors | Activism & Engagement

fund managers and many of the largest publicly traded companies believe that directors who serve on too many boards are bad for business. Indeed, it does appear that directors are spending more time on board matters than a decade ago. According to the 2016-2017 NACD Public Company Governance Survey, the average director time commitment was 245 hours per year, representing a significant increase from an average of 210 hours per year reported by the NACD in 2008.

Overboarding policies and guidelines

Policies and guidelines adopted by proxy advisory firms, institutional investors and companies themselves that are intended to limit the

number of boards on which a director serves could directly contribute to a trend of directors serving on fewer boards, particularly in the US. In response to concerns that directors are becoming overextended, influential proxy advisory firms have adopted guidelines addressing overboarded directors. The leading firm, Institutional Shareholder Services (ISS), will generally recommend a vote against or withhold from a director nominee of a US company who serves on more than five public company boards or is CEO of a public company who serves on the boards of more than two public companies besides his or her own (ISS will recommend withhold only at their outside boards). ISS first adopted overboarding guidelines in 2004. Since then, in order to address ‘evolving market realities’, ISS has decreased the cap on the number of boards on which a non-CEO director may serve in the US from six to the current five, beginning in 2017, and has stated that it will continue to evaluate the ‘optimal level of directorships’ for CEO directors. ISS’s overboarding guidelines for Canadian companies listed on the TSX are substantially the same as the US company guidelines. In the UK, Ireland and many of the countries comprising continental Europe, ISS may recommend a vote against a director nominee who holds more than five mandates at listed companies (with a non-executive chairmanship counting as two mandates and an executive director position counting as three mandates). In addition, a director nominee who

holds an executive director position at one company and a non-executive chairman position at another company will be considered overboarded. We would not be surprised if, during the next few years, ISS tightened its overboarding parameters across all jurisdictions.

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Summer 2019 | Ethical Boardroom 81

Activism & Engagement | Board Directors The three largest index fund managers in the US, BlackRock, Vanguard and State Street, have also sent a clear message to their portfolio companies that they may vote against the election of directors serving on an excessive number of boards under their respective internal proxy voting guidelines. BlackRock will consider a director candidate to be overcommitted if he or she serves on more than four public company boards (two boards in the case of a CEO director) for its US portfolio companies. For its European, Middle Eastern and African portfolio companies, BlackRock expects companies to provide an explanation where a board candidate is a director serving on more than three other public company boards, a chairman serving on more than two other public company boards (or only one if he or she is chair of both boards) or an executive officer serving on more than one other public company board (BlackRock would vote against election only at the external board). Just a few months ago, Vanguard adopted a new overboarding policy for its US portfolio companies under which it will consider any director who serves on five or more public company boards to be overcommitted and will vote against the director at each company except one where he or she serves as chair of the board. In

the case of a director who is also a ‘named executive officer’ (NEO) and sits on more than one outside public board, Vanguard will generally vote against the director at each company where he or she is a non-executive but not the one where he or she serves as a NEO. State Street’s policies for its US and Canadian portfolio companies are slightly more lenient than those of its counterparts, stating that it may withhold votes from directors who sit on more than six public company boards and CEO directors who sit on more than three public company boards. For its European portfolio companies, State Street will look at the number of outside directorships held by a non-executive director when considering his or her election. We expect to see other asset managers in the US continue to adopt similar overboarding policies. Asset managers outside the US are beginning to adopt such policies based on similar concerns with expanding time commitments of directors serving on multiple boards. Just recently, Legal & General Investment Management, the UK’s largest fund manager, stated that it would encourage executive directors not to hold more than one external non-executive directorship of a listed company and encourage non-executive directors not to hold more than five public

company directorships. In France, BNP Paribas Asset Management will not vote for the election of non-executive directors who have five or more director mandates or three or more director mandates in the case of executive directors. As the influence of institutional investors on the election of directors around the world continues to grow, the implementation of their overboarding policies could play a key role in reducing the number of board positions held by directors. Companies are placing their own restrictions on the number of outside directorships that may be held by their directors. In the US, many of the larger

Companies are placing their own restrictions on the number of outside directorships that may be held by their directors. In the US, many of the larger publicly traded companies have adopted such limitations within their internal corporate governance guidelines

SERVING ON DIFFERENT BOARDS Fund managers are cracking down on directors spreading themselves too thin

82 Ethical Boardroom | Summer 2019

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Board Directors | Activism & Engagement publicly traded companies have adopted such limitations within their internal corporate governance guidelines. According to a study entitled Corporate Board Practices in the Russell 3000 and S&P 500 (2019 Edition) issued by The Conference Board in collaboration with Debevoise & Plimpton, Russell Reynolds Associates and the John L. Weinberg Center for Corporate Governance, 77 per cent of S&P 500 companies had such overboarding policies in 2018. This represents a significant increase from 27 per cent of S&P 500 companies in 2006, according to consulting firm Spencer Stuart in its 2016 Board Index. According to The Conference Board, such policies have a standard limit of three to four outside directorships. Similar policies are maintained by companies outside the US with varying frequency, depending on the country. In France, most companies listed on the SBF 120 have adopted governance standards developed by the French Association of Large Companies (AFEP) and the Movement of the Enterprises of France (MEDEF) known as The AFEP-MEDEF Code 2018 (the AFEP-MEDEF Code), which contains specific overboarding recommendations. Under the AFEP-MEDEF Code, a director should not hold more than four other directorships in listed companies and an

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executive officer should not hold more than two other directorships in listed companies. And in Ireland, for example, the multinational Johnson Controls’ policies prohibit directors from serving on more than three other public company boards and further limit the CEO to one other public board in addition to the company board. While such internal overboarding policies are not nearly as prevalent outside the US, we would not be surprised to see a gradual increase in the adoption of such policies on a global basis. The adoption of these internal overboarding policies reflect a desire by boards, particularly in the US, to ensure their memberships have sufficient bandwidth to effectively perform their duties, but it could have a direct impact on reducing the number of outside boards on which their directors serve.

Overboarding rules and regulations

Governments around the world are beginning to address concerns with overextended directors by introducing overboarding rules and regulations. We are not aware of any federal or state overboarding rules in the US. However, advances in this area are being made in Europe. Although the UK does not have mandatory overboarding requirements, concerns with

directors who are spread too thin on time and other commitments are clearly reflected in the UK Corporate Governance Code (July 2018). The UK Code recommends that non-executive directors should have ‘sufficient time to meet their board responsibilities’ and that prior to appointing new directors, the board should ‘take into account other demands on directors’ time’ and ‘significant commitments should be disclosed with an indication of the time involved’. In addition, the UK Code advises that full-time executive directors should not accept more than one non-executive directorship in a FTSE 100 company or ‘other significant appointment’. In Germany, the German Stock Corporation Act has a relatively permissive overboarding provision, limiting the number of positions an individual may serve on mandatory supervisory boards of commercial enterprises to a maximum of 10. However, the current draft of the German Corporate Governance Code, which would only go into effect after the act (ARUG II) for implementing the Second EU Shareholder Rights Directive is enacted, contains clearly defined overboarding provisions that would replace the general recommendation under the existing code that the supervisory board should satisfy itself that director candidates are able to devote the expected amount of time to discharge their duties.

Summer 2019 | Ethical Boardroom 83

Activism & Engagement | Board Directors Under the draft code, it is recommended and experience in the boardroom, boards that a supervisory board member who is not are increasingly adding directors with a member of any management board of a backgrounds in tech, digital, consumer listed company may not accept more than marketing and other areas of emerging five supervisory board mandates at outside importance. They are casting a wider and listed companies (with a chairmanship deeper net to identify director talent who are counted as two mandates). Moreover, the available and interested in taking on board draft code recommends that a member of roles”. Indeed, in a Spencer Stuart survey of a management board of a listed 177 nominating/governance company may not have more A perfect storm committee members of US than two supervisory board between May of overboarding companies mandates at outside listed and June of 2018, 48 per cent policies and companies and may not serve of respondents considered as chair of a supervisory board technology experience regulations, of an outside listed company. to be a high priority board shifting board recruiting profile. Thirst for diverse and profiles and The increasingly high ‘next-gen’ directors demand for diverse and shareholder Public companies all over next-gen directors is the globe are exhibiting an making traditional directors, activism could insatiable thirst for more particularly those of the lead to a gradual diverse and highly specialised ‘male, pale and stale’ profile reduction in the who serve on multiple directors whom we believe could contribute to a reduction number of board boards, less attractive in the number of board to companies. We believe positions taken on by directors. positions taken contracting demand for The push to promote on by directors non-diverse candidates who board diversity is a global lack these specialised skill sets phenomenon that shows no signs of abating. could also contribute to a gradual drop in the In addition to highlighting the inequality number of board positions held by directors. engendered by the lack of diversity of many The impact of public company boards, there is abundant shareholder activism research showing a correlation between The explosion of shareholder activism in diverse boards and improved financial the US and Canada during recent years performance, corporate governance and and its burgeoning expansion into Europe accountability to stakeholders. As a result, and Asia could also contribute to a trend it should come as no surprise that the same of directors scaling back on their board proxy advisory firms, such as ISS, and the commitments. In the first half of 2019 large institutional investors, including alone, according to Activist Insight Online, BlackRock, Vanguard and State Street, who more than 570 companies worldwide were are combatting overboarding with their publicly subjected to an activist demand. voting policies have also endeavoured to As the leading law firm to shareholder foster greater diversity, particularly gender activists in the US, we have observed diversity, in the boardroom. first-hand how directors become much In the US, California became the first state busier after an activist has surfaced. After a to require public companies headquartered company is targeted by an activist, directors in California to comply with certain gender who may have spent the average 200 to 300 quota requirements for boards, including hours a year on board matters could spend having a minimum of one female on the double that amount engaging with the board no later than the end of this year. activist, exploring and implementing Similar legislation is in the works in other value-enhancing initiatives suggested by states. Countries outside the US are also busy the activist or taking reactionary measures, adopting board diversity rules and policy such as adopting anti-takeover provisions. recommendations for their local companies. We believe directors who have personally In the meantime, a new breed of highly been on the receiving end of an activist specialised directors, referred to by Spencer campaign and experienced the spike in Stuart as ‘next-gen directors,’ are playing an working hours required to respond to the expanding role in the refreshment of boards activist, begin to think twice about taking on across the globe. These next-gen directors, additional board positions out of fear of being who are typically younger than the average spread too thin. In addition, understanding director and have highly coveted expertise that no company is immune to activism, in areas such as cybersecurity, social media many boards are being their own ‘activists’ in and other high-tech and digital fields, are an effort to make themselves less vulnerable being recruited heavily by boards. as targets. This typically involves undertaking In its 2018 US Board Index, Spencer Stuart rigorous, time-consuming initiatives, such discusses this trend: “Recognising the as periodic evaluations of the company’s strategic imperative for new perspectives 84 Ethical Boardroom | Summer 2019

strategies, operational efficiencies and capital structure, focussing on board optimisation and refreshment and corporate governance best practices and in engaging stakeholders proactively. Separate and apart from the formidable time commitment directors around the world are experiencing engaging with and preparing for activists, we believe directors are also becoming more reluctant to serve on multiple boards out of fear that doing so increases the odds of becoming the subject of public scrutiny by an activist.

Perfect storm of global trends

A perfect storm of overboarding policies and regulations, shifting board profiles and shareholder activism could lead to a gradual reduction in the number of board positions taken on by directors. Evidence of this is beginning to crystalise in the US. While a vast majority of directors of Russell 3000 companies serve on one board, there has been a very slow yet steady decrease in the average number of board positions held by directors during the past five years. According to ISS, the average number of board positions held by directors of Russell 3000 companies decreased during each of the past five years (see Figure 1, below). During this time period, according to ISS, the number of directors of Russell 3000 companies that held three or more board positions began to steadily decrease after 2016 (see Figure 2).

FIG 1: AVERAGE DIRECTORSHIPS HELD BY DIRECTORS (RUSSELL 3000 COMPANIES) 1.49

1.48

1.47 1.44

2014

2015

2016

2017

1.43 2018

FIG 2: NUMBER OF DIRECTORS THAT SERVE ON 3+ BOARDS (RUSSELL 3000 COMPANIES) 2,125

2,135 2,076

2,032 2014

2,022 2015

2016

2017

2018

It would not surprise us to see similar trajectories for directors outside the US, given the global scope of these governance trends. What will be interesting to see is whether fierce competition for a smaller pool of diverse and next-gen directors will actually result in an increase in the number of board positions held just by this subset of directors, despite an overall trend of fewer board commitments among all directors. www.ethicalboardroom.com

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Activism & Engagement | Directors

Fitforduty The evolving roles and responsibilities of directors in the age of shareholder activism Arthur B. Crozier

Chairman of Innisfree M&A Incorporated and Lake Isle M&A Incorporated

Directors’ roles and responsibilities at publicly traded companies have changed dramatically over the last decade, largely fuelled by the rise in shareholder activism across the globe and, especially in the United States, the sharp increase in share ownership by passive investors, particularly the ‘Big Three’ index funds: Vanguard, BlackRock and State Street. Directors must now take on an active role in engaging with institutional investors and considering those investors’ viewpoints as part of the board’s deliberations, even if a shareholder activist is not seeking change. This article will trace the history of these developments and discuss the types of actions and concerns that directors should consider when undertaking their evolving roles and responsibilities. Until recently, it was very rare for directors to engage directly with shareholders. At virtually all publicly traded companies, the investor relations programme, if there even was one, focussed exclusively on actively managed institutional investors, which generally made up the bulk of the shareholdings.1 Those active managers necessarily have in-depth knowledge of the company and considered views on its strategy and management team. They rarely saw the need to engage directly with board 86 Ethical Boardroom | Summer 2019

members, even in contested director elections. If there was a proxy contest, directors’ involvement with third parties was limited to participation in meetings with proxy advisory services. Directors, in effect, stood for election; they did not run.

Compensation challenge

The requirement for shareholder votes on executive compensation programmes (say-on-pay), which began in 2011, started to change that dynamic. While say-on-pay proposals incorporate all forms of executive compensation, it has been viewed as a referendum on CEO compensation in particular. As such, it was generally considered inappropriate for the CEO to lobby shareholders to support the proposal if there was controversy. Consequently, it often fell to the chair of the compensation committee, along with other members of senior management, other than the CEO, to meet directly with institutional investors, although such participation was, at least initially, often controversial.2 At approximately the same time, shareholder activism exploded. Aggressive hedge funds, often referred to as ‘value investors on steroids’, targeted board members and management teams at companies that they viewed as underperformers, seeking significant and often short-term share price improvement. Tactics included the development of extensive white papers, detailing the supposed failings, causing inferior shareholder returns, demands to present the activists’ findings and alternative strategies directly to the board and implicitly and, sometimes explicitly, threatening the targeted company with the dissidents’ ultimate hammer – a proxy contest to replace incumbent directors. Companies of all sizes and their directors, including mega-caps that were once thought invulnerable due to their size, were targeted. Even companies generally considered well-managed and well-performing came under activist attack. This aggressive model of activism has continued to grow and is increasingly attracting new types of activists, beyond

ENGAGING WITH SHAREHOLDERS Directors themselves must be more active in the days of activism

hedge funds, including so-called ‘reluctivists’, or traditional institutional investors (including mutual funds, investment advisers and pension funds) using customary activist tactics and assertiveness to force change at lagging portfolio companies. According to recent statistics compiled by Activist Insight, 949 companies globally were targeted by 851 activists in 2018, compared to 611 companies targeted by 452 activists in 2013. Activism in 2019 may even exceed those levels with 555 companies targeted by 449 activists as of 11 June. While activist approaches were causing targeted directors to be more directly involved with shareholders in order to rebut the activists’ challenges, the www.ethicalboardroom.com

Directors | Activism & Engagement

dynamics of companies’ shareholder bases were changing in ways that would also result in more director involvement, even in the absence of a shareholder activist.

Passive investing

Passive investors have seen huge increases in AUM as the result of the extraordinary bull market following the 2008 market correction. Total inflows to passive managers far exceeded inflows to all types of active managers. Vanguard, BlackRock and State Street, in particular, have been outsized beneficiaries of this development. During the period 2009 to www.ethicalboardroom.com

As index investors, the Big Three are focussed on long-term sustainable shareholder value creation — as long as a company is in an index, they will be investors 2018, the Big Three received 82 per cent of total asset inflows to all active and passive investment funds. 3 As index investors, the Big Three are focussed on long-term sustainable shareholder value creation – as long as a company is in an index, they will be investors. Consequently, they consider themselves to be permanent capital. As such, they tend to support boards and managements who enunciate a credible long-term value creation strategy as opposed to an activist shareholder

whose strategy is more short-term or, if long-term, is less credible. In fact, at recent contested director elections, Vanguard supported management 70 per cent of the time, BlackRock 66 per cent and State Street 76 per cent.4 This strong record of management support, combined with the Big Three’s significant ownership at most US public companies, demonstrates that the Big Three can be the deciding factor in a proxy fight, the ultimate and most powerful activist tactic. Summer 2019 | Ethical Boardroom 87

Activism & Engagement | Directors As of 2017, the Big Three in the aggregate owned on average 20.5 per cent of the outstanding shares at S&P 500 companies, and, unlike other retail and institutional investors, they vote all of their shares, resulting in a disproportionate portion of shares actually voted. In 2017, the Big Three represented on average 24 per cent of shares voted at S&P 500 companies. If current trends continue, in 10 years, the Big Three would own on average 27 per cent of the shares at S&P 500, which could represent 34 per cent of shares voted at those companies. 5 By contrast, institutions that are directly influenced by ISS now generally represent 20 per cent or less of a company’s shares. As a result of this shift in the shareholder base at US public companies, the managementfriendly Big Three effectively counterbalance (and, in the future, will almost always overpower) investors who subscribe to ISS’ dissident-friendly recommendations.6

Ensuring effectiveness

funds’ views in planning for the following year’s annual meeting. The funds will often not take up subsequent requests for engagement but will track such requests and appreciate the outreach effort. In many cases, the declination of an engagement request is a sign that the fund does not have any significant concerns with the issuer. Before undertaking an engagement programme, there are several things directors and management need to consider carefully. Careful preparation is essential. First impressions are lasting. An initial bad impression by a director can taint the fund’s view of the entire board, can take a long time to dissipate and will distract from key messages. Directors who participate in meetings or calls need to appear active, knowledgeable and engaged. Typically, the independent chairman or lead independent director should participate. Any other participating directors should be carefully chosen to ensure they have the right expertise and experience on the board to address likely concerns, as well as a shareholder-friendly attitude.

