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Independent state of mind. The case for independent directors on boards.


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Business Day Live recently reported (http://www.businesslive.co.za/bd/companies/financial-services/2018-06-25-psg-to-engage-with-shareholders-after-hefty-opposition-to-its-pay-policy/) that PSG has undertaken to engage with its shareholders after a 32% vote against the implementation of its remuneration report at its annual general meeting.
Concerns about the shortage of independent directors has been cited as one of the reasons for the shareholder opposition.

Why does it matter?

There is no legal distinction between executive and non-executive directors.  All directors have the duty to act in the best interest of the organisation on whose governing body they serve.

The South African Companies Act does not expressly distinguish between executive and non-executive directors, and independent and non-independent directors.  The Companies Act provisions dealing with the appointment, election and composition of the governing body do not provide that there should be independent directors on a company’s governing body, save in specific circumstances (audit committee, social and ethics committee), and in those cases "independence" is based on inter alia the following criteria: that independent directors not be involved in the day-to-day management of the company’s business or have been so involved at any time during the previous financial year; a prescribed officer, or full-time employee, of the company or another related or inter-related company, or have been such an officer or employee at any time during the previous three financial years or a material supplier or customer of the company, such that a reasonable and informed third party would conclude in the circumstances that the integrity, impartiality or objectivity of that director is compromised by that relationship and not be related to any person who falls within any of the aforementioned criteria.

In terms of the JSE’s listing requirements issuers must implement certain specific corporate governance practices and must disclose compliance therewith in their annual reports. One of these specific corporate governance practices is that the chairman must either be an independent non-executive director, or the issuer must appoint a lead independent director, in accordance with the King IV Report.  In addition, the capacity of each director must be categorised as executive, non-executive or independent, using the following as guidelines to determine which category is most applicable to each director:

The requirement of having independent directors on a governing body is found in the King IV Report.

The King IV Report defines "independence " as follows:
Independence generally means the exercise of objective, unfettered judgement. When used as the measure by which to judge the appearance of independence, or to categorise a non-executive member of the governing body or its committees as independent, it means the absence of an interest, position, association or relationship which, when judged from the perspective of a reasonable and informed third party, is likely to influence unduly or cause bias in decision-making.

Principle 7 of the King Report provides that:
The governing body should comprise the appropriate balance of knowledge, skills, experience, diversity and independence for it to discharge its governance role and responsibilities objectively and effectively.
The King IV Report also sets out various recommended practices to be considered in respect of the composition and operation of governing bodies of organisations.

We highlight the following:
The governing body should assume responsibility for its composition by setting the direction and approving the process for it to attain the appropriate balance of knowledge, skills, experience, diversity and independence to objectively and effectively discharge its governance role and responsibilities.
When determining the requisite number of members of the governing body, the appropriate mix of executive, non-executive and independent non-executive members should be considered.
The governing body should comprise a majority of non-executive members, most of whom should be independent.
Subject to legal provisions, each member of the governing body should submit to the governing body a declaration of all financial, economic and other interests held by the member and related parties at least annually, or whenever there are significant changes.
At the beginning of each meeting of the governing body or its committees, all members should be required to declare whether any of them has any conflict of interest in respect of a matter on the agenda. Any such conflicts should be proactively managed as determined by the governing body and subject to legal provisions.
Non-executive members of the governing body may be categorised by the governing body as independent if it includes that there is no interest, position, association or relationship which, when judged from the perspective of a reasonable and informed third party, is likely to influence unduly or cause bias in decision-making in the best interests of the organisation.

The governing body should consider the following and other indicators historically, and on a substance-over-form basis, when assessing the independence of a member of the governing body for purposes of categorisation. The member of the governing body:
is a significant provider of financial capital, or ongoing funding to the organisation: or is an officer, employee or a representative of such provider of financial capital or funding;
if the organisation is a company, participates in a share-based incentive scheme offered by the company;
if the organisation is a company, owns securities in the company, the value of which is material to the personal wealth of the director;
has been in the employ of the organisation as an executive manager during the proceeding three financial years, or is related party to such executive manager;
has been designated external auditor responsible for performing the statutory audit for the organisation, or a key member of the audit team of the external audit firm, during the preceding three financial years;
Is a significant or ongoing professional adviser to the organisation, other than as a member of the governing body;
Is a member of the governing body or the executive management of another organisation which is a related party to the organisation; or
Is entitled to remuneration contingent on the performance of the organisation.
A non-executive member of the