The participation of independent directors is critical in obtaining support from the Big Three. Although the funds have been adding investment professionals with expertise in a variety of sectors, these investors necessarily do not have in-depth knowledge Understanding strategy and understanding of every company in As noted above, the funds’ concerns now their portfolios, given the vast number go beyond isolated corporate governance of companies in which they must invest issues. Directors must be able in order to accurately demonstrate understanding track their chosen indices. Recent shifting to of the business strategy, Consequently, the funds must dynamics in the particular challenges ultimately rely on the quality confronting that strategy, of directors to ensure that the the markets explain the processes the board board is effectively working have caused follows in ensuring that the with management in strategy continues to be developing a strategy that directors to effective and illustrate that will deliver long-term value, assume a the board holds management has taken into account the new, more accountable for successfully critical factors that could executing the strategy. impact that strategy, are out-front role, While directors need to be effectively overseeing particularly knowledgeable, they do not management’s execution of that plan and holding with respect to need to be able to get into the weeds on every particular management accountable shareholders topic. Senior management will for any shortcomings. also be present and can address Those qualities cannot be details. In doing so, however, the directors demonstrated only on paper or through should not appear to be overly reliant on, videos on the company’s website. Direct or deferential to, management. engagement is critical, ideally in person. In addition to being prepared with respect Further, the board cannot view such to the company’s affairs, it is vital to review engagement as a one-and-done activity. in advance the fund’s voting guidelines In essence, engagement is about building and policies and be prepared to address credibility. Credibility is not built in a day, likely areas of concern. The nature of particularly if that day is shortly before a ESG concerns as they impact long-term contested election. value creation continue to evolve and each Outreach efforts to the Big Three need fund has different topics it focusses on. to be a regular part of every company’s It is important to remember that the overall investor relations programme. Many purpose of the meeting is not to win an companies schedule annual engagements in argument, but to cause the fund to believe: the Fall, when there are fewer shareholder that the board is a careful steward of the meetings occupying the funds and the shareholder’s investment; that it is company has time to take into account the 88 Ethical Boardroom | Summer 2019

committed exclusively to the shareholders’ best interests; is open to suggestions and alternatives; and has knowledgeably and thoughtfully analysed the important drivers of shareholder value creation. In most instances, the board does not need to simply agree with any suggestions made by a fund. It is important, however, to appear open to suggestions and willing to bring the fund’s concerns to the full board. In doing so, even if it is unlikely that the board will ultimately adopt the fund’s suggestion, it is important to validate the fund’s concern. The directors should indicate that the board understands the fund’s concern is legitimate as a general matter; but, while leaving open further discussions on the topic, there are particular reasons that dictate the company’s current policies on the topic and then discuss those reasons. Finally, perhaps the most important pointer is to listen as much as to talk. While it is vitally important to ensure that the funds understand the company’s strategy and the board’s bona fides, it is equally important for the funds to come away with the view that the board has listened to their concerns and is prepared to carefully consider them and to continue a meaningful dialogue, as appropriate. Recent shifting dynamics in the markets have caused directors to assume a new, more out-front role, particularly with respect to shareholders. That new role, however, also opens up opportunities to communicate more effectively with key shareholders, thereby enhancing a company’s ability to continue to pursue long-term, sustainable shareholder value strategies for the benefit of all shareholders. The potential dangers can be easily addressed through careful preparation. Depending upon a company’s business sector, individual holders can own up to as much as 30 per cent of a company’s shares in the aggregate, although such high levels are now rare – 10 to 15 per cent ownership by individuals is more typical. Most investor relations efforts directed to individuals now consist of a brief Chairman’s letter bound into the annual meeting proxy statement. Glossy annual reports, which used to be the primary means of communicating with individual holders, are largely a thing of the past, due to concerns that the high cost of producing and mailing such materials are not justified in light of the reduced levels of ownership by individuals. 2Early on, more than one General Counsel asked me if ‘I was out of my [expletive deleted] mind’ to suggest that a director should meet with a shareholder. Indeed, not every director is ready for the ‘prime time’— directors should be prepared to ensure their meetings with stockholders effectively transmit the company’s key messages. Also, this development capped the fulfillment one of the original goals of the executive compensation reform movement in the early 1990s: to use compensation as a mechanism to force boards to maintain accountability for management. 3Bebchuk & Hirst, ‘The Specter of the Giant Three’, John M. Olin Center for Law, Economics and Business, Discussion Paper 1004, May, 2019, https://corpgov.law.harvard.edu/2019/05/21/ the-specter-of-the-giant-three/ 4Source, Innisfree M&A Incorporated 5See, Bebchuk & Hirst, supra. 6Over the past several years, ISS supported dissidents approximately 66 per cent of the time in proxy contests at companies with a market cap of $1billion or more. 1

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Activism & Engagement | Change

EFFECTIVE SHAREH Shareholder engagement and activism continue to rise, prompted by institutional investors whose influence has grown in recent years and counterbalanced the impact of the shift from active to passive investing. When BlackRock CEO Larry Finks writes to CEOs about BlackRock’s engagement priorities for the companies in which it has invested for 2019 and beyond, we know that shareholder engagement is on an inexorable rise. Last July, the SEC announced a round table on the proxy process in the US. In his opening statement, chairman Jay Clayton noted that it had “seen a dramatic increase in the number of US companies reporting shareholder engagement, with 72 per cent of S&P 500 companies reporting engagement with shareholders in 2017, compared to just six per cent in 2010”. Here in Europe, the revised European Union Shareholder Rights Directive (SRD II) came into force on 10 June 2019. With rights come responsibilities. While the title of the directive continues to refer to shareholders’ rights, SRD II aims to promote effective stewardship and long-term investment objectives also by focussing on the responsibilities of the investment community. It sets new obligations for investors and asset managers, including a greater transparency about engagement policies (which now ‘should be publicly available online’), investment strategies and voting behaviour. Companies will have to become accustomed to a

What shareholders can learn from companies that have implemented successful change Paola Perotti

CEO and Managing Partner, GO Investment Partners LLP higher level of engagement activity from investors but should not be unduly concerned. While some forms of shareholder engagement have degenerated into public mudslinging with disastrous consequences for all concerned, most shareholders have a genuine concern for the long-term interests of the companies in which they are invested. They want to ensure the long-term sustainability of the business by engaging constructively with management to improve the business. They want to work with investee companies to create positive and sustainable change. When I reflect across the long engagement experience of GO Investment Partners, the firm I am honoured to lead, I am drawn to the conclusion that the main challenge shareholders face when they ask boards to justify governance practices or adopt new ones is unrealistic expectations. Too many engagements are driven by optimistic schedules. Change does not happen overnight – it takes time, hard work and dedicated effort from many individuals and groups. Patience and persistence are key. So, as investors continue to increase their corporate engagement, what can they learn from

companies and their managers about effecting change within organisations? As most readers of this publication will know, bringing about effective corporate change is a difficult and complex process, requiring herculean efforts, especially in larger organisations. In this context, I thought it may be helpful to outline the main features exhibited by successful corporate changes in the hope that investors can derive key lessons or pointers for a more effective dialogue between us and companies. Management Guru Peter Drucker defined ‘change leaders’ as those people and organisations that lead change rather than react to it. In his book, Management Challenges for the 21st Century, he argued that to thrive in the new millennium, managers cannot just adapt to change: they have to lead it. “Unless an organisation sees that its task is to lead change,” Drucker wrote, “that organisation – whether a business, a university, or a hospital – will not survive. In a period of rapid structural change, the only organisations that survive are the ‘change leaders’.” Change starts at the top – change will not happen unless the leadership team recognises and is willing to discuss the issues that are preventing the attainment of specific corporate goals. One of the most successful workplace changes ever is undoubtedly the

WORKING TOWARDS A NEW DIRECTION Shareholders want to create sustainable change 90 Ethical Boardroom | Summer 2019

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Change | Activism & Engagement

OLDER ENGAGEMENT transformation of IBM from a soon-to-beobsolete producer of mainframe computers into the innovative AI-driven technology company that we know today. We all know the adage that ‘nobody gets fired for buying IBM’ – yet by the early Nineties, customers were choosing faster, smaller computers and droves of customers were abandoning the company. As future chairman and CEO Louis V. Gerstner, Jr. recounted: “The leadership of IBM was paralysed, unable to act on any prediction.” In an interview with Fortune Magazine in July 1991, then CEO and chairman John F. Akers blamed IBM’s poor performance on the company being caught in an industry moving so fast and changing so much that nobody in it could adjust quickly enough. Yet he was hopeful that a revamped product range and better execution would turn its fortunes around. They did not and Mr Akers was asked to leave by the board soon after. As he recounts in Who Says Elephants Can’t Dance? – an account of IBM’s historic turnaround – Louis Gerstner, who took over the running of

IBM from John Akers, the firm had drawers full of supposedly visionary plans. Gerstner knew that unless IBM changed its business model soon, it had no future. He took the bold decision to refocus the company’s strategy on the services and the emerging e-business. This leads us to our first key lesson for meaningful engagement:

Is the leadership of the company willing to consider alternative viewpoints? Have they got the temperament to turn into change leaders or appoint someone who is a change leader? When engaging on topics of strategy or performance, it is generally best to start engaging at the C-suite level, particularly the CEO. No change will take place if the

One of the most successful workplace changes ever is undoubtedly the transformation of IBM from a soon-to-be-obsolete producer of mainframe computers into the innovative AI-driven technology company that we know today

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CEO does not acknowledge that some aspects of the business could possibly be run differently. If the CEO is not willing to listen, then engage with board members. Independent directors will benefit from hearing what their shareholders think about the company, and investors

will benefit from hearing the board’s perspective on governance and strategic issues and how this relates to the board’s decisions and actions. Some of your viewpoints will resonate with the board. If they do not, a shareholder will still get an important insight on how the leadership of the company thinks about their business. However, even the most change- committed board cannot change an organisation alone. They will need to convince key people within the organisation that change is necessary and enlist their help. One of the first actions taken by Samuel J. Palmisano who succeeded Gerstener as IBM chairman and CEO in March 2002 was to dismantle the corporate executive committee of IBM and replace it with a number of teams organised around strategy, technology and operations that were supportive of the changes he wanted to implement.

Summer 2019 | Ethical Boardroom 91

Activism & Engagement | Change In 2006, Indra Nooyi was elected CEO of PepsiCo and she wanted to re-orient PepsiCo’s product offering towards more health-oriented lines. One of her first steps was to reorganise PepsiCo into three business units and to refresh and galvanise its global leadership team by emphasising its role in positioning the new business structure for future growth.

I am impressed by the manner in which my colleagues at Governance for Owners Japan approach this specific aspect of engagement. They will point out inefficiencies in the strategic make-up of a business, perhaps by showing how peers have addressed a similar issue or challenge. They encourage rather than instruct and they know they must be patient.

widen your 2 Gradually sphere of influence within

takes time 4 Change – learn to be patient!

the company’s management It is not unusual for some investors to ask Once a dialogue with the CEO and the for conglomerates to be split into smaller board has been initiated, a shareholder units or for some activities to be sold. should seek to widen their sphere of As a former investment banker, I know influence to other members of management that these corporate actions take time. – planting a seed that, hopefully will In March 2018, Prudential announced grow through internal discussions and it would demerge its UK operations and reflections. The more company insiders list them as M&G Prudential. At the time, know about your plans, the more they will Prudential stated that the demerger may start to coalesce into an idea that cannot not happen until late 2019 or early 2020 as be cast aside without due consideration. You do not necessarily need a clear strategy to initiate a dialogue about change. Shareholders need not put forward strategy plans for the companies in which they are invested. Sometimes not even management knows exactly where the future will lie. Asking the right question is more important than getting the right answer. In his first letter as chairman of IBM in 2002, Palmisano soberly reflected that ‘right now, we have as many questions as answers, and more a sense of where we must go as a company than a clear path to get there” but he was determined to make IBM a truly great company Sometimes “a great partner, investment and not even employer – for our generation and for our times”. management Again, when Sergio Marchionne knows exactly took over the running of an ailing Fiat in 2004, he was not where the thinking that he would merge future will lie. it with Chrysler within four Asking the Prudential first needed to years, but he knew that he out a number of steps, somehow had to restructure right question carry including the completion Fiat’s uneconomic plants and is more of the UK annuity portfolio globalise its product offering. sale, the transfer of the Hong important You do not need to have Kong business and seeking to than getting a solution for every minimise costs associated with engagement issue you want the demerger. If you assume the right to raise before you start the board spent a minimum answer engaging with a company of 18 to 24 months assessing As a shareholder, it is not the feasibility of a demerger, it will realistic for you to expect to know have taken at least three to four years from your portfolio companies as an insider origination to final execution. knows them. But you can draw on your To refresh a board, you need to assess accumulated knowledge and experience what additional competences are needed to highlight areas that do not look right and then find the right person to fit the (e.g. a business not currently returning its position – 12 to 18 months to find the right cost of capital or the lack of a specific skill person for the job is by no means exceptional. or competence within the existing board). We investors need to learn the value of Ask the right question. Ground your patience and appreciate the complexity of observations in facts and common sense. some of the requests we make of companies.

92 Ethical Boardroom | Summer 2019

prepared to revise 5 Be your original thesis

When a shareholder starts engaging with a company, they will formulate a hypothesis of how the company could improve, based on the information available at the time. Through dialogue with the company, it may surface that the original hypothesis was based on wrong assumptions. Be prepared to accept that your initial analysis was faulty or incomplete. In the early 2000s, I was invested in a Swiss manufacturing company and one of the main tenets of the engagement was that they were to divest of a pumps business that, at the time, was not returning its cost of capital. Through repeated interaction with the company’s management, it became increasingly clear to us that the business had a strong strategic rationale for remaining in the company and the reason for the unsatisfactory returns was a gap in its pump

DELIBERATING A FUTURE STRATEGY Shareholders should be thinking about questions to ask

size range, which encouraged clients to buy elsewhere. The Swiss company needed to fill that gap to be meaningful to its clients. We were the first in line to congratulate the company on its announcement of a small acquisition that completed its product line. As has been said before, engagement is an art, not a science and there is no magic formula that we can apply. Shareholder engagement is all about dialogue and successful dialogue requires a genuine commitment on both parties to understand each other’s position. In conclusion, the most successful engagements I can think of are those which have morphed over time and ended up as an amalgamation of the shareholders’ and the management’s position. Parties working together with one goal in mind – the long-term sustainability of the company they have committed to. www.ethicalboardroom.com

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Activism & Engagement | Remuneration content HOW MUCH IS PAID FOR WHAT Companies need to provide more clarity on the rationale behind their pay decisions

The

new rules on remuneration 94 Ethical Boardroom | Summer 2019

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Remuneration | Activism & Engagement

A major change to the EU-wide Shareholder Rights Directive is to give shareholders a right to vote, or a ‘say-on-pay’, during the general meeting on the directors’ remuneration policy (at least every four years) and on the directors’ remuneration report (annually).

The Shareholder Rights Directive II and its implications for executive pay disclosure

This will apply to companies with their registered office in a member state and with shares trading on a regulated market situated or operating in a member state. The revised Shareholder Rights Directive II (SRD II) was developed in response to the 2008 financial crisis, which led to criticism that companies and shareholders had placed excessive focus on short-term profits, as well as there being a general lack of transparency and shareholder engagement. Besides the key issue of remuneration, it is also worth briefly highlighting a number of other matters:

report will show how the policy was implemented in the year and will be subject to an advisory vote. There will be no guidelines on the remuneration policy. A key objective of the guidelines is to ensure consistency of reporting across Europe so that shareholders and other stakeholders can easily read remuneration reports across countries. Another objective, just as fundamental, is to ensure that the remuneration report provides the information readers want to find.

■■ The directive aims to facilitate the identification of shareholders so that companies can engage directly with them ■■ Intermediaries should facilitate the exercise of shareholders’ rights, including the right to participate and vote in general meetings ■■ The directive requires more transparency from investors on their approach to engagement and on their investment strategy ■■ Proxy advisors will need to provide more information about their research, notably in relation to procedures put in place to ensure the quality of the research, advice and voting recommendations as well as information on the qualifications of the staff and whether they take into account national market specific conditions and information on their engagement with companies

Shareholder engagement

We have already observed more activity from institutional investors, notably with an increase in public statements on executive pay and broader environmental, social and governance (ESG) matters, more transparency on voting decisions and engagement activities and an increase in the number of staff in their governance teams. One aim of the SRD II is to encourage long-term shareholder engagement and enhance transparency between companies and investors. As part of this, the European Commission has been tasked with drafting guidelines on standardised presentation of remuneration reports. This www.ethicalboardroom.com

Anne-Sophie Blouin

Senior Director of Executive Compensation, Willis Towers Watson

Big picture reporting

Current reporting requirements vary greatly across Europe, making it challenging for a non-specialist to analyse the information provided. The European Commission has published draft guidelines in March 2019 and we expect a further draft to be published in the autumn. The guidelines are non-binding and member states may apply different regulatory requirements and issue their own guidelines, therefore we may still not have complete harmonisation across Europe.

The draft guidelines suggest that companies include an introductory statement where companies would place the remuneration into context The draft guidelines suggest that companies include an introductory statement where they would place the remuneration into context: summarising information on business performance and key events that have affected the business and remuneration decisions; information on changes in directors during the year; changes in the policy or its application; and decisions on pay and how the vote or views of shareholders were taken into account. This statement is, in essence, where a company, maybe its remuneration committee chairman, would tell their story and bring pay decisions into the bigger picture of what has happened or is happening in the business. Although some of this information is provided in other

parts of the annual report, not all readers will read the report from cover to cover and it is therefore helpful for companies to outline key relevant matters. It is also an opportunity to clearly explain how the remuneration structure and the performance metrics support the long-term strategy and how pay outcomes align with the performance of the business. This introduction could be seen as the one- or two-pager that would provide sufficient information to a reader, in case they do not want to read the full document. The report includes the total remuneration awarded or due for the year. This is a confusing terminology as the terms ‘awarded’ and ‘due’ mean different things. Remuneration awarded can be in the form of cash received or shares awarded, but that could be released in future years, depending on performance and/or service conditions. Remuneration due could be a cash payment or share award where the payment or release is deferred in time (for example payable in two years) with no condition. Both remuneration awarded or due have to be reported in the remuneration report. It will therefore be critical to differentiate what is ‘earned’ or due to what may be received, in part or in full, in the future.

Understanding performance and rewards

If we step back from the technical details and focus on the ultimate objective of the reporting on pay, shareholders and other stakeholders usually want to know how much an individual received for the year (i.e. their take-home pay). How much an individual receives is what is often referred to as realisable pay and represents cash receivable and equity vested. The ultimate value received by the individual may differ as the individual, for example, could determine to exercise their options or sell their shares years later. This is their investment decision. However, it remains useful to the reader to understand how much the individual could receive once performance and service conditions have been met. This notably enables readers to assess the link between pay and performance at that time. The SRD II also requires directors’ pay to be compared with company performance over five years. The aim is to enable the reader to assess the appropriateness of the pay outcomes in light of the corporate performance. The draft guidelines suggest companies use profit and other metrics the company considers appropriate. This could be, for example, selected key performance indicators stated at the front of the annual report. In the UK, companies have to show historical total shareholder return (share price change and dividends). Summer 2019 | Ethical Boardroom 95

Activism & Engagement | Remuneration Currently, a number of countries require the reporting of a mix of realised and awarded pay, whereby companies disclose base salary and bonus paid but show an accounting valuation of equity awards. This mixes apples and pears and does not enable an assessment of pay for performance. The accounting value of share-based awards is a theoretical value, which is subject to a number of assumptions. There are, for example, differences in how stock market-based and non stock market-based performance conditions are accounted for. Shareholders and proxy advisors generally prefer to consider what is payable and what is granted and, by and large, ignore accounting values. Information on share-based awards is also valuable as shareholders are keen to understand potential maximum awards and what the individual needs to do to receive them. This is an up-front assessment of the incentive structure. Disclosure of performance metrics, as well as targets and outcomes (and the methodology used to assess the outcome), is arguably the most challenging for companies. There is a general understanding by investors and proxy advisors that not all performance targets can be disclosed up front due to commercial sensitivity, so retrospective disclosure, once performance conditions have been met, will generally be acceptable. Some performance criteria are very sensitive and, indeed, the SRD II provides that there is no requirement to disclose information that would be seriously prejudicial to the company. These elements may relate, for example, to some planned but not yet communicated strategic change. The experience of the UK shows that disclosure in narrative form of some individual objectives and not an exhaustive list of all that was expected to be achieved, as long as the proportion on these elements is not significant, is acceptable to shareholders and proxy advisors. We have observed a reduction of the weight of individual objectives and some companies have discontinued the use of individual objectives and now measure only corporate objectives, which may include a range of financial and non-financial criteria, including some ESG criteria.

ESG goes mainstream

We are moving from compliance to an era where stakeholders want to better understand why companies do what they do: whether it is from a broader reporting perspective with increased expectation for companies to disclose their purpose and values, or how the strategy and business model align with these, and also now on their remuneration. It is interesting to note 96 Ethical Boardroom | Summer 2019

that whilst many shareholders were when drawing up the policy. The initially sceptical about the inclusion remuneration report will include a of ESG in pay, this has become more comparison of change in pay for employees acceptable and even actively encouraged and directors. The vast majority of by a number of investors. The SRD II companies treat their employees fairly itself places emphasis on the use of and take it for granted that the reader would varied performance criteria, including know. The new reporting requirements ESG where appropriate. effectively ask companies The SRD II requires provide further insights The SRD II requires to companies to explain into their fair pay agenda. companies to how their remuneration The SRD II requires policy aligns with their companies to show the explain how their strategy and long-term in each director’s remuneration policy change sustainable performance. pay against the change This includes explaining in average employee pay. aligns with their how different pay elements Where individuals are strategy and longalign with these and how employees of the company term sustainable performance is assessed. (i.e. the reporting entity) and therefore may performance represent a small number (and in some cases, no employees if the reporting entity is a holding), the draft guidelines suggest that companies could consider using a broader group. There have been significant debates on the usefulness of pay ratios disclosure. In the UK, companies have had to disclose their Gender Pay Gap for a few years and there is no doubt that the publication has triggered some further discussions and may have accelerated some actions to address the issue. Contrary to the gender pay gap data, there is no easy target number (i.e. eliminate the gap). Focus should not be on the numbers, but on the underlying expectation that boards consider broader employee pay and conditions when determining pay outcomes and that employees are paid fairly across the organisation. Pay ratios will have to be disclosed for the 2019 financial year in the UK. However, more than half of FTSE 100 companies have already reported pay ratios voluntarily in their 2018 annual report and we have observed that a number of companies have provided further insights into their broader employee pay policy and fair pay agenda. Ignoring the detailed requirement, the ask is relatively straightforward: ■■ Explain your pay structure and performance metrics and why these support the successful execution of your long-term strategy ■■ Explain how pay is aligned with performance There is also increased focus on how decisions on executive pay relate to decisions for broader employees.

Fair pay agenda: A wider remit The SRD II requires a company’s policy to include information on how employee pay and conditions were taken into account

Conclusion

Regulations and reporting requirements on executive pay have been increasing over time. Companies will have a choice of considering the new requirement as a compliance exercise or as an opportunity to review whether their current arrangements (whether these are remuneration structure, performance metrics, terms of service contracts, recruitment or termination arrangements) remain fit for purpose or whether changes should be made. Shareholders have different views on pay structure, which makes it even more important that companies provide more clarity on the rationale behind the decisions they make when selecting criteria for key performance metrics. www.ethicalboardroom.com

Global News Asia Pacific

National Australia Bank appoints new CEO Mahindra bans Ross McEwan, recognised for engineering Royal Bank of Scotland’s (RBS) revival, has been appointed the new chief executive officer and managing director of scandal-hit National Australia Bank. New Zealand-born McEwan, who resigned from RBS in April after five-and-a-half years in

the role, previously worked at Commonwealth Bank of Australia. Australia’s banking industry has been severely criticised for misconduct, such as continuing to charge fees to the families of dead customers, with National Australia Bank singled out for ‘not learning from its mistakes’. Phil Chronican, the interim CEO at National Australia Bank, will become its new chairman.

NZ scheme wants more women on boards A new scheme aligned with ethical investing promises will only invest in New Zealand listed companies that have at least one female director on their boards. The CareSaver scheme, established by Pathfinder Asset Management, will exclude potential target companies that fail to ‘demonstrate a commitment to addressing the absence of women at the boardroom table’. Pathfinder’s CEO John Berry said: “While diversity is broader than gender, those New Zealand listed companies that do not

have female directors do not meet our bottom-line diversity criteria. This is not tokenism. “All listed company directors must be appointed on merit, however we believe boards without diversity of perspectives are more likely to have blindspots when assessing key long-term business risks. New Zealand is an outlier compared to the UK, US and Australia, and we’d like boards to explain why.” According to advocacy group Global Women, 18 per cent of NZX-listed companies (27 companies) have no women on the board.

Shanghai tech exchange starts trading More than 140 companies have signed up to list their stocks on a new science and technology-focussed equities facility run by the Shanghai Stock Exchange. The STAR Market was announced by President Xi Jinping last year and has been billed as China’s answer to Nasdaq, the tech-dominant stock market in the US. China hopes that the new board will enhance the information disclosure,

98 Ethical Boardroom | Summer 2019

corporate governance and internal control mechanism of listed companies. The STAR market is also aimed at encouraging investment in domestic tech companies and to lead more Chinese businesses listing at home rather than overseas.

plastic bottles

Indian billionaire Anand Mahindra, the chairman and managing director of multinational conglomerate holding company Mahindra Group, has banned plastic bottles in all boardrooms.

The company has stopped the use of branded plastic water bottles and replaced them with glass jars, glass bottles and glasses following a suggestion by a Twitter follower. After reading a tweet that said “I think the boardroom should have steel bottles instead of plastic bottles”, Mahindra replied “Yes, plastic bottles will be banished. We were all embarrassed to see them that day.” Mahindra, who has an estimated net worth of $1.55billion, also used Twitter to applaud an eco-friendly parking idea created using a recycled plastic water tank, commenting that it ‘was good to see people creatively recycling stuff as well’.

Good governance crucial to Singapore

Maintaining good corporate governance is crucial for Singaporean businesses to tackle current political, economic, social and technological challenges, its government has said. In his keynote address at the Singapore Corporate Awards 2019, Deputy Prime Minister and Finance Minister Heng Swee Keat (above) told the audience that the Singapore government and the corporate sector ‘must work more closely together’. Mr Heng said that the government will continue to partner businesses to promote forward-looking, pro-business regulations and policies, such as rules that would ‘enable innovation and reduce the cost of compliance, while ensuring that risks are effectively managed’.

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CMY

Minority Shareholders Watch Group (MSWG) was set up in the year 2000 as a Government initiative to be part of a broader Capital Market framework to bring about awareness primarily on minority shareholders interest and corporate governance matters through shareholders activism and engagement with stakeholders. MSWG is a professional body licensed under the Capital Market & Services Act 2007. It is self-governing and non-profit body, funded predominantly by the Capital Market Development Fund (CMDF). It is an important channel of market discipline, encouraging good governance with the objective of creating sustainable value. Since incorporation, MSWG has evolved into a respected and independent corporate governance research and monitoring organization in the capital market. It highlights and provides independent views and guidance to investors.

Regulatory & Compliance | Advertorial

Torben Fischer & Sandra Söbbing

Torben is a Forensic, Risk & Compliance Partner in the Hamburg office. Sandra is Tax Advisory Partner in the Frankfurt Main office, BDO AG Wirtschaftsprüfungsgesellschaft

German businesses: It’s time to take action How companies can minimise risk by implementing a tax compliance management system Breaches of German tax law can result in serious consequences for a company and persons acting for the company. In the case of management, individuals can also often incur the risk of personal liability and even imprisonment, even where the offence is committed unwittingly. A tax compliance management system (TCMS) can minimise risk in this area. Although such a system can, in practice, be implemented in a practical and pragmatic way, it is often given only limited consideration.

Tax is seldom the focus of compliance measures

Company directors are obliged to organise and supervise their companies in a manner that is compliant with the law. Multinational groups, in particular, have made great efforts over the last few years to design systems that ensure that employees and the corporate bodies of the company comply with regulatory requirements. This is clearly related to the considerable penalties and reputational damage that can 100 Ethical Boardroom | Summer 2019

result from breaches of the law. However, it can be seen that the systematic way in which compliance is addressed via management systems is often limited to the prevention of corruption and breaches of competition law. Nevertheless, when it comes to tax compliance, it is regularly the case that the compliance function is often reduced to the timely filing of tax returns, which is often left to the tax department or an external tax adviser to perform satisfactorily. What is certain is that from a risk management point of view, this is insufficient, since tax risks regularly arise in the course of business operations that are not within the responsibility of the tax or accounts departments. These can extend, for example, from field service staff’s entertaining expenses, via IT structures, to falsely labelled events or the question of where goods were in fact sent. If the aim is to ensure that all the data necessary for timely, full and correct compliance with tax obligations will be available to the tax department or a tax adviser, a tax compliance management system must to this extent provide a process for so doing. For, even though an external tax adviser may provide additional assurance, in the event that incorrect and incomplete data are present,

the adviser will, as a rule, have no possibility of spotting this and will correspondingly base his /her assessment on this erroneous data. Until now, tax departments have rarely been involved in the analysis of complex business processes so that they may identify the tax risks and take the appropriate risk minimisation measures leading to complete, correct and timely compliance with tax obligations. From a tax point of view, the complexity of business processes intensifies where internationally active businesses are concerned, due to the multiplicity of regulations, interpretations and viewpoints of the respective tax authorities involved. Alongside numerous international initiatives, such as the OECD’s Base Erosion and Profit Shifting (BEPS) action plan, local legislators have also enacted laws and taken initiatives that address these issues in very different ways. In this respect, it can be concluded that the demands on taxpayers are constantly increasing. For this reason, it is precisely internationally active companies that are faced with a constant dilemma. On the one hand, they must comply with the law as it stands; on the other, they run the risk of paying too much tax. An appropriately designed system must therefore provide a solution simultaneously covering both central taxation concerns and adaptation to local systems and requirements. www.ethicalboardroom.com

Advertorial | Regulatory & Compliance

Stricter rules in Germany – effects on international companies In addition to general tax obligations such as

■■ Obligations to notify (Arts. 137-139 of the General Tax Code ([Abgabenordnung]) ■■ Accounting and record-keeping obligations (Arts. 140ff) ■■ Document-retention obligations (Art.147) ■■ The duty of truthfulness (Arts. 150, 153) ■■ The duty of cooperation (Arts. 90, 200) ■■ The obligation to file tax returns (Arts. 149ff)

Arts. 370, 378 AO

Art. 130 OWiG

Art. 30 OWiG

Art. 29a OWiG

Tax evasion

Breach of supervisory duty

(Independent) Fines on legal property

(Independent) Sequestration of property

➜ Imprisonment or fines

➜ Fines (up to €1million)

➜ Fines ➜ Up to the amount (up to €10million) of the economic advantage

Other

...

1st Step: The executive bodies Legal measures are always initiated in the first place against the authorised representatives of the executive bodies 2nd Step: Delegation A transfer of tasks and activities to employees in respect of compliance with tax obligations is in principle possible (vertical delegation of duties),

the taxpayer is also faced with a great whereby the selection and monitoring duty remains unchanged number of constantly more complex 3rd Step: Participants documentation requirements and Employees who have taken part in the return process or who have signed the return regulatory requirements (e.g. CbCR, e-accounting, etc). In its letter of 23 May 2016, the German sequestration of property under Art. 29a 1/2016 of the Institute of Public Auditors Federal Finance Ministry provided a of the Code. in Germany (Institut der Wirtschaftsprüfer commentary on the General Tax Code In connection with a Tax CMS, the in Deutschland e.V.), which is based on Application Decree (Anwendungserlass so-called organisational defaults are of the following seven essential elements: zur Abgabenordnung) on the application particular importance. Under Art. 130 of Art. 153 of the General Tax Code. This of the Administrative Offences Code, it ■■ Tax compliance-culture clearly states: “Where the taxpayer has is not the tax defaults that are directly ■■ Tax compliance-objectives implemented an internal control system penalised but rather the failure to take ■■ Tax compliance-risks that provides for compliance with tax appropriate measures that would have ■■ Tax compliance-program obligations, this can where applicable be a prevented the commission of such errors ■■ Tax compliance-organisation contra-indication against the existence of or, at least, have made it difficult. ■■ Tax compliance-communication and deliberate intent or carelessness. However, In the event of an intentional or grossly ■■ Tax compliance-monitoring this does not preclude an investigation of negligent failure to comply with tax and enhancement any individual case.” This implies that, in obligations, there is also the risk of a BDO the inverse case, that carelessness can be recourse to private assets. Careless tax With more than 1,900 employees, BDO is assumed in the event of potential errors or fraud or tax evasion can result in monetary ready to serve as competent partner for contentious interpretations where these penalties as well as imprisonment. If the your company’s success at 27 offices across are associated with an unsatisfactory tax amount of tax evaded exceeds €1million, Germany. For audits and audit-related compliance management system or indeed there is, as a rule, no possibility of a services, tax and business law consulting, with the lack of one altogether, suspended sentence. or general advisory services, BDO always laying the taxpayer open to However, in its judgment of provides just the right professional contacts a charge of tax evasion. 9 May 2017, the Supreme TAXTAXCOMPLIANCE and sustainable solutions. Personal In this respect, in case Court (Bundesgerichtshof) COMPLIANCE MONITORING & assistance, reliability, and the highest in of breaches of German emphasised the OBJECTIVES ENHANCEMENT quality demands as well as integration into tax law, the risk mitigatory effect the international BDO network performance of material of a Tax CMS and ensure services that are coordinated consequences for indicated that it can TAX TAXTAXprecisely with your individual needs. the company and also be taken into COMPLIANCE COMPLIANCE COMPLIANCE account in cases The BDO AG Wirtschaftsprüfungsgesellschaft individuals exists COMMUNICATION CULTURE RISKS is a founding member of the international significantly more where breaches of BDO network (founded in 1963), which rapidly than the law have already has more than 80,000 employees in 162 heretofore. For the occurred. That is TAXTAXcountries and in fiscal year 2018 generated management, this to say, it optimises COMPLIANCE COMPLIANCE sales of $8.9billion. can also involve the controls and provides ORGANISATION PROGRAM risk of personal liability for internal processes to and even imprisonment, be so designed as to make even where the offence is the occurrence of comparable committed unwittingly. breaches of the law much more Failure to comply with obligations can difficult in future. give rise to material consequences for the Effective organisational measures aimed company and the individuals concerned. at compliance with tax regulations can In this connection, financial risks often thus reduce the risk to management in cases come first to mind, such as penalty interest where there may be exposure to charges BDO AG Wirtschaftsprüfungsgesellschaft or late-payment surcharges. However, of deliberate intent or gross negligence. Fuhlentwiete 12 there may also be significant penalties by How such a system can be designed will 20355 Hamburg, Germany way of the fines on legal persons under be explained in more detail in the next +49 40 302 930 Art. 30 of the Administrative Offences issue of Ethical Boardroom, in which we hamburg@bdo.de www.bdo.de Code (Ordnungswidrigkeitengesetz) or shall, in particular, focus on Practice Note www.ethicalboardroom.com

Summer 2019 | Ethical Boardroom 101

Regulatory & Compliance | Tax Governance

Do you ‘say what you pay with pride’? That was the challenge to companies set by a number of UK campaign groups during Fair Tax Week in July 2019, billed as a week of events celebrating organisations that are proud to pay their fair share of corporation tax.

Companies should treat tax as a corporate governance matter and focus on risk and compliance

Within this slogan there are two questions for company boards. First, do you know how much corporate tax your business pays in the jurisdictions where it operates? And, secondly, how do you communicate with stakeholders about the amount of tax that you pay? For any directors struggling to answer those questions, now is the time to focus on building a sustainable approach to tax governance. That is particularly the case in a world where media and public scrutiny of corporate tax matters can lead to PR disaster for firms which are not on top of these issues.

but the attitude of tax authorities across the major developed economies has moved things on significantly. In my home jurisdiction, the UK, the government and tax authority (HMRC) has introduced a range of measures which, when taken together, represent a drive to ensure that large businesses treat tax as a corporate governance matter. Recent initiatives include a requirement that large businesses publish (and update annually) a UK tax strategy, setting out the organisation’s approach to risk management and governance of its UK tax, attitude towards tax planning, the level of risk it is willing to accept in relation to UK tax and its approach to its dealings with HMRC. This sits alongside measures that impose corporate criminal liability for tax governance failings (where a business, regardless of its size, fails to prevent tax evasion in its supply chain) and personal

Tax is a corporate governance matter

The starting point is to understand tax as a corporate governance matter. This would once have been a fairly radical proposition,

Gregory Price

Tax partner at Macfarlanes LLP

liability for senior accounting officers whose businesses suffer tax reporting failures. The UK is not alone in taking this approach. In Australia, large businesses are similarly encouraged to publish their tax strategy (through a voluntary tax transparency code) and to disclose and explain the amount of taxes that they have paid. The Australian Taxation Office has also produced a substantial ‘tax risk management and governance review guide’, which starts by acknowledging that ‘we have embraced the increasingly global view that tax risk management should be a part of good corporate governance’. Similar measures have been adopted in other major economies and there is increasing activity in this area at an international level. In 2016, the OECD published a report entitled Co-operative Tax Compliance: Building Better Tax Control Frameworks with the stated aim of bringing more rigour to the co-operative compliance concept. Co-operative compliance – which includes the idea that responsible taxpayers should be able to police themselves on tax matters, without the need for tax authorities to intervene – is closely tied to the idea of a tax as a corporate governance matter. If a company has good tax governance, tax authorities should be content to give them space to resolve tax matters without intrusive

Building a sustainable approach to tax governance

102 Ethical Boardroom | Summer 2019

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Tax Governance | Regulatory & Compliance audits. Data collected by the OECD suggests that an increasing number of tax authorities are adopting this approach in relation to large businesses. Examples include the Japanese tax authority, which runs a programme that reduces the burden of tax audits for large companies that are assessed as having good tax corporate governance. For UK groups, a ‘business risk review’ rating determines the level of scrutiny it can expect – and a ‘low’ risk rating generally means less scrutiny. In the US, a number of large businesses are involved in the IRS Compliance Assurance Process, which offers the same incentive: a longer gap between audits for taxpayers who demonstrate high levels of transparency and cooperation. The IRS suggests that joining this programme ‘complements current corporate governance and accountability’.

TABLE 1: AREAS COVERED BY THE 2019 UK CORPORATE GOVERNANCE CODE

1 BOARD LEADERSHIP AND COMPANY PURPOSE 2 DIVISION OF RESPONSIBILITIES 3 COMPOSITION, SUCCESSION AND EVALUATION 4 AUDIT, RISK AND INTERNAL CONTROL 5 REMUNERATION and international fiscal developments. To build a sustainable approach to tax governance, directors need a framework to bring it all together. Those familiar with corporate governance matters in other contexts will know the value of a code, or a set of principles, for bringing coherence to the management of complex organisations. Examples are included in Tables 1 and 2.

Designing your approach

Tax is complicated. Groups need to cope with a bewildering array of domestic

TABLE 2: THE UK’S WATES CORPORATE GOVERNANCE PRINCIPLES FOR LARGE PRIVATE COMPANIES

PRINCIPLE ONE: Purpose — An effective board promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose PRINCIPLE TWO: Composition — Effective board composition requires an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of a board should be guided by the scale and complexity of the company PRINCIPLE THREE: Responsibilities — A board should have a clear understanding of its accountability and terms of reference. Its policies and procedures should support effective decision-making and independent challenge PRINCIPLE FOUR: Opportunity and Risk — A board should promote the long-term success of the company by identifying opportunities to create and preserve value and establish oversight for the identification and mitigation of risk PRINCIPLE FIVE: Remuneration – A board should promote executive remuneration structures aligned to sustainable long-term success of a company, taking into account pay and conditions elsewhere in the company PRINCIPLE SIX: Stakeholders – A board has a responsibility to oversee meaningful engagement with material stakeholders, including the workforce, and have regard to that discussion when taking decisions. The board has a responsibility to foster good relationships based on the company’s purpose

To build a sustainable approach to tax governance, directors need a framework to bring it all together

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Summer 2019 | Ethical Boardroom 103

Regulatory & Compliance | Tax Governance However, the best-known corporate governance codes (such as the code for London-listed companies) do not say anything about tax. The Wates Principles, a UK code for the corporate governance of large private companies, produced recently by a coalition convened by the Financial Reporting Council, similarly contains no express mention of tax matters. I asked James Wates CBE, who chaired the coalition, about this. He said: “While the Wates Principles do not explicitly reference tax, I hope that they provide a useful framework that is relevant to all parts of a business, including its approach to tax. Articulating the company’s purpose is the first step in applying the Wates Principles, and in my view everything should hang off that. Board composition, directors’ responsibilities, managing opportunity and risk, remuneration and stakeholder relationships and engagement should all be guided by the company’s purpose. Tax is relevant to all of those and shouldn’t be thought of in isolation.” Reflecting on that, the idea that corporate purpose and culture can inform a company’s approach to tax governance is a compelling one. Corporate purpose is disseminated from the top. Boards need to ensure a company’s purpose, its values, culture and strategy permeates through the business – including to the tax department. If the directors get that wrong, they will struggle to bring a coherent approach to tax governance. Both of the major UK corporate governance codes start by challenging the board to establish the company’s purpose, and that should be as applicable to tax as it is to anything else. Guided by the corporate purpose, the next building block is ensuring the board can properly discharge its supervisory role in relation to tax matters – in other words, to demonstrate responsibility. Groups will need to show that there is somebody on the board who has enough knowledge of tax matters to provide effective oversight and to inform top level decision-making. That might be straightforward if the head of tax participates in board meetings, but where that does not happen companies need the right processes in place to ensure they have the necessary information to make proper decisions about tax matters. A recurring theme in the approach of tax authorities in OECD member countries is to test whether top management are sufficiently involved in tax-related decision making and oversight. A responsible board is one that can demonstrate to tax authorities that it is taking the group’s tax affairs seriously. Linked to this is the idea of ‘tax risk’. Boards must be able to show that they understand the group’s attitude to tax risk and have appropriate risk management procedures in place. These should be 104 Ethical Boardroom | Summer 2019

familiar ideas for directors: ‘audit, risk and internal control’ is one of the five areas of focus in the UK Corporate Governance Code. In addition, demonstrating a firm grip on tax risk can unlock relationships with tax authorities and thereby minimise tax-related compliance costs. The final point is how the company communicates on these issues with its stakeholders, which the Wates Principles recognise as a core principle in itself (and a further aspect of corporate purpose). Some stakeholders, often including employees, will take a direct interest in how a group approaches tax matters and whether, or how, that furthers the company’s purpose. Tax authorities, the wider body of taxpayers and society at large also fall within the TAX AS A CORPORATE GOVERNANCE MATTER Boards must take ownership of managing tax affairs

expanding concept of stakeholders, which many companies now recognise. Investor engagement on tax matters would once have gone little further than looking at a group’s effective tax rate – and perhaps querying whether a lower rate could be achieved. Not now. There has been a sea change in investor attitudes to corporate tax matters, exemplified by the Principles for Responsible Investment (PRI) recommendations from institutional investors on corporate income tax disclosure (see Table 3 above). Investors who adopt these recommendations require companies to put in place an appropriate tax governance regime and then to prove that it works by providing data on the firm’s tax practices. This is part of a wider investor-led project to raise the bar on environmental, social and governance (ESG) issues across investment portfolios. When it comes to tax, directors must recognise that this is an integral part of the company’s approach to governance and will be viewed as an expression of its corporate

TABLE 3: PRI INVESTORS’ RECOMMENDATIONS ON CORPORATE INCOME TAX DISCLOSURE

Companies adhering to the recommendations will provide investors with: ONE: An overview of the company’s policy/approach to tax, including how the firm balances the letter of the law with the intent of the law and societal expectations on tax TWO: Reassurance that appropriate governance and risk management measures are in place THREE: Data and examples to ascertain future financial, legal, operational and reputational risks FOUR: Data and examples to determine if a firm’s tax practices reflect its tax policy/framework

purpose. Tax is no longer a discrete subject than can be left to the specialists.

Some conclusions

Boards will recognise that tax needs to be treated as a corporate governance matter, and that governance codes provide an invaluable framework for building a sustainable approach. Reduced to its simplest, this can be expressed in three key conclusions. First, directors must establish the company’s purpose, values and strategy and be able to explain how this is manifested in the company’s approach to tax matters. Secondly, tax is now a boardroom matter and responsibility must be allocated appropriately among senior management. Finally, stakeholder engagement is increasingly a core part of any approach to tax governance – and directors should expect investors to continue to raise the bar on this topic. Given the significance of that last point, campaigners may have hit the nail on the head when they challenge companies to ‘say what you pay with pride’. www.ethicalboardroom.com

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Regulatory & Compliance | Integrity BASE INSTINCTS Compliance is a matter of self-preservation

Playing by the rule of law Compliance in context — we all have a responsibility to pay attention to potential risks Robert Clark

Manager, Legal Research at TRACE

One fine day, Bear, Fox and Rabbit were roaming the fields when they happened upon the home of Farmer MacGregor. Glancing at the farmer’s garden, Rabbit said: “I sure would love to nibble on those delicious carrots – but that would be stealing, and stealing is wrong.” Eyeing the farmer’s chicken coop, Fox said: “Those fowl look mighty tasty – but I’m worried about getting caught by that mean old farmer.” Bear said nothing but straightaway made a run for the farmer’s front door, knocked it down and proceeded to devour the entire MacGregor clan. Witnessing this horrific 106 Ethical Boardroom | Summer 2019

scene, Rabbit nervously chuckled to Fox: “I guess you can have those chickens now.” Fox replied: “Suddenly, I’m in the mood for something a little more gamey…”

The rationales for compliance

‘Culture of integrity’ has a nice ring to it. Whether driven by enlightened self-interest or by a principled sense of justice, the adoption and sustained reinforcement of high ethical norms within an organisation is rightly understood as a critical defence against corruption. It serves as a complement to the array of due diligence protocols, training programmes and oversight mechanisms that constitute a well-built compliance programme. It also helps ensure that we are not just going through the motions – that we understand the rules as more than just an impediment to our entrepreneurial resolve. But what is that something ‘more’? What principle undergirds our commitment to integrity? We have a range of possibilities. Penalties for noncompliance can be severe, making rigorous adherence to applicable laws a matter of direct financial interest.

Developing a reputation for honest conduct can attract more reliable business partners and thwart the advances of would-be rent seekers. Popular sentiment and public relations provide their own substantial motives for upright corporate behaviour. Finally, we cannot ignore the reality and significance of individual conscience in the process of collective decision-making. These are all good reasons to comply. Any one of them would be enough to support the conclusion that, given the choice between cheating and not cheating, it is better to not cheat. We should consider ourselves lucky to have that choice; corruption is not always so permissive.

The constraints of systemic corruption

In isolation, a bribe can appear as a simple exchange of money for advantage, a misuse of authority for personal gain – an essentially limited transaction. Even a large-scale scheme, involving enormous payments and detailed planning, can be reflexively construed as a matter of ‘going astray’ in the misguided pursuit of profit. We recognise, of course, the collateral www.ethicalboardroom.com

Integrity | Regulatory & Compliance

prospect of illicit gain. When it does not, damage that bribery wreaks upon refusing to ‘play ball’ with crooked forces government: the degradation of services, may invite more extreme consequences. the misallocation of resources, the Such demands can be a matter of physical progressive loss of legitimacy. It is not safety, not just ethics. difficult to see the dire effects of this dysfunction on the governed populace, Legitimacy and complicity whether economically, civically or Discussing compliance as a matter of personally. We do not excuse bribery – it existential self-preservation may sound is a crime, and those who engage in it are a bit hyperbolic, particularly for large sanctioned as criminals. But consider what enterprises with the resources to defend makes that outcome possible: a functioning themselves even in lawless environments. state with the political will to proscribe For these organisations, perhaps the such acts and enforcement agencies with danger is not that they will be destroyed, the muscle to prosecute them. but that they will be co-opted. This is hardly a novel observation. Ordinary crime operates alongside We know corruption thrives under the legitimate order of economy and weak governance, and we know doing governance. It seeks to evade detection business in such an environment carries and exploit weakness a heightened compliance within that order, risk. At least, that is how Even a large-scale positioning itself in a we usually think of it: as scheme, involving fundamental antagonism. a compliance risk. We However, at a certain understand ourselves enormous point, profit is better served to be operating under a payments and by a more collaborative functioning state with the power to punish our detailed planning, engagement. Criminal turn to the misfeasance, and we guard can be reflexively syndicates private sector to establish ourselves against defying construed as a fronts and channels for that power. money laundering, while But what if the state matter of ‘going nominally legitimate were not there? Or, more astray’ in the entities can be used to gain plausibly, what if the state had itself become utterly misguided pursuit privileged access to public coffers, securing lucrative corrupted and unable or of profit government contracts by unwilling to carry out means of a well-placed bribe legitimate enforcement of or infiltration of a key agency. the law? Power, like nature, abhors a This is not a new story. Throughout vacuum; we can be sure that some manner the industrial and post-industrial ages, of enforcement will step in to fill the void. organised criminal enterprises have The state offers protection. When it been active throughout the world, functions as it should, turning down exercising overt control over street-level corrupt solicitations endangers only the www.ethicalboardroom.com

activities while establishing regional dominance over entire industries. What is relatively new is the degree to which these organisations and networks have broadened their reach across national borders, making full use of global developments in trade, finance and telecommunications. This prompted the US government to conclude in 2011 that transnational organised crime ‘poses a significant and growing threat to national and international security, with dire implications for public safety, public health, democratic institutions and economic stability across the globe’.1 There is no reason to assume that multinational companies are immune from this sort of criminal exploitation. To be sure, the large-scale bribery schemes underlying the seemingly endless series of record-breaking Foreign Corrupt Practices Act (FCPA) enforcement actions are scandalous enough without further elaboration. But when we see a pattern of bribery used to secure predominance within or control over an industrial sector within a country or continent, we may wish – with all due caution – to look for signs of other involvements.

Breaking the rules, or breaking the game

At stake is how we understand the nature of grand corruption. Our attention in these cases is naturally focussed by the specific terms of a criminal indictment. And a criminal indictment charges the defendant with violation of a specific law based on specific legally admissible facts. It tells the story of how the rule was broken, and its narrative is limited to what is needed to establish the case. Summer 2019 | Ethical Boardroom 107

Regulatory & Compliance | Integrity If that were the end of the story, we would rightly concern ourselves above all with maintaining our own integrity – resisting any temptation to cheat, cut corners and break the rules to secure the commercial upper hand. This outlook holds a particular attraction when the systemic corruption takes place across borders, away from the well-functioning jurisdictions under which we are governed. We do ourselves a disservice if we imagine our own systems of governance to be immune from systemic criminal corrosion. Not that the possibility and the reality of such infection has ever really been in doubt, but our discourse about corruption needs to acknowledge how, if unchecked, the usurpation of our institutions of government

But if the law is undermined, these ethics may fall short. When the rule of law gives way to the unprincipled exercise of power, our fear may become more visceral, our relations contaminated, the public sphere stifled, and our conscience reduced to a liability. If these are the stakes in the dialectic between the ‘legitimate’ world and the ‘underworld’, our notion of integrity needs to account for it. We must view the law neither as an impediment nor as an ideal, but as a contested space requiring our protection as much as we require its. The directors of a company have a fiduciary obligation to safeguard the interests of the company’s stakeholders. Share price is one way to measure that interest. We might also propose that there

proceeds apace: policies are set forth, risks are assessed, oversight mechanisms are established and due diligence is undertaken. There is value, though, to bringing the variety of compliance concerns under a unified concept. Consider the range of regulated issues: bribery, money laundering, accounting and reporting, conflicts of interest, human trafficking, forced labour, political contributions, conflict minerals, product standards and outright fraud. Each of these can be understood as matters of both law and ethics. But, taken together, they can also be seen as a charting of the tools used to conduct global criminal activity. In its present-day coordination, this illicit activity does not just cause harm and suffering; it aims and threatens to seize

The farmer will watch over the farm as long as he can, protecting his hard-won investment in the domestication of crop and beast. It is in our interest to keep an eye out for him and vehicles of commerce can lead not only to widespread rule-breaking, but to a basic fracturing of the rules themselves. As long as the centre holds, we can feel safe in confronting the problem under the rubric of law enforcement. But past a certain point, things begin to fall apart, and the proverbial ‘mere anarchy’ is loosed upon the world.

Maintaining fiduciary legitimacy

How might this perspective affect our understanding of corporate integrity? When the law and its authority are not in doubt, the usual rationales may be sufficient: fear of punishment, desire for good relations, concern for public opinion and simply wanting to do the right thing. 108 Ethical Boardroom | Summer 2019

is a foundational interest in preserving the conditions of legitimacy under which the company is able to operate and thrive – a responsibility to defend the corporate entity against exploitation by criminal forces. Integrity, in this view, requires a keen awareness of the surrounding threats and a firm commitment to avoiding any complicity or intrusion.

The singular logic of the compliance function

A shift in outlook does not necessarily involve a radical change in practice. The ideal of a ‘culture of integrity’ can affect the spirit with which a compliance programme is executed, but the day-to-day legwork

control of the very mechanisms of governance that might otherwise constrain it. Within an organisation that would maintain its legitimacy, the compliance function carries the charge of rebuffing any such advances. It is a collective endeavour that crosses the global economy, and it requires our full, clear-eyed attention. The farmer will watch over the farm as long as he can, protecting his hard-won investment in the domestication of crop and beast. It is in our interest to keep an eye out for him. United States National Security Council, Strategy to Combat Transnational Organised Crime: Addressing Converging Threats to National Security (July 2011) https://obamawhitehouse.archives.gov/ administration/eop/nsc/transnational-crime. 1

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Regulatory & Compliance | Finance

Unexplained wealth orders: A reality check Can the UK stay open for overseas investment if it ramps up its anti-money laundering measures? George Voloshin

Head of Paris Office at Aperio Intelligence Ltd

In February 2018, the UK’s National Crime Agency (NCA) secured the first-ever unexplained wealth orders (UWOs) against two high-end properties with a total market value in excess of £22million.

This was barely two months after the revised provisions under the Criminal Finances Act (CFA) 2017 came into force, which introduced a brand-new legal mechanism for so-called non-convictionbased confiscation of unlawfully obtained assets. In October 2018, the name of the UWO recipient was finally revealed to the public. Zamira Hajiyeva, the wife of a disgraced Azeri banker convicted of fraud at home, has since become an infamous symbol of the UK’s renewed focus on fighting financial crime on national soil.

What are UWOs?

Much ink has been spilt to explain what the UWOs are and how they are supposed to revolutionise Her Majesty’s Government’s efforts to combat organised crime, in particular money laundering by corrupt individuals from third countries. It is nonetheless still useful to revisit the key concepts. Section 1 of the CFA 2017 inserts sections 362A-362I into Chapter 2 of Part 8 of the Proceeds of Crime Act (POCA) 2002. The High Court of England and Wales can grant a UWO at the request of any of the following authorities: the NCA, the Financial Conduct Authority, the Serious Fraud Office, the Crown Prosecution Service and HM Revenue & Customs. There are several conditions to be satisfied for a UWO application to be successful, yet 110 Ethical Boardroom | Summer 2019

always at the High Court’s sole discretion. These are: (1) the respondent holds, or somehow exercises control over, the property; (2) the property is worth at least £50,000; (3) there are reasonable grounds to suspect that the known sources of the respondent’s legally obtained income would have been insufficient to obtain the property in the first place; (4) the respondent is a politically exposed person, or there are reasonable grounds to suspect that the respondent has been involved in serious crime in the UK or elsewhere in the world, or that a person connected with the respondent has been involved in such crime. In order to prevent any unauthorised use of the property, an interim freezing order can be sought and issued at the same time as a UWO. UWOs draw their raison d’être from the principle of reverse onus of proof, whereby the respondent must provide, within a timeframe set by the court, any relevant information about the nature and extent of their interest in the property, and how and with what funds it was obtained. Failing that, a civil recovery order may be issued under Part 5 of POCA. As per Section 362C, the respondent’s only option for retaining the property would be to prove in the course of civil proceedings that it is not recoverable. At any stage, providing false or misleading statements would be considered tantamount to committing a criminal offence. Given the historically scant use of Part 5 on its own, the UWOs were apparently designed with the intent to make the recovery of ill-gotten assets less cumbersome for law enforcement.

The Hajiyeva case

Born in 1961, Jahangir Hajiyev worked from 1993 to 1995 at Azerbaijan’s Ministry of Foreign Economic Relations following his graduation from an MBA programme at an American business school. In 1995 he joined the International Bank of Azerbaijan (IBA), one of the country’s largest lenders in subsequent years, and became its chairman in 2001. He

resigned from his post in March 2015, citing health issues, but was arrested in December of that year in connection with allegations of large-scale financial irregularities. In October 2016, a Baku court sentenced Hajiyev to 15 years in prison on charges of embezzlement and fraud. According to Azeri prosecutors, the state-controlled bank had been defrauded of up to $5billion under Hajiyev’s leadership. In 2017 the IBA, whose $10billion worth of assets amounted to some 40 per cent of the Azeri banking system’s total asset base, defaulted on its debt obligations and filed for bankruptcy protection. Between the end of July and late October 2018, Hajiyev’s wife Zamira was invariably identified in the media as the woman who had spent, or as some wrote ‘blown’, £16million at London’s world-famous department store Harrods over a decade of living in the UK. Then the unsavoury details followed. In 2009, a BVI-registered company controlled by the Hajiyevs bought a London mansion for more than £11million, making a down payment of more than £4million. The loan for the remainder from the Swiss subsidiary of a British bank was fully repaid in only five years. In 2013, the Hajiyevs also bought a golf course in Berkshire for more than £11million. The couple also owned a Gulfstream jet worth upwards of $42million. According to court documents, Zamira Hajiyeva splashed out more than £433,000 on a single day in June 2008 on jewellery from a Cartier boutique. The almost limitless access to her husband’s money further allowed her to secure a foothold in the UK while Jahangir Hajiyev was running the bank back at home. In 2010, she applied to live in the UK as a wealthy investor and, in support of her application, snapped up £1million worth of gilts. In 2015, not long before her husband’s arrest, she claimed to have enough funds to sustain herself as part of a new application for

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Finance | Regulatory & Compliance indefinite leave to remain. Today, she is fighting not only to retain title to the frozen properties but also to escape extradition to Azerbaijan.

Limitations of UWOs

There are myriad ways to speculate about a shortage of UWOs since the rollout of the new mechanism at the beginning of 2018. In fact, then NCA director Donald Toon said at the time that the agency was working on between 120 and 140 potential cases, a dozen of which could quickly see the light of day. So far, only three sets of UWOs have materialised: the ones against Zamira Hajiyeva, issued in February 2018, and several others whose existence was again revealed by the NCA itself in May and July 2019. The latest ones have been issued against an unnamed businessman from northern England who is suspected of links to serious organised crime and has amassed a £10 million “property empire”. The other ones relate to three London properties in prime locations and with a combined at-purchase value exceeding £80 million. All were bought by offshore companies. Beyond any reasonable speculation as to why they are still so few and far between, it should be noted that UWOs are not exempt from their own inherent limitations. For instance, if the respondent is not a politically exposed person (PEP), it may be difficult for law enforcement to collect enough evidence of their involvement in serious crime for the High Court to grant a UWO. This is especially true in the case of foreigners whose criminal activity often occurs in unfamiliar jurisdictions, far away from the UK, but who launder the proceeds of crime on UK soil.

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Further, there is something deeply counterintuitive about how the PEP concept is treated in the current legislation. For PEPs from outside of the European Economic Area (EEA), there is no requirement to prove any involvement in serious crime as only reasonable grounds to suspect a disparity between the value of the property and known sources of income are enough. When it comes to domestic PEPs or PEPs

from within the EEA, the involvement in serious crime criterion must be fulfilled. This considerably restricts the NCA’s (and the other law enforcement or supervisory authorities’) ability to initiate a freezing action. Indeed, what to do about a corrupt functionary from an EEA country or even a UK official who is skilfully laundering criminal proceeds on UK soil?

Summer 2019 | Ethical Boardroom 111

Regulatory & Compliance | Finance Lastly, as RUSI, a UK think tank, wrote in its June 2019 research paper on UK non-conviction-based confiscation techniques, enforcement authorities have only 60 days to try to refute a claim contained in the respondent’s submission. The report legitimately argues, based on common logic and numerous interviews with law enforcement professionals, that such a short timeframe is totally unrealistic for getting hold of enough counterevidence, especially if foreign countries, including tax havens and secrecy jurisdictions, are involved.

MONEY-LAUNDERING POST BREXIT The UK can boast tough measures on wealth but will this change after exiting the EU?

One of many tools

To be effective, even in the presence of the above limitations, UWOs cannot and should not be viewed in isolation from other important fronts in the war being waged by the UK authorities against serious crime. After so many laundromats, that is to say money laundering scandals in which millions and sometimes billions of dollars, pounds or euros were shifted from one jurisdiction In addition to to several others using a Companies complex web of banks and professional enablers, it has House, the UK become clear that corporate needs to find a transparency is key. As the way to deal with Hajiyeva case shows, it is of utmost importance for the thick veil investigators to be able to London. The Draft of secrecy that Registration of Overseas establish the initial connection between a Entities Bill is steadily moving for years has given property and a given forward, with 2020 set plagued its real as the year of introduction individual so that the first criterion, which relates to of a nationwide register of estate sector, control over the property, overseas entities and their especially in can be fully satisfied. UBOs that own UK property. and around Until 5 August 2019, the In March 2019, Global Witness UK Department for Business, estimated that more than London Energy & Industrial Strategy 87,000 properties in England is conducting a public and Wales, worth a total of consultation under its ongoing reform £100billion, were owned by anonymous of Companies House in response to the companies registered in tax havens. repeated misuse of UK-registered entities, To tackle the problem head-on, active among them Scottish limited partnerships, cooperation will be required from abroad, for money laundering and tax evasion first and foremost from the British crown purposes. Indeed, while the persons of dependences and overseas territories. significant control (PSC) regime – as Cooperation with the BVI Financial expanded by the EU’s Fourth AML Directive Investigation Agency allowed the NCA in – instituted a legal obligation to disclose 2018 to obtain UBO information on the owners of at least 25 per cent in a wide offshore company that bought one of the range of legal entities (subject to specified Hajievs’ properties. Yet, this is not enough. exemptions), there is no one to ensure the In mid-June 2019, Jersey, Guernsey and the quality of data. UBOs hiding behind shell Isle of Man made a joint pledge to establish firms in non-transparent jurisdictions are by 2023 three levels of beneficial ownership still too common to call Companies House a registers of companies under their success. Global Witness, an NGO, estimates jurisdictions. For some, this is already too that more than 10,000 UK entities declare a little too late, but any meaningful progress foreign company as their PSC, with ties to a on this critical front is obviously welcome. secrecy jurisdiction in 72 per cent of cases. Looking beyond Brexit In addition to Companies House, the UK With so few UWOs issued to date, it is fair to needs to find a way to deal with the thick ask how Brexit – whether ultimately with or veil of secrecy that for years has plagued its without a deal – will impact upon the UK’s real estate sector, especially in and around 112 Ethical Boardroom | Summer 2019

ability, and willingness, to go after financial crime using this novel legal tool. Even before the Skripal poisoning case shook the world in March 2018, Security and Economic Crime Minister Ben Wallace had sent a warning to Russian oligarchs with UK assets against whom there were suspicions of corruption. In May last year, the House of Commons’ Foreign Affairs Committee released its Moscow’s Gold: Russian Corruption in the UK report, chiding the government for not doing enough to curb money laundering and other illicit activities by well-connected and politically exposed Russians. More stern messages have followed since, focussing not only on Russian nationals but also on well-heeled Chinese citizens using investor visas to gain a physical presence in the UK. Steps have now been taken to scale down the programme, resulting for instance in the non-renewal of Russian billionaire and Chelsea FC owner Roman Abramovich’s long-term UK visa. Yet, Brexit carries its own risks. The UK will want to remain competitive and attractive for foreign capital beyond 2019. An active use of UWOs, and other concurrent measures aimed at curbing economic crimes and doing away with London’s reputation as the global capital of money laundering, could turn away some investors worried about having to answer too many questions at some point in time. There is a delicate balance to strike in the end, and not one to be taken lightly, given the UK’s uncertain future. www.ethicalboardroom.com

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Regulatory & Compliance | Integrity

Embedding a sense of accountability The number and nature of the recent Royal Commissions into the financial, aged care, disability and franchise sectors brings into sharp focus the relationship between misconduct and integrity in a business context. It has led to the urgent need for corporate Australia to reassess business integrity frameworks and bring about much-needed change.

The importance of awareness and education in achieving an ethical ethos

In a Western country which, for all intents and purposes, is seen as quite mature in terms of business governance, the findings of the various inquiries of widespread corporate misconduct have highlighted the fact that corporate Australia is not as squeaky clean in terms of governance and integrity as previously perceived. This has led to:

■■ Improving the bottom line. While it can be difficult to quantify, achieving and maintaining a culture of integrity in business has a positive financial effect ■■ Greater willingness of stakeholders to speak up about misconduct. This is further enhanced when the stakeholder’s organisation acts on matters reported ■■ Reduced staff churn. Employees working in an environment based on integrity and ethics feel more secure and are more likely to stay. This has a positive financial impact due to the decreased cost of recruiting and training new staff ■■ Customer/client retention. e.g. when a corporation responds quickly and fairly to negative feedback, customer loyalty grows and so does the organisation’s brand and reputation

■■ Significant brand and reputational damage ■■ The demise of high-profile board and management careers ■■ A huge wake-up call for corporate Australia PKF Integrity is actively helping our clients heed this call for change by assisting to critically assess integrity frameworks and implement strategic 114 Ethical Boardroom | Summer 2019

David Morgan

Managing Director of PKF Integrity and operational change. The benefits of achieving and maintaining a strong, organisational ethical culture are myriad and include, but are not limited to:

■■ Reduced reliance on complex and inefficient control structures. Because a workforce whose actions are base on principles of integrity become the moral pulse and caretakers of the organisation ■■ Less exposure to the risk of regulatory action One of the fundamental strategies to building the desired culture is raising awareness about why acting with integrity in a personal and business context is such an important factor. Making employees aware of the positive and negative consequences of their conduct, together with strong ethical leadership that overtly supports and lives the right culture, will empower them to proactively assist a business to manage integrity risk.

Factors leading to integrity issues in business

Factors that contribute to an increase in integrity -related issues in a business primarily relate to: ■■ A lack of awareness on the part of management of the drivers of workplace misconduct, e.g. the elements of the fraud triangle ■■ Pressure, such as personal financial stress or work-related pressure, such as achieving financial KPIs ■■ An all-consuming focus on financial performance and a dismissive attitude of the positive influence of workplace integrity www.ethicalboardroom.com

Integrity | Regulatory & Compliance

■■ Opportunity, e.g. a person in a position of trust who can circumvent or override controls ■■ Rationalisation. closely related to culture, but basically justifying one’s conduct because others are behaving the same way ■■ Poor leadership behaviour, more commonly referred to as ‘tone at the top’ ■■ Lack of written guidance and training about operational processes or expected standards of behaviour among employees ■■ Inadequate and/or ineffective operational controls

Why awareness of integrityrelated issues is relatively low inside some organisations

The bottom line is that some businesses fail to recognise the benefits that an ethical culture can bring to a workplace. Many will exert little effort in achieving it because they see the activities associated with doing so as a cost to the business or they pay lip service to it by implementing written policy as a ‘tick the box’ exercise without intending to bring about real change. These types of attitudes are hard to understand, given the dynamic, ever-changing business world. Consequently, the risks an organisation is exposed to will change or evolve over time. This presents the ongoing challenge of effectively managing business risk, including integrity-related risks. While most leaders and managers are aware of common integrity risks, such as fraud, corruption and conflicts of interest, a large proportion of employees lacks the required level of understanding of these and other risks. For example, in the matters we investigate we often see that while an organisation may have a conflicts of interest policy, the individual being investigated in relation to an undeclared conflict of interest has either blatantly ignored the policy or just did not have a full appreciation of the issue. www.ethicalboardroom.com

While most leaders and managers are aware of common integrity risks, such as fraud, corruption and conflicts of interest, a large proportion of employees lacks the required level of understanding of these and other risks As eluded to above, change is a key factor and has a significant impact on how integrity-related issues manifest themselves. For example, the technological age has changed the way in which misconduct can occur in the workplace. Workplace bullying and sexual harassment issues now often occur online through social media platforms or via email, text and web-based messaging platforms,

leading to a new phenomenon called ‘cyberbullying’. There are many other emerging integrity risks. A business is exposed to potentially significant negative financial and reputational outcomes when it fails, for whatever reason, to: ■■ Recognise that technological, environmental, social and regulatory change is occurring on a regular basis ■■ Implement measures, such as training and awareness initiatives, to mitigate organisational risk, including integrity risks Summer 2019 | Ethical Boardroom 115

Regulatory & Compliance | Integrity

Let your employees be your eyes and ears

Your employees can be your most important asset when it comes to managing risk and identifying integrity-related issues. Let’s face it, the most significant cost to business is generally staffing cost, so why not harness the power of that resource. The 2018 Association of Certified Fraud Examiners (ACFE) Report to the Nations found that 40 per cent of all fraud investigations conducted over the period of analysis (2016 to 2018) were discovered due to tip-offs and that 53 per cent of those tip-offs came from employees.1 Nearly one-third (32 per cent) of those that led to fraud detection came from people outside the organisation: customers, vendors and competitors. This highlights the importance of developing effective channels for key

ESTABLISH TONE FROM THE TOP Communicate the organisation’s support for ethical behaviour and disclosure

stakeholders such as employees and suppliers, to report misconduct. Educating them about how and why to report misconduct is equally important. The report also found that effective integrity strategies and processes reduced the time to detect fraud and corruption. Where there was a code of conduct in place, the time to detect fraud was reduced by 46 per cent with a corresponding reduction in financial loss of 56 per cent. A code of conduct is a vital policy because it provides guidance about the organisations behavioural expectations. The results relating to having this measure in place are, in our view, closely aligned with those for organisations that have training programmes in place for their employees. The report found that of the frauds examined, they were discovered 50 per cent faster in organisations where fraud training programmes were provided to managers/ executives and employees. This increased speed of detection resulted in financial losses being reduced by 41 per cent in the case of employee training programmes and 116 Ethical Boardroom | Summer 2019

by 35 per cent where training programmes were provided to managers/executives, compared to organisation who did not provide such programmes. 2 The report found that all the key controls and processes considered, contributed to reducing the risk of fraud. Some of the other key controls and processes were: ■■ Formal fraud risk assessments This resulted in a 50 per cent reduction in the time to detect fraud, which resulted in a 38 per cent reduction in financial losses, compared to organisations that did not conduct regular fraud risk assessments ■■ Hotlines This resulted in a 50 per cent reduction in the time to detect fraud, which resulted in a 50 per cent decrease in financial losses incurred, compared to organisation who did not have a hotline. 3

fundamental to detecting it. It affords a business the opportunity to deal with it before it becomes a much bigger problem. However, the willingness of an employee to speak up is dependent on feeling secure in doing so and in the knowledge that whoever the issue is reported to will do something about it. A 2013 article about three University of Michigan studies relating to ethicality in the workplace and its effect on willingness to report misconduct, cites two of the main reasons for the reluctance to report misconduct as ‘“…in summary, as being a feeling of futility and a fear of retaliation, whether that’s being fired, demoted or ostracised. ‘You can be retaliated against by your boss or your peers, so there is a big risk in speaking up,’ the report says. ‘In summary, the studies found that ‘…although the ethicality of one’s supervisor matters, co-workers must model the same ethical behaviour if we want employees who witness unethical conduct to report it to management.”4 This only highlights our earlier contention about the importance of cultivating an ethical culture right across an organisation from leadership through to middle management and all employees. While new legislation in Australia now provides greater protection for whistleblowers, the driving force for achieving strong cultures of ethics and speaking up should be that it just makes plain common sense. In most organisations, written guidance

Your employees can be your most important asset when it comes to managing risk and identifying integrity-related issues. Let’s face it, the most significant cost to business is generally staffing cost, so why not harness the power of that resource While we have only highlighted some of the key processes and controls considered in the report, the statistics clearly show the benefits of implementing and maintaining a multi-faceted integrity system; a key element of which is providing training and awareness. In many of the matters we investigate, education and awareness programmes have either been non-existent or are poorly contrived with only a compliance objective in mind. Providing training programmes that provide relevant, practical examples of the integrity risks in an organisation and that provide guidance about how those risks should be navigated, are the most effective in achieving the desired culture and risk mitigation objectives.

in the form of a whistle-blowing policy that provides the ‘how to’ and emphasises protection of whistle-blowers, should be provided to all employees, regardless of whether there is a legislative requirement to do so. The principles and operational aspects of the policy should then be driven home through ongoing training and awareness initiatives.

How do employees report an incident that may be suspicious?

2018 ACFE Report to the Nations on Occupational Fraud and Abuse, page 17 22018 ACFE Report to the Nations on Occupational Fraud and Abuse, pages 27-29 32018 ACFE Report to the Nations on Occupational Fraud and Abuse, pages 27-29 4https://news.umich.edu/blowing-the-whistleon-bad-behavaior-takes-more-than-guts/

As alluded to above, the willingness to speak up about misconduct in the workplace is

Conclusion

Workplace misconduct will happen in any organisation, but the prevalence of it will diminish when an organisation establishes and nourishes a strong ethical culture; one that is supported by strong ethical leadership and ongoing communication, awareness initiatives and training. 1

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Regulatory & Compliance | Human Rights

Human Rights:

Reporting insights Good reporting will help companies assure their stakeholders that they are meeting responsibilities Richard Karmel

Managing Partner of Mazars’ London office

In 2015, the UN Guiding Principles (UNGP) Reporting Framework on Business and Human Rights was launched following a collaboration between Mazars, the global professional services firm, and Shift, the non-profit centre for business and human rights.1 Since its launch, the Framework has allowed companies to more successfully integrate the UNGPs into their business operations. These Principles were unanimously endorsed by the UN Human Rights Council in 2011 and clarify the responsibility of governments and business as regards the impacts businesses can, and do, have on people and how business should provide or enable remedy to those who have been harmed. The UNGPs are the most authoritative guidance and the blueprint for embedding human rights practices in business. Since 2011, the EU has required all of its 28 states to prepare ‘national action plans’ setting out how businesses need to align with the UNGPs. In today’s interconnected world, wherever people are harmed by business, some form of media is likely to have reported the event. It, therefore, seems inconceivable that companies, which spend billions of dollars on building up their brands and reputations, would be pursuing and conducting business practices without putting in place processes to protect people, be they customers, workers at suppliers, the wider communities in which their factories operate or their own employees, to name but a few. One of the key philosophies behind the UNGPs is that of ‘know and show’. Companies need to (1) understand how they can potentially harm people and put processes in place to mitigate against 118 Ethical Boardroom | Summer 2019

those risks happening in practice (the ‘know’ part) and (2) report on what those risks are and what they are doing about them (the ‘show’ part). So, eight years on since the endorsement of the UNGPs and four years since the release of the Reporting Framework, how meaningful is human rights reporting? By looking at public reports (annual reports, sustainability reports, human rights reports), this article sets out some of the trends that can be seen, by industry and by region, and the areas on which companies are reporting well and those with which they are struggling. This is not a definitive study but is the perception of the author who has worked in this area over the past eight years.

The big picture

There is an upward trend in the number of companies reporting separately on human rights. In 2015, only 13 companies had separate human rights reports. This figure rose to 52 by 2017 (Forbes, 2018); still a drop in the ocean considering the number of publicly listed companies, but with global companies such as Unilever, Nestlé and ABN AMRO addressing this area, their leadership is proving invaluable for others to follow. Indeed, they have each produced more than one report, so they have been able to demonstrate and report on progress as well as their successes, together with the challenges. As regards industries that have more mature reporting than others, the extractives (oil, gas and mining) and the apparel sector appear to be leading with those with an agricultural element, such as tobacco or cocoa, also making notable improvements. Ironically, the two industries that have a major impact on people’s 21st century lives are lagging; financial services and media technology industries haven’t yet meaningfully got to grip with how best to report on the risks that they are potentially contributing to or being linked with. There are exceptions, such as ABN AMRO and Microsoft, but they are in a minority within their sectors.

RESPECTING HUMAN RIGHTS Businesses have a responsibility to protect people

Nevertheless, the overall quality of human rights reporting still needs to be more meaningful and prolific. On the one hand it is pleasing to see many companies stating publicly that they are aligning behind the UNGPs; on the other hand, reporting is at such an embryonic stage that it is difficult to see whether they are actually doing so in practice. On the whole (there are some notable exceptions), reporting is currently not robust enough. Indeed, analyses of company reporting of many large and listed organisations across several sectors, reveals only five per cent are classed as ‘leading’ on human rights reporting. Nearly half of companies fall www.ethicalboardroom.com

Human Rights | Regulatory & Compliance of it, this reads well. However, as a reader we are none the wiser as to the effectiveness of this training; we don’t know the outcomes on the workers who are impacted or on the business itself. A key ethos behind the UNGP Reporting Framework is straightforward; companies shouldn’t report on every single human rights issue; just report on those salient issues where the business poses the greatest risk to people. By doing this, it provides the company with a methodology for prioritisation and focus. However, only eight per cent of companies reviewed actually identify salient issues, which is leading to less mature reporting.3

Sector differences

LEADING MATURE ESTABLISHED IMPROVING BASIC NEGLIGIBLE

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into or below the improving category.2 The struggle many companies have with embedding respect for human rights is that they are less easy to quantify than environmental issues. It is easier to place sensors and meters in the waste outflow from factories than it is to measure the impact of not paying a living wage. For human rights reporting to be meaningful, it requires a narrative. For example, to address improvement in working conditions in a factory, a company may train all its managers and the company will report that it is addressing improvement in factory working conditions through training. On the face

It can also be seen that sectors that have inherent issues, such as tobacco and oil and gas companies, are performing better than other sectors. For example, in the tobacco sector, several large companies are not only addressing how they are producing less harmful products but also how they are working with governments and others to eradicate child labour in their supply chains. Despite the lack of robust reporting, the general trend remains upwards. In this sense, some sectors are pulling away from others with differences in the maturity of reporting between sectors. In recent years, the apparel sector has been continually improving its human rights reporting. H&M and Marks and Spencer have been producing strong reports for the last few years but others in the sector are catching up. In fact, Adidas now sits at the top of the Corporate Human Rights Benchmark (CHRB, 2019) after making improvements on its previous reporting. Spanish multinational clothing company Inditex has also made improvements as companies in the sector compete on human rights. The impacts of the clothing industry – think GAP and Nike at the end of the last century – have been well known for a while. It is only really now that it is becoming more mainstream for consumers to turn to more sustainable sources of clothing. Fast fashion’s environmental and human rights impacts are now becoming unacceptable to consumers and companies within the sector are having to put greater efforts and resources into combating the negatives impacts. Food and beverages also perform higher compared to other sectors, with Unilever, Nestlé and Coca-Cola all providing strong reporting. Mondelēz appears to have taken note and is starting to produce improved reports. Summer 2019 | Ethical Boardroom 119

Regulatory & Compliance | Human Rights However, one of the big issues that we have recently seen in the media are the human rights impacts in the online world. They might not be classed or referred to under the umbrella of human rights, but they are. Three of the biggest companies in the world have a huge influence on our daily lives yet are not keeping up with their human rights reporting and, one assumes, performance. If you look at Facebook, Google and Amazon you will struggle to understand what they see as their key risks to people. The rapid emergence in online technology has led to firms in this sector almost by-passing their responsibilities as regards human rights, and governing bodies are now scrambling to keep up with appropriate and effective laws. Microsoft, however, appears to be bucking DOING THE RIGHT THING Consumers will boycott companies if they don’t endorse important issues

the trend, producing a detailed human rights report that identifies their salient issues and tells us how it is tackling them.

Regional differences

Whilst there are differences between sectors, there are also differences within regions. From our findings, an even bigger determinant of maturity of human rights reporting is location. By this, we mean location of the company’s headquarters rather than location of their operations, since most companies will cover several geographical regions. Law has played a part in this, such as the UK Modern Slavery Act and the Duty of Vigilance law in France. In addition, improvements to the UK Modern Slavery Act and the government’s National Action Plan (NAP) for implementing the UNGPs, along with a new NAP on Business and Human Rights in Germany are expected to emerge in 2019. 120 Ethical Boardroom | Summer 2019

When it comes to meaningful reporting in the financial sector, a leading country is the Netherlands. Finance and banking are sectors globally lagging in addressing human rights issues or, at least, reporting what they are doing. There is minimal meaningful reporting from UK and German banks. However, banks headquartered in the Netherlands are bucking the trend. ABN AMRO in particular has strong human rights reporting. ABN was one of the first companies to engage and report against the UNGPs and with its 2019 public reporting releases it has made significant steps. Furthermore, ABN has become a leader in pushing human rights reporting onto the agenda for business as a whole. Yet, it is far from the only Dutch bank to proactively addressing human rights. ING

is probably a key driver in this and helps it sit above its American and Asian competition. Indeed, our general view on human rights reporting is that European companies produce more mature human rights reports than their American and Asian counterparts. Once again, there are exceptions – Coca-Cola, Citi, Microsoft in the States and Ajinomoto Group in Japan.

Conclusions and recommendations

The general trend in human rights reporting is upwards. That being said, it's coming from a very low base. While more companies report in some way on human rights, much of the reporting is superficial, ticking a box and lacking depth and purpose. Even the companies with the most mature reporting, compared to others, know that they still have more to do and are generally not afraid to state this. Most companies, though, are yet to get to the start line. Perhaps this is where laws, regulations and voluntary guidelines are starting to have greater influence. Many people are sceptical of law playing its part in human rights reporting, believing it will make it a compliance target rather than one of commitment. However, the difference in maturity of reporting in different regions suggests that law does have a role to play. At the very least, it is crystallising recognition in companies that they need to be committing resources Companies to this area and is giving that have companies a baseline. At Mazars, we have been a strong helping some of the world’s human rights largest organisations better understand their actual and performance potential impacts on people. It will become brings a new way of thinking the companies about the role that business has to play in our 21st of choice for Group, De Volksbank and century societies. The more the future Rabobank are all improving enlightened companies are their reporting. Human rights already addressing this, bringing reporting at banks is crucial; they have value to themselves and their stakeholders. much influence, not only as corporate Just because an area that at first glance lenders but also as investors. In fact, this appears complex doesn’t mean it shouldn’t is part of a wider process of the Dutch be addressed. ministries of Foreign Affairs and Economic Overall, good reporting can be a driver Affairs, which are creating sector-based for improved human rights performance covenants to ensure human rights are at and for potentially reducing the negative the core of business processes. impacts on people. Helping to improve We similarly see governments influencing lives provides a tremendous opportunity reporting in the extractives sector. Due to for companies. Investors need to take note the UK Modern Slavery Act, Anglo mining and encourage companies to address firms have stronger human rights reporting this area in order to reap the rewards. than many Canadian mining firms, where Companies that have a strong human human rights reporting is weak and human rights performance will become the rights abuses are widespread. The exception companies of choice for the future. is Newmont which is far ahead of its regional 1 www.UNGPreporting.org 2https://www.ungpreporting. peers. Total, the French oil company, org/database-analysis/methodology/ 3https:// outperforms other oil firms in human rights www.shiftproject.org/resources/publications/ reporting. The French Duty of Vigilance Law corporate-human-rights-reporting-maturity/ www.ethicalboardroom.com

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Global News North America Health boards ‘lack tech expertise’

Equifax fine should ‘deter executive neglect’ Equifax’s $800million US settlement over a 2017 data breach that exposed customers’ social security numbers and other private information should serve as a warning to corporate executives, according to lawyers. Hackers were able to steal confidential data of nearly 150 million people after the credit agency failed to patch its systems. “Companies that profit from personal information have an extra responsibility to protect and secure that data,” said Jo Simons, chairman of the Federal Trade Commission.

“Equifax failed to take basic steps that may have prevented the breach.” Norm Siegel — one of the co-lead counsels on behalf of consumers in the Equifax settlement — told security news outlet CSO that he thinks security professionals and executives should ‘take the Equifax breach to heart’. “We were able to secure meaningful data security improvements, including a major capital commitment backed by a court order, which is another important feature of this settlement that perhaps will be a deterrent to executive neglect of cybersecurity,” Siegel added.

CannTrust board shakeup over pot scandal

2020 for Canada diversity disclosure update New diversity disclosure requirements for public companies incorporated under the Canada Business Corporations Act will come into effect in 2020. Public corporations will be required to annually disclose their term limits, diversity policies and targets, if any, as well as statistics regarding representation by ‘designated groups’ on both the corporation’s board and at the executive officer level. The term ‘designated groups’ takes its meaning from the federal Employment Equity Act and includes women, Aboriginal people, persons with disabilities and members of visible minorities. The new diversity disclosure requirements to be implemented by public companies on 1 January 2020 do not cover banks or public companies that are incorporated under provincial business corporations acts.

122 Ethical Boardroom | Summer 2019

Canadian cannabis producer CannTrust has ousted its CEO and forced its chairman to resign amid an investigation into its unlicensed cannabis greenrooms. Emails seen by the Globe and Mail reportedly show that top executives were aware that the Canadian company was growing cannabis in unlicensed rooms for months before regulators discovered it. The company’s board of directors decided to ‘terminate with cause’ chief executive Peter Aceto and also demanded company chair Eric Paul resign after a special committee uncovered new information on the company’s failure to comply with Health Canada regulations. The board has appointed the special committee’s chair Robert Marcovitch as interim CEO and he will no longer be a member of the committee.

Boards of directors at US hospitals and health systems lack sufficient oversight over technology, according to a new US study of C-suite executives. The Black Book report found that 91 per cent of hospital boards rely entirely on consultants for IT strategy and advice rather than the healthcare tech expertise of trustees. Among currently serving board members, only four per cent have direct technology experience relevant to the healthcare industry. “Advisors on which health system boards depend are historically inclined to give very broad advice on vendor selections and the competitive landscape, which may not motivate digital transformation, but will keep the organisation from lagging behind,” said Doug Brown, founder of Black Book Research.

Congress rejects mandatory ESG disclosure The US House of Congress has rejected proposals to align the country’s environmental, social and governance (ESG) reporting requirements with the more rigorous standards being applied in Europe. In July, Republican members of the US House Committee on Financial Services rejected Democrat proposals requiring companies to report more ESG information, including disclosures on the risks faced from climate change. An increasing number of investors are seeking to incorporate ESG ratings and Europe is introducing rules to make them mandatory. According to FT.com, Michigan Republican representative Bill Huizenga said: “Mandatory ESG disclosures only name and shame companies as well as waste precious company resources. Mandating these disclosures is only doing more harm than good.”

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Corporate Governance Awards | The Winners

Financial Services Royal Bank of Canada Mining Barrick Gold Corporation Transportation & Logistics The Canadian National Railway Co. (CN) Canada

INDIVIDUAL NORTH AMERICA WINNERS 2019 Best Company Secretary — Financial Services Karen McCarthy Royal Bank of Canada Best Company Secretary — Transportation & Logistics Sean Finn The Canadian National Railway Co. (CN) Best General Counsel — Insurance Timothy P. Harris Prudential Financial Inc. Best General Counsel — Oil & Gas Kelly Rose ConocoPhillips

INDIVIDUAL CARIBBEAN WINNERS 2019 Best Company Secretary — Financial Services Kimberly G. Erriah-Ali Republic Financial Holdings Ltd Best General Counsel — Telecommunications Tristan Gilbertson Digicel Group Ltd

Food & Beverage GraceKennedy Group

Conglomerate Massy Group

Telecommunications Digicel Group Ltd Jamaica

Financial Services Republic Financial Holdings Ltd Insurance Guardian Holdings Ltd Trinidad & Tobago

Airlines Atlas Air Worldwide Inc. Food & Beverage Florida Ice and Farm Company S.A. (FIFCO) Costa Rica

Automotive General Motors Construction Fluor Corporation Food & Beverage The Coca-Cola Company Insurance Prudential Financial Inc. IT Services Hewlett Packard Enterprise Oil & Gas ConocoPhillips Real Estate Investment Trust HCP Inc. Utilities Avangrid USA

Construction Gafisa Construction Materials Grupo Argos S.A. Holding Company Grupo de Inversiones Suramericana (SURA) Colombia

INDIVIDUAL LATIN AMERICA WINNERS 2019 Best General Counsel — Holding Company Juan Luis Múnera Gómez Grupo de Inversiones Suramericana (SURA)

Utilities CPFL Energia Industrial Services Ferreycorp S.A.A. Peru

IT Services TOTVS S.A. Manufacturing Natura Holding S.A. Brazil

Financial Services Banco de Crédito e Inversiones S.A. (Bci) Retail Cencosud S.A. Chile

Best CEO — Industrial Services Mariela García Ferreycorp S.A.A. 124 Ethical Boardroom | Summer 2019

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Introduction | Corporate Governance Awards

AWARDS2019

THE AMERICAS AND CARIBBEAN

Boardroom diversity means better business The Americas & Caribbean Organisations that want to improve their effectiveness need to do more to ensure that different perspectives are regularly sought and integrated into their board’s work. An acceptance of the need for diversity (gender, race, diversity, etc) has been fuelled by numerous studies that show a strong correlation globally between business performance and workforce diversity – with evidence that it leads to better organisational performance, effectiveness, profitability and revenue generation. According to Egon Zehnder’s 2018 Global Board Diversity Tracker, more women are being appointed to corporate boards, with the United States and Canada among the countries leading the way. Latin America, though improving, still has a long way to go, with big differences among the countries. Almost 50 per cent of listed companies in Colombia, Argentina, Brazil, Chile or Mexico have no women on their boards but progress has been hampered by an overall sense of instability and shifting politics, rather than a lack of will.

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In the US, a coalition of chief executives is trying to get more corporate boards to create diversity and inclusion plans at American companies. More than 700 CEOs of the world’s leading companies and business organisations are taking part in the CEO Action for Diversity & Inclusion scheme. And, in July, the last S&P 500 company with an all-male board of directors – online car auction company Copart

More than 700 CEOs of the world’s leading companies and business organisations are taking part in the CEO Action for Diversity & Inclusion scheme

– added a woman to its ranks. However, still only one in four board seats at S&P 500 companies is occupied by women and all-male boards are still common among hundreds of smaller public companies. In Canada, the Canadian Venture Capital and Private Equity Association, in partnership with BDC Capital, recently released its first State of Diversity and Inclusion report with the intention to measure the private capital sector’s progress over the coming years. The report found that at 23 private equity firms, only 17 out of 145 partners were female and at 36 venture capitalist firms only 11 per cent of partners were female. The results clearly show the need to increase representation of women in senior ranks of private capital investment firms, but the study does suggest there is opportunity in the private capital industry to promote more women into partner roles because the female talent pipeline is strong. The Ethical Boardroom Corporate Governance Awards recognise and reward outstanding companies who have exhibited exceptional leadership in the area of governance. The awards highlight the important role that corporate governance plays in dictating a company’s success and a board’s contribution to the creation of long-term value. Ethical Boardroom is proud to announce its Corporate Governance Awards Winners in the Americas and Caribbean.

Summer 2019 | Ethical Boardroom 125

Corporate Governance Awards | Republic Bank

AWARDS

WINNER 2019 CARIBBEAN FINANCIAL SERVICES

Principles of corporate governance Republic Financial Holdings reveals its statement of corporate governance practices Kimberly Erriah-Ali

Group General Counsel and Corporate Secretary, Republic Bank Limited and Republic Financial Holdings Limited

On December 16, 2015, Republic Financial Holdings Limited (RFHL) was established in order to facilitate the restructuring of the Republic Group. This restructuring ensured that Republic Bank Group is in line with international best practices to facilitate future growth.

Following this change, RFHL became the parent company for several subsidiaries, including the following banks: Republic Bank Limited (formerly Fincor); Republic Bank (Barbados) Limited; Republic Bank (Grenada) Limited; Republic Bank (Guyana) Limited; Republic Bank (Cayman) Limited; Republic Bank (Ghana) Limited and Republic Bank (Suriname) N.V. The Board of Directors of RFHL continues to be committed to maintaining the highest standards of corporate governance. To this end, there is continuous monitoring and updating of Republic Bank’s internal systems in order to ensure standards reflect 126 Ethical Boardroom | Summer 2019

best international practice, tailored to the specific needs of the members of the Group. In this regard, RFHL has adopted the Trinidad and Tobago Corporate Governance Code on the ‘apply or explain’ basis.

RESPONSIBILITIES

The Group has 10 principles of corporate governance that summarise the objectives of the Board and provide a framework for the manner in which it functions and discharges its responsibilities. These principles support the Board’s aim of promoting strong, viable, competitive corporations and are in line with the Group’s core values of integrity, professionalism, customer focus, respect for the individual and results orientation. The 10 principles are:

Lay solid foundations for management and oversight. The Board is responsible for: ■■ Oversight of the Bank, including its control and accountability systems ■■ Appointing and removing the managing Director, deputy managing Director, executive Directors and senior management ■■ Formulation of policy ■■ Input into and final approval of management’s development of corporate strategy and performance objectives ■■ Reviewing and ratifying systems of risk management and internal compliance and control, codes of conduct and legal compliance ■■ Monitoring senior management’s performance and implementation of strategy, and ensuring appropriate resources are available

■■ Approving and monitoring financial and other reporting ■■ Approving and monitoring the progress of major capital expenditure, capital management and acquisitions and divestitures ■■ Approving credit facilities in excess of a defined amount ■■ Updating and maintaining organisational rules and policies to keep in step with changes in the banking industry This framework for management and oversight is designed to: ■■ Enable the Board to provide strategic guidance for the Bank and effective oversight of management ■■ Clarify the respective roles and responsibilities of Board members and senior executives in order to facilitate Board and management accountability to both the Bank and its shareholders ■■ Ensure a balance of authority so that no single individual has unfettered powers the Board to add value 2 Structure The Group must ensure that there is a

balance of independence, diversity of skills, knowledge, experience, perspective and gender among the Directors. It should have a Board of an effective composition, size and commitment to adequately discharge its responsibilities and duties. The Board is structured in such a way that it: ■■ Has a proper understanding of, and competence to deal with, the current and emerging issues of the business ■■ Can effectively review and challenge the performance of management and exercise independent judgement www.ethicalboardroom.com

Republic Bank | Corporate Governance Awards ethical and 3 Promote responsible decision-making

The Board ensures that the Bank promotes ethical and responsible decision-making and complies with all relevant policy, laws, regulations and codes of best business practice using the Group’s ethics and operating principles. The ethics and operating principles address the following matters: conflicts of interest, corporate opportunities, confidentiality, fair dealing, protection of and use of the Group’s assets, compliance with laws and regulations and encouraging the reporting of unlawful/ unethical behaviour. integrity in 4 Safeguard financial reporting

The Board has a structure in place to independently verify and safeguard the integrity of the holding company’s financial reporting, including the internal audit department headed by the chief internal auditor and the establishment, as required by law, of the audit committee, to which the chief internal auditor reports. The existence of an independent audit committee is recognised internationally as an important feature of good corporate governance and is required by the Financial Institutions Act. The Group’s internal audit is also governed by a charter, which sets out the roles and responsibilities of internal audit, the professional standards by which it is to be governed, the staff’s authorities and organisation and emphasises the independence of internal audit in the Bank’s organisational structure. Each audit committee is also guided and governed by its own terms of reference. timely and balanced disclosure 5 Make The Board shall promote timely

and balanced disclosure of all material matters concerning the Bank. To achieve this the Bank has put in place structures designed to ensure compliance with the relevant legislation and to ensure accountability at a senior management level for that compliance, such that: ■■ All investors have equal and timely access to material information concerning the Bank – including its financial situation, performance, ownership and governance ■■ Bank announcements are factual and presented in a clear and balanced way. ‘Balance’ requires disclosure of both positive and negative information the rights of shareholders 6 Respect The Board respects the rights of

shareholders and facilitates the effective exercise of those rights. To this end, the Board has a responsibility, for ensuring that a satisfactory dialogue with shareholders www.ethicalboardroom.com

takes place. In furtherance of this responsibility the Board empowers the shareholders by: ■■ Communicating effectively with them ■■ Giving them ready access to balanced and understandable information about the Bank ■■ Making it easy for them to participate in general meetings and manage risk 7 Recognise The Board has a responsibility to

review the adequacy and effectiveness of the bank’s risk management strategies and review and approve the Bank’s risk management framework. To achieve this, the Group has developed an enterprise risk management policy and a risk appetite statement that governs the manner in which risk is managed in the Group. In addition, there is a Group chief risk officer as well as the enterprise risk committee (ERC). The Group chief risk officer and the ERC make recommendations and the Board approves and implements: HEAD OFFICE Republic Bank’s HQ is based in Port of Spain, Trinidad & Tobago

information they need to discharge their responsibilities effectively. Management is required to supply the Board with information in a form, time frame and quality that will enable the Board to discharge its duties and responsibilities. When needed, the Board has access to the advice of both in-house counsel, the Bank’s external counsel and other independent professional advice, if necessary. fairly and responsibly 9 Remunerate The Board shall ensure that the level

and composition of remuneration is sufficient and reasonable and that its relationship to corporate and individual performance is defined. To achieve this, the Bank has adopted remuneration policies that attract and maintain talented and motivated employees so as to encourage enhanced performance of the Bank. It is important that there is a clear relationship between performance and remuneration. The Bank has designed its remuneration policy in such a way that it: ■■ Motivates management to pursue the long-term growth and success of the Bank within an appropriate control framework ■■ Demonstrates a clear relationship between key executive performance and remuneration the legitimate 10 Recognise interests of stakeholders

■■ The Bank’s risk appetite framework, tolerance, limits and mandates, taking into account the Bank’s capital adequacy and the external risk environment ■■ Strategic or material transactions, focussing on risk and implications for the risk appetite and tolerance of the bank ■■ Oversight and maintenance of a supportive risk culture throughout the Bank ■■ Risk assessment, including risk assessment processes, identifying and managing risk and monitoring and understanding the risk profile of the Bank ■■ Risk monitoring and reporting, including adequacy and effectiveness of the technology infrastructure ■■ Risk management function enhanced performance 8 Encourage The Board is committed to encouraging

enhanced Board and management effectiveness through periodic performance evaluations and reviews. The Board also ensures that Directors and key executives are equipped with the knowledge and

The Bank is subject to a number of legal requirements that affect the way business is conducted. These include contractual requirements, banking practice, compliance, consumer protection, respect for privacy, employment law, occupational health and safety, equal employment opportunity and environmental controls. In addition to its obligation to its stakeholders, the Bank has other obligations to non-shareholders such as employees, customers and the community as a whole. The Board has a responsibility to set the tone and standards with respect to the corporate social responsibility of the Bank and to oversee adherence to these. The Group’s ethics and operating principles, which state the value and policies of the Bank assists the Board in this task and acts as a guide for employees and management in conducting business and general behaviour.

Republic Bank Limited

P.O. Box 1153, 9-17 Park Street, Port of Spain, Trinidad, West Indies email@rfhl.com

Summer 2019 | Ethical Boardroom 127

Latin America | Gender Diversity SPOT THE FEMALE DIRECTOR Only 58 per cent of Latin American companies have at least one woman in their boardroom

Reinforcing the need for diversity in Latin America’s boardrooms A look at the progress and dynamics at play in five countries Cristina Manterola

Principal and Member, Egon Zehnder’s Diversity & Inclusion Council

In Latin America, 91.7 per cent of board seats are occupied by men – an improvement on the 94 per cent of board seats belonging to male directors in 2012.

128 Ethical Boardroom | Summer 2019

Diversity by the numbers

The Global Board Diversity Tracker found that while more women are being appointed to corporate boards, the level of progress varies greatly by region, with Australia, the United States, Canada and Western Europe leading the way. Latin America, though improving, still has a long way to go, with big differences among the countries. Data from Mujeres en la Bolsa (Women in the Stock Exchange), an initiative to enhance the visibility of women in boards

of corporations, including all traded companies in each country, showed Colombia and Argentina are leading the way in gender diversity with 18 and 15 per cent of listed company board seats held by women. For comparison, the global average of board seats held by women was 20.4 per cent, according to the Board Diversity Tracker. Almost 50 per cent of listed companies in Colombia, Brazil, Chile and Mexico have no women on their boards (see Figure 1, below). By comparison, the global average from the Board Diversity Tracker of companies with no female board members was 15 per cent. We can also see that there are massive variations among countries. Mexico, Chile and Brazil still have some catching up to do in order to have a stronger female representation on boards (see Figure 2, opposite).

FIGURE 1: PERCENTAGE OF WOMEN ON PUBLIC COMPANY BOARDS 44%

Colombia Argentina

13%

27%

25%

29% 62%

190 85

Brazil

58%

23%

19%

417

Chile

57%

25%

18%

244

Mexico

42%

30%

28%

142

Total number of companies

While these statistics from Egon Zehnder’s Global Board Diversity Tracker may appear disheartening or frustrating, there is reason to be hopeful about women’s progress in the boardroom. Board composition does evolve: more than half of boards (58 per cent) in the five Latin America countries we studied (Argentina, Brazil, Chile, Colombia and Mexico) had at least one woman on their board, compared to only 43 per cent in 2012. However, it is important not to be complacent about progress. When comparing the Latin America average of companies with a woman on the board (58 per cent) to the global average (85 per cent) in 2018, it’s obvious Latin America has some catching up to do. Using findings from Egon Zehnder’s 2018 Global Board Diversity Tracker, which analysed 1,610 companies globally with market caps

above seven billion euros, combined with country-specific data and interviews with consultants in five Latin American countries, we uncovered several trends that are affecting women’s paths to boardrooms and developed some actions we can take to speed up progress.

■ No women ■ 1 women ■ 2 or more women www.ethicalboardroom.com

Gender Diversity | Latin America Grimoldi, head of Egon Zehnder’s Buenos Aires office. “We are in survival mode now.” Despite the ‘wait-and-see’ mode that Argentina is in, there has been some gender equality progress made in the public sector, moving from the 1991 requirement of a 30 per cent women quota on legislative candidates, to a parity of gender on the candidate lists.

Brazil

Brazil is governed by a right-leaning leader (President Jair Bolsonaro), who has been criticised for his less inclusive behaviour towards women. He named only two women to his 22-person cabinet, although, in more positive news, there was a record number of women elected to congress – 77 women were elected as federal deputies, compared to 51 in the previous term. Even with a complex political backdrop, there are signs of hope for change in the boardroom. “Diversity is appreciated more and more by companies now. They understand that new perspectives are business differentiators. Companies see the importance of female leadership and the number of female board searches has increased

FIGURE 2: PERCENTAGE OF SEATS OCCUPIED BY WOMEN IN PUBLIC COMPANIES 18%

15%

11%

Colombia Argentina Brazil

Chile Mexico

Economic and political concerns impact diversity

While progress in diversifying Latin American boards has historically been slow, hampering the progress is an overall sense of instability and shifting politics. Below is a brief overview of the landscape in each of the five countries.

Argentina

In Argentina, the economic crisis leaves little room for conversation about diversity. With the world’s highest inflation rates amid a dramatic recession, many are waiting for the October elections, which could change corporate regulations and policies if the government shifts to the left. “Diversity hasn’t been as high on the agenda as it should be,” explains Marcelo www.ethicalboardroom.com

substantially,” explains Ângela Pêgas, an Egon Zehnder consultant based in São Paulo. “However, we still have to move to having more than one female per board so that they feel more included and not only the diversity representative.”

Colombia

While Colombia has been making steady progress towards gender diversity, it is still facing a difficult path ahead. The economy is struggling, unemployment is high and there is extreme polarisation between the left and right arms of political parties. “We have a new president, but old tensions and uncertainty remain,” explains Juliana Rodríguez, an Egon Zehnder consultant in the Bogotá office. One of the reasons Colombia has been able to achieve the progress it has thus far is that the country introduced quotas years before others in the region, and diversity has been on the agenda for a longer period of time. “Culturally, there is a stronger

acceptance and larger penetration of women in the boardroom,” Rodríguez says.

Mexico

Mexico has its first leftist president in history, creating an environment for unpredictable policy making. This governmental shift led Fitch to downgrade Mexico’s sovereign debt rating and Moody’s to lower its outlook on Mexico to negative. However, it may have opened a door for more diversity, at least in the public sector, which has incorporated quotas. Currently, 49 per cent of the lower house and 51 per cent of the senate are women. “The corporate environment is slowly becoming more welcoming to women,” says Carlos Vázquez, an Egon Zehnder consultant based in Mexico. “But we still have few women at the top.”

Chile

The government is playing a positive role in Chile, where there is a push for companies to deliberately consider women for board positions. Since 2017, Chile has quotas for female political candidates for congress and incentives for the incorporation of women, which have fostered more participation in the political arena. In April, the government went so far as to create a list of 136 women who could be eligible for corporate boards, for which they asked search firms and other experts for input. However, the list did little to generate a noticeable change in corporate statistics, given the small overall turnover. After the annual round of shareholder meetings earlier this year, four more women joined the ranks of the 260 directors in the IPSA index. While this initiative may have stalled, the gender equality discussion remains very much alive.

Growth of independent board members

The particularly slow evolution of familyowned companies when it comes to adding independent directors has been another barrier for women. In Chile, most large companies are controlled by powerful male members of the family . Although the number of independent board members has increased, boards are still mainly composed of these family members and their male friends and colleagues. Companies are feeling the need to have corporate governance best practices in the boardroom, including diversity, but change has been slow to materialise because it is difficult to replace a friend with an independent or diverse board member. Summer 2019 | Ethical Boardroom 129

Latin America | Gender Diversity Brazil has made a push for more independent directors in the boardroom and is seeing some gains. To be part of the top governance levels at the Brazilian stock exchange, publicly traded companies must have independent directors, but this is beginning to trickle into family businesses as well. “Family companies are less concerned about whether the independent director was a former CEO or CFO, which broadens the pipeline of candidates,” Pêgas says. But this openness to women in familycontrolled companies does not resonate in all Latin American countries. In Argentina, family businesses do not seem to be motivated to appoint female family members to directors, though this might change, given that the country recently passed a law saying that after 10 years of board service a director would no longer be considered independent. In Mexico, family company board members still tend to be family and friends, but this is changing. “New family generations are often motivated to appoint truly independent and professional directors,” Vázquez says. “They look for women and for international diversity in those independent directors.” However, he also noted that women sometimes hesitate to take on C-suite roles at family companies out of concern that the corporate culture may not be prepared for a female leader.

Evolving director criteria

As is true elsewhere, boards in Latin America tend to seek former CEOs, and sometimes CFOs, when they have a seat to fill. Unfortunately, the number of women in those positions is severely lacking. Our Global Board Diversity Tracker found that women make up just 3.7 per cent of CEO positions globally and only 1.9 per cent in Latin America. Women in CFO roles fare only slightly better, with women holding 12.2 per cent of CFO roles globally and 8.9 per cent in Latin America. However, the desire for digital, consumer and stakeholder management expertise is opening the door to more diverse candidates. For example, at Hering – the leading

clothing and textile manufacturer in Brazil – shareholders pushed for the board to be less homogenous and include directors with expertise outside of financial services. CEO Fabio Hering sought out more retail and digital experts and ended up with two women on a seven-member board. Grimoldi notes the same trend in Argentina: “You can’t get the digital experience without tapping into a younger generation. While this isn’t necessarily gender specific, it can level the playing field for women,” he says.

Greater awareness of biases

The #metoo and similar movements have helped to spur action in Latin America, not only to protect women, but also to raise awareness in society at large about the different treatment received by men and women. In Chile, people are feeling empowered like never before, and there have been massive feminist protests on the streets. In Colombia, a no-tolerance policy for abuse is gaining strong momentum. “These movements are forcing regulators and society to take a closer look at women and examine their disadvantages,” Rodríguez explains. This is resonating in other Latin American countries as well. A distinct ‘machista’ culture embedded across Latin America has long been a barrier for women in achieving top leadership roles, but that culture is beginning to fade. One solution to overcoming this barrier is mentorship. “I see men taking a stronger step toward sponsoring women. Men have mentored most women who have achieved a seat at the board. Their trust and guidance have been key in developing these women,” says Carolina González-Alcántara, a former Egon Zehnder principal and current partner at EY.

Taking action

To continue to spur needed change in Latin American boardrooms, there are several recommendations and action steps that can be taken.

■■ Shareholders should consider increasing the number of independent board members and using this opportunity to add new competencies and diverse experiences to the table. This will enable the board to successfully face the challenges ahead, including digital transformation, customer-centricity, environmental and community relationships and cybersecurity, among others. ■■ Companies should identify high-potential young women early in their careers and mentor them, helping them through important milestones in their career journeys, particularly looking at the promotion processes and ensuring women have an even chance. Companies could also invest in executive development programmes for women. Rodríguez noted that she is seeing a demand for leadership development programmes to help mould their female talent into top positions. “They want to move women from the base of the hierarchy to the top,” she says. ■■ Women should not allow self-doubt to prevent them from taking on new and challenging roles. González-Alcántara notes that women often view themselves through a hyper-critical lens. “Women look at job requirements and want to be able to check all the boxes,” she says. “Men wouldn’t even look at the requirements and would go after the position.” Change in the boardroom does not happen overnight. In Latin America, women – and men – must keep the conversation about the need for boardroom diversity alive. It must be an ongoing discussion on the board agenda and management must find ways to develop and support female and diverse talent through all levels of their careers. We must view our progress to date as both a milestone and a stepping stone on the path to truly diverse boardrooms.

MENTORING CAN BRIDGE THE GAP Companies should be doing more to support young, high-performing women to progress 130 Ethical Boardroom | Summer 2019

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Latin America | Executive Pay PAYING WELL TO ENJOY SUCCESS Organisations can keep directors motivated with an effective remuneration system

Breaking the remuneration taboo Being a board member is a part-time job, with full-time responsibilities. If this reality was better weighted, renowned professionals would more carefully consider accepting being appointed as part of a board of directors. And they would more objectively analyse the ratio between remuneration, time and responsibility.

Little has been said and written about the subject, since all the governance discussions revolve around the ‘say-on-pay’ for executives’ remuneration. In that sense, it is important in the first place, to overtake the mental bias of believing that board members’ remuneration is a restricted subject and be aware of the importance of this matter for any corporate governance system. If we look at corporate governance international standards, the British model (UK Corporate Governance Code) briefly states that non-executive directors’ remuneration should reflect the level of commitment required in terms of time and responsibilities and it recommends not to include stock options as part of the compensation package. The Toronto Stock Exchange’s guides (Guide 8) have greatly contributed to the 132 Ethical Boardroom | Summer 2019

Why it is ‘politically correct’ to talk about a board’s remuneration

Total Board Remuneration (TBR) = ($ + e) (r + p)LtP Where: $ = cash, e = equity, r = risks, p = proportionality, LtP = Long-term performance

Andrés Bernal & Catalina Rojas

America’s (North and South) situation regarding systems and amounts

Both Partners at Governance Consultants S.A subject by referring to the risks and responsibilities involved in the board of director’s role. As opposed to the UK model, it explicitly recommends minimum requirements of shares ownership that directors must have. On the other hand, the US model (from the Securities Exchange Commission – SEC and the International Shareholder Services – ISS) succinctly establishes that a director’s remuneration must be aligned with the company’s long-term interests. In its recommendations Governance Quality Score (Q140 and Q144), ISS explicitly advises that all directors must keep ownership in the company. The question is: how and when companies must remunerate a director. There are two main mechanisms: payments in cash or systems linked to share value. From our point of view, the answer must consider the equation below (each element is explained in a more detailed manner later in this article).

According to information provided by the National Association of Corporate Directors, in North American listed companies (large, medium and small companies, excluding the top 200), a yearly director’s compensation varies between $165,000 and $230,000. Approximately, five per cent is paid in stock options, 50 per cent in full-value stock, eight per cent constitutes committee pay, three per cent is board meeting fees and 34 per cent is cash retainer. In large and medium companies, within the US, the non-executive chairman can receive more than $300,000 as remuneration (including additional amounts for the extra time required for leading the board). The presidents of the board committees have additional remunerations between $15,000 and $25,000 per year. The Latin American situation is quite concerning; countries such as Mexico and Colombia have not succeeded in updating director’s remuneration. According to our analysis, in the last few years, there is an unfair gap between the earnings perceived www.ethicalboardroom.com

Executive Pay | Latin America by shareholders and the remuneration not enough data in Peru on which to base an packages for executives and directors’ fees. opinion; but in Chile, the largest companies Remuneration linked to meeting spend approximately $200,000 per director, attendance (board or committees) is per year. the model that still prevails within the Our recommendation region. For most of the listed companies, in three steps remuneration is under $2,000 per meeting, Putting the subject on the table including additional fees for attending It must be acknowledged that the first committee meetings. Based on these big obstacle is to find the right moment rates, external directors receive a yearly for discussing the subject. As we've already remuneration below $40,000. discussed, there never seems to be a good However, in a region where there are time to discuss board remuneration in high levels of poverty, relatively low levels Latin America, but the board evaluation of growth and where it is frowned upon to provides the perfect opportunity to activate talk about other people's income, it is hard a conversation. to find data on directors' pay; it sometimes At the beginning of the company–director feels politically incorrect to even discuss it. relationship, social interaction plays But an incorrect director’s remuneration a fundamental role, so is practically model has a wicked effect on a company's impossible to individually negotiate corporate governance system. Especially if remuneration, as it would happen for an you believe that a good board is responsible executive position. If the company is going for a sound long-term strategy and that through a transformation process (and when every day is clearer that the competition do companies not transform and adjust in for the best talent has also reached boards. current times?) it's not a good moment for The problem is not only how much is paid, the board to ask for a remuneration rise but what directors are being paid for. From for its members, especially if, at the same our analysis of the top 100 Latin-American time, the governing body is approving cuts listed companies, more than 95 per cent in expenses and big investments. use a system based on payment for Remuneration is meeting attendance. This a subject that is more implies a fundamental The Latin American being disconnection between corporate governance recently acknowledged and talked the board’s incentive system needs to grow about within board model and the interest evaluation processes. in long-term value regarding directors’ From our experience of creation for shareholders. remuneration and evaluating boards from In Mexico, there leading companies in are even medieval acknowledge the Latin America, several practices used by some conversations with conglomerates, by which value destruction due they still compensate to not candidly talking independent board members end up with their directors with about the subject the following thought: golden coins! ‘there is an increasing The culture around demand on directors' time and they have director remuneration is not helped by more and more responsibility, however the view held by a significant number of the remuneration remains the same or influential institutional investors and proportionally less’. In those spaces for regulators that directors should not own analysis about the best strategies to enhance shares in the company; that they shouldn't the board’s operation, it is convenient have 'skin in the game'. That is why the to openly talk about its compensation. prevailing system is remuneration based on meeting attendance. This practice goes Rethink the remuneration system, against what is happening in other regions, based on meeting attendance and where the markets are more appreciative evolve into including remuneration of companies where independent directors packages aligned with value creation have shares in the companies. There's an increasing need to create new The Latin American corporate governance systems based on retainer fees (amounts system needs to move on and acknowledge paid independent of the number of meetings) the value destruction being caused by not and compensation linked to value creation candidly talking about board remuneration. (EVA and other long-term indicators of value Research has found no logical link growth should be considered). between board remuneration in Latin The system of employing deferred stock America and company revenues and value units (DSU) is becoming frequently used creation - that is, where you can find the in different markets as a mechanism to data. In Colombia and Mexico, for example, incentivise directors to think in the total average remuneration does not even company’s long-term interest. This model has reach $300,000 for the entire board; there is

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the advantage of aligning payments with share value, without involving short-term interest gains (to inflate or liquidate the shares), as is the case in stock options or restricted stock units. With this system and variations derived from it, it's possible to make the long-term interest prevail, adjust the company’s risk appetite and align it with key factors for value creation for shareholders. Rethink the system based 3 on cash and equity

A recommended formula is to structure a model that considers cash and long-term value creation, adjusted to each company’s reality (industry, size, ownership structure, board quality, etc). The starting point can be a remuneration system based on an 80/20 cash/equity ratio, which can be adjusted, according to each company’s reality and moments. It's recommended company's refine this using the Total Remuneration Formula (opposite) while also bearing in mind: ■■ Proportionality derived from comparative analysis with similar companies in the country, the region and globally. It is important that companies think whether they are competing on a local or a global scale since this would greatly influence the talent needed for the board (the answer is always the same: which industry is nowadays not competing with global players…) ■■ In the proportionality of the board’s remuneration model, the company must consider the compensation packages for its executives. Although this is a purely referential element, it is important to consider that the time, responsibility and risk required for a board member are easily comparable to the requirements for the CEO ■■ The level of legal and reputational risk for directors, due to the company’s industry, ownership structure, legal regime and the context of their position in the country in which the company is based ■■ The level of alignment in order that the compensation system ensures that directors are properly motivated to create value for the shareholders in the long-term. In this case, it is convenient to structure models that have objective aspects to measure performance (such as DSUs) If companies want to have good boards, they must attract good directors and keep them motivated through a good remuneration system. Although it’s difficult to find a good moment to have this conversation, and the subject may be seen as politically incorrect, it’s fundamental that chairs, institutional investors and controlling shareholders, openly speak about it if they want to build an efficient corporate governance system that creates value for the organisation. Summer 2019 | Ethical Boardroom 133

Global News Latin America & Caribbean

Investors unimpressed with Pemex plan International investors have spurned the Mexican government’s plan to revive its debt-laden state-owned oil company, Pemex. The plan aims to reduce Pemex’s tax burden and grants the company $7.2billion in financial support from the government over the next three years. According to financial analysts, Pemex bond investors

believe the plan by President Andrés Manuel López Obrador fails to address long-term challenges at the company. “It’s likely buying a couple of years’ time for Pemex, while doing little to avoid another downgrade by year-end,” Yerlan Syzdykov, the global head of emerging markets at Amundi Asset Management told FT.com.

Casino mulls Latin America revamp French retailer Groupe Casino has unveiled plans to ‘simplify the structure’ of its Latin America business activities. Casino owns wholesale chain Assai, electronics and appliance retailer Via Varejo and retailer Grupo Pao de Acucar (GPA) in Brazil and supermarket chain Grupo Éxito in Colombia, Argentina, Uruguay and Chile.

The restructuring will result in Casino controlling its entire Latin American activities across Brazil, Colombia, Uruguay and Argentina through a 41.4 per cent stake in GPA, which would itself control Éxito and its subsidiaries. As part of the structure, GPA’s shares would be moved to the Novo Mercado stock exchange to comply with stricter governance standards.

Petrobras eyes governance programme exit Petrobras is considering ending its participation in a programme set up by the Sao Paulo stock exchange to certify good governance, according to Reuters. The report claims that the Brazilian state-run oil firm is pushing the possibility of exiting the ‘Distinction in Governance Program for State-Run Firms’, established by exchange operator B3 SA. In a statement to Reuters, Petrobras said its continued participation in the programme would depend on ‘the best interests of the company and its shareholders, always seeking more efficiency without, however, reducing internal controls’. In a security filing, Petrobras also said it would keep investors informed on any decision to exit the governance programme but insisted that any exit would not weaken its corporate governance.

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Peru ex-President arrested in US

A former Peruvian president wanted in connection with one of the biggest corruption scandals in Latin America was arrested in the United States in July. Alejandro Toledo (right) is accused of taking $20million in bribes from the Brazilian construction company Odebrecht during his time in office between 2001 and 2006 in exchange for aid to win public works contracts. As part of a US plea deal, Odebrecht has admitted to paying nearly $800million in bribes to governments across Latin America. Toledo, 73, who was arrested in California, has repeatedly denied any wrongdoing.

Murder charges recommended for Vale execs

The chief financial officer Luciano Siani Pires (pictured) and the former CEO — Fábio Schvartsman — of iron ore miner Vale should be indicted for murder, according to a Brazilian senate committee. A 400-page report by the committee on the deadly dam collapse at the mine in Brumadinho could influence prosecutors in their ongoing probe of Vale and its executives. Nearly 300 people were killed in the dam disaster. The senate committee also recommends the indictment of Vale and dam stability auditor TÜV SÜD for environmental damages and corporate responsibility for actions of their employees. Vale has agreed to pay out £86million in collective moral damages and £150,000 to each of the close relatives of those involved but has argued that it followed all the required safety measures.

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KEEPING IT ABOVE BOARD “Essential reading for boards who want to stay ahead of the governance curve”

Board Leadership • Board Governance • Activism & Engagement Technology • Regulatory & Compliance • Risk Management twitter.com/EthicalBoard

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Technology | ESG

Focussing on ESG How can a board governance software manage ESG programmes efficiently? For global organisations accustomed to focussing on financial performance, it has been interesting to see certain non-financial factors take front stage in the last few years. ESG, which stands for environmental, social, and governance, can include anything from trying to reduce the carbon footprint of an oil manufacturer to making sure the organisation complies with child labour laws and avoiding major class action launched over executive decisions or behaviour. Regardless of the issue being addressed, it has become clear that organisations must report these non-financial factors to shareholders, employees and the general public as well as communicate how their organisation is confronting these global concerns. The challenge for these organisations will be in finding a method to report ESG data efficiently and effectively, across multiple stakeholders, internal and external parties, in a global economy with offices and employees located all over the world.

ESG focus equals greater financial performance

When discussing current ESG practices, it is vital to understand the link between ESG, its integration into the organisation’s overall strategy and how the practices affect the organisation’s financial performance. Multiple studies have shown a positive correlation between an organisation’s financial performance and its commitment to ESG. In other words, those who invest more time and resources in ESG programmes see greater financial improvement. As increasing numbers of organisations understand the link between

136 Ethical Boardroom | Summer 2019

Andrea Ratzenberger

VP of Sales & Marketing, Sherpany ESG and financial performance, they are investing more time and resources in incorporating it into their business strategy. For example, a study of BofA (previously known as Bank of America Merrill Lynch) in 2018 found that companies with better ESG records showed higher three-year returns, were seen as higher quality stocks, and were less likely to have large price declines or to go bankrupt.1 In another study, from Harvard University, researchers found similar results. 2 Additionally, in a KPMG survey of 900 board members and business leaders from 41 countries worldwide, almost half of directors and executives believed that an organisation’s ability to focus on ESG not only contributes to the organisation’s financial performance but also gives them more of a competitive advantage in the industry. 3 They also felt that the expectations of customers, employees, and other stakeholders were a driving force for them to focus on these issues. Overall, there is a general consensus that there is room for improvement in terms of organisational focus on ESG. Encouraging more organisations to make ESG a priority is probably the first step. Increasing numbers of organisations are finding that investing in greater transparency, reporting and collaboration between internal and external parties with stakes in the organisation are intrinsically linked to better long-term financial outlook. Many experts estimate a global increase in the number of organisations looking to focus on ESG, and today the EU requires companies listed in its member states to include non-financial ESG data along with annual reports.4 This is especially the case with consumer goods and

manufacturing industries. 5 Since transparency with these types of data often requires transmitting sensitive documents across multiple regions, parties and platforms, many companies are discovering that non-digital methods of communicating data are neither the most transparent nor the most efficient. Thus, companies are trying to find alternative, digital solutions instead.

Integration of ESG into the long-term business strategy

Beyond performance, however, integration of ESG into the long-term strategy of an organisation was also found to play a key role in their success. This means incorporating ESG into the operations, risk management and business strategy of the organisation and, ultimately, viewing ESG as an integral part of the core business practice.6 “Integration is key,” Harvard Business School Professor George Serafeim told the AVI in an interview. “As sustainability issues are becoming core business issues affecting a company’s competitive positioning, they need to be integrated at the core of the organisation with board oversight.”7 But integration must be combined with an eye towards the long term and ESG issues’ impact on stakeholders. This is especially true for organisations that have a long-term and major impact on the global economy and many stakeholders with a highly vested interest, such as pension funds. And in order for these organisations to properly communicate information about ESG to their stakeholders, executives and boards must properly understand how ESG practices impact the entire organisation, from its operations to its business strategy, and be able to make decisions about these issues – at any given moment, in any region in the

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ESG | Technology

to make the world a better place,â&#x20AC;? explained Rina Kupferschmid-Rojas, head of sustainable finance at UBS Group.8 One of the suggestions to improve integration is to ensure that ESG is made more of a strategic priority in organisations by delegating and clarifying specific roles to focus on these issues along with duties and a way to measure results. In addition, board oversight could be improved by finding a way to track these issues, especially through standardised KPIs and metrics.9 Digital technology, such as board portal software, can be an effective method for executives and boards to track these metrics.

The high stakes of ESG for the board of directors

One of the suggestions to improve integration is to ensure that ESG is made more of a strategic priority in organisations by delegating and clarifying specific roles to focus on these issues along with duties and a way to measure results world. Digital tools can be a transparent, safe, and effective way for them to do so. Realising the importance of these issues, there has been a huge increase in demand for ESG investment options in the last few years. Take UBS Asset Management, the largest wealth management in the world at $2.4billion, where ESG investment options have more than tripled since December 2016, with $17billion in assets under

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management (AUM). These investment options include sustainable funding, which can focus on investing in options centred on a theme, such as global warming, forest restoration or impact investing. Impact investing in particular concentrates on funding organisations that have successfully contributed to an ESG issue while showing financial profit. â&#x20AC;&#x153;Our wealthiest clients want to know their investments are making a difference

Since many investment companies are jumping on the ESG bandwagon, the stakes are high for not just the individual organisations, but for the entire global economic community. For example, in 2006, at the establishment of the UN-backed Principles for Responsible Investment (PRI), 63 investment companies with a net worth of $6.5trillion in assets pledged a commitment to include ESG in their investment decisions. In 2018, however, the number of companies had grown to 1,715 with a net worth of $81.7trillion.10 Financial gain connected to ESG can have massive global benefits and chain reactions. Sine they have a greater understanding now of its contribution to the bottom line, many investors demand to see a commitment to ESG, in addition to tangible reports and data to ensure that their investment decisions are based on the right information.11 For this reason, more than half of the board members in the KPMG survey refer to stakeholder expectations as the biggest motivating factor for focussing on ESG.12

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Technology | ESG “ESG issues have become much more important for us as long-term investors,” Cyrus Taraporevala, president and CEO of State Street Global Advisors, the world’s fifth largest asset manager with $2.8trillion in assets as of 2017, explains. “We seek to analyse material issues such as climate risk, board quality, or cybersecurity in terms of how they impact financial value in a positive or a negative way. That’s the integrative approach we are increasingly taking for all of our investments.”13 Along with the understanding of the high stakes involved comes greater transparency demanded from stakeholders, investors and the board. It is in the interest of organisations to determine not only the type of data to report, but also to select a digital tool, such as an executive governance board software, that will assist them in presenting it to boards, shareholders and investors in the most efficient, unified and transparent way possible.

Digitalisation can help alleviate the board’s challenges of which data to use when taking decisions regarding ESG programmes. It could also support the board in communicating this data in an easy, effective and secure manner, and demonstrate the link between ESG and financial performance whilst also focussing on why it would benefit the organisation for ESG to become an integral part of that organisation’s business strategy.20 With the trend towards greater transparency among stakeholders, employees and management, more automated tools, such as board governance software, are necessary, not only for collaboration between

ever more complex, more automation will be necessary to standardise metrics and reporting, especially in a global economy with teams residing in different geographic regions. A reliable executive and board software for ESG metrics would be particularly useful as these increasingly complex data metrics are communicated to different parties across multiple geographic borders. When a reliable system is set in place to easily communicate such complex information, it can even provide early-warning systems and prevent or mitigate economic crisis, loss in profit and declining trust in the brand.23

The role of the board in supporting ESG programmes

As new issues related to ESG continue to evolve, the role of the board of directors will continue to develop and expand. Experts suggest the role of the board consists of a formal ESG assessment, including identifying risks and opportunities to its long-term business strategy across all areas of the organisation. The board should then become a key player in the communication of issues related to ESG between the organisation and stakeholders, which may entail setting up a committee, a board review, or an individual role, such as a chief sustainability officer or another C-suite executive.14 The board also plays a key role in disseminating that information through ESG reporting, which includes both the type of public disclosure, such as, for example, the company website, as well as setting clear goals, metrics and KPIs to measure ESG progress over time.15 For example, many organisations rely on third-parties for more rigorous measurements of both financial and non-financial data related to ESG, and the board must understand this process as part of its role in overseeing communication with stakeholders. Deciding which information to disclose, as well as under what circumstances, presents both a challenge and an opportunity for boards.16 The challenge is to ensure that management is using the ESG data correctly, and the opportunity is to position it along with the long-term integration into the business strategy.17 One specific example was the case of Royal Dutch Shell, a company that this year had the largest market capitalisation on the FTSE100, whose board decided to link executive pay to the organisation’s ESG goal of lowering its carbon footprint.18, 19 138 Ethical Boardroom | Summer 2019

the different parties but also for the distribution and communication of metrics and KPIs across the organisation.21 Board portal software can also support organisations in being fully compliant with regulations, such as the General Data Protection Regulation (GDPR), and in ensuring data privacy not only between various board members but between different geographic regions as well. Since ESG information is often vague and delivered in the form of spreadsheets or digital platforms that are focussed on a specific topic, such as carbon emissions, supply chain or customer retention, it is not often in a digestible format for the organisation to understand and link to performance. If organisations put a priority on their executive and board software replacing these internal systems and including ESG data, it would put a force in motion to mainstream ESG in many organisations. These ESG metrics would also go hand in hand with third-party standardised metrics.22 An organisation, such as Shell, would greatly benefit from being able to integrate internal metrics with ESG and communicate it to multiple parties to provide a baseline with which to pay their executives. As these organisations and their internal, external and ESG data increase and become

Leveraging ESG as both a challenge and an opportunity

Organisational focus on ESG will only gain more attention in the years to come. Reasons for this include the enticement of improved financial performance, the opportunity to have a greater competitive advantage and the pressure from stakeholders for greater transparency related to ESG issues. Along with this focus on ESG will be a push towards increased standardisation of metrics and KPIs for communicating ESG data across the organisation and to the public sphere. Boards will play a key role in the dissemination of information by deciding which information needs to be collected for ESG reporting and understanding how it impacts the organisation and contributes to its long-term business strategy. They will also ensure that the organisation has the digital tools it needs to make important decisions related to ESG among multiple parties and stakeholders, from anywhere in the world, at a moment’s notice. In a digital era of increasingly complex data, this presents both an immense challenge and opportunity to any organisation that desires to incorporate ESG into its long-term business strategy. Footnotes will be run in full online

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Technology | Board Tools underestimate your service 5 Don’t needs (and read the small print)

I once met a company secretary who was working for a large construction company. He expected his new board portal to be ‘rock-solid’, just like the buildings his company constructs. In his mind, the software he just bought might have taken some time to be built, but once it’s done, it’s done. Unfortunately, software is always under construction: new features are added, underused ones are removed, bugs are fixed and security gaps are closed. And this is done by releasing new software versions at a considerable pace. Facebook, for example, does it weekly. As a result, prepare for an ever-changing product. The board portal that you have today will look different in a couple of months. And this means that you will be relying on your provider’s support and service throughout your contractual relationship. A well-orchestrated first onboarding and training is fine, but you will need more. The less frequently your board meets, the more important this becomes as board members get out of practice. My recommendation is, therefore, to check with your new board portal provider about its release cycle: how often do they make updates? What is its philosophy in this regard? And how will you know and be alerted about the upcoming changes? Also, seek to find out how many trainings are offered with no additional charge and what type of trainings, manuals, tutorials, etc, you are entitled to. The same holds true for support. Every software has flaws, particularly if the release cycles are frequent and testing periods are short. In fact, providers who opt for frequent releases typically hazard the consequences of producing more bugs. These are then fixed ‘on the go’ – as users notice them. Read the small print in your service level agreement. What does it say about response time and criticality of incidents? During the sales process, ask to see some historic metrics that reflect the availability of your new board portal: what is the mean time between service incidents and what is the mean time between failures (reliability)? What is the mean time to repair (maintainability)? Finally, assure yourself that your provider has enough service and support staff. Ask how many accounts a customer success manager has to take care of on average. This will provide you with an idea of the level of responsiveness you can expect from your customer success manager. miss out on getting a clear 6 Don’t picture on security and confidentiality

Data security and confidentiality require the involvement of experts. Get your internal audit and risk people on board early on in the evaluation process. Board portals nowadays have decent security standards. I would 146 Ethical Boardroom | Spring 2018

expect all of them to rely on multiple-factor authentication for logins and to use a state-of-the-art, end-to-end encryption method (i.e. on-server and on-device hardware encryption, TLS (transport layer encryption) and backup encryption). However, there are more questions to be asked: if applicable law and jurisdiction are important to you, ask your board portal provider about server location, the identity, ownership and domicile of their subcontractors, and the location of developers who have access to your data. When it comes to external validation and reporting, go beyond just reading the reports and pay some attention to the reputation and credibility of the external auditors and testers. Related to that, seek to find out whether your contract foresees the commissioning of external audits orchestrated by you and at what cost. Moreover, ask questions about transaction data. Those data include, for example, who logs in and how often, from which type of

update was made to the software. Also, he vehemently opposed any new features or changes in design. At some point, however, his board rejuvenated with different board members joining. To his surprise, the new members requested more, not fewer features. This was a game changer. The company secretary eventually understood that he cannot assume to know his board members’ preferences in advance. My recommendation is thus to look ahead. What features does the current version of your preferred board portal include and what features are in development? Ask to see your provider’s roadmap. That said, upon making your decisions, bear in mind that roadmaps are not always to be trusted. Feature development, testing and release might take more time than expected and don’t necessarily depend on your providers’ efficiency alone. Therefore, if you need a particular feature today, you are well advised to go with a provider who already has it built

MORE EFFECTIVE MEETINGS Boards that go digital cite ease of transparency

device and IP-address, etc. Who owns this data: you or your software provider? And can you get logs of this data? How easily and at what cost? What is the quality of these logs? As a specialist in corporate governance, I can assure you that board work is fully transparent these days. Boards who transition from paper to digital can, at least in theory, provide full transparency over such things as time invested in meeting preparation. Finally, and most importantly ask about key handling and server crypto-control. While your data is (hopefully) encrypted on the servers, the salient question is who has a copy of the key (or ‘password’) to decrypt the data? Server crypto-control can be led by the provider, by you or by no one. If a zeroknowledge protocol is used for encryption, you can trust that no unauthorised person has access to your data and board materials. get stuck in short-termism 7 Don’t I remember a company secretary who

was extremely annoyed every time an

in. If not, try to find out about the stage of development of that feature: is it already specified? In production? Already being tested? Is there a release date in sight? In addition, in looking ahead, plan for exit in case you decide to opt for a different solution. Make sure you know what will happen to your data, post-exit, and whether you can get your board materials extracted to some external hardware. What are the costs of this process? How efficiently can this data be uploaded into a new tool? Last but not least, once you have made all your choices and have wholeheartedly opted for your preferred board portal provider, bear in mind that most observers expect the market to consolidate in the near future. Smaller providers might not achieve growth and may disappear altogether while your provider of choice might eventually be acquired by a bigger competitor. What’s your plan B? Global Board Portal Market: Trends & Opportunities (2016 Edition) 2Market Guide for Board Portals – Gartner 2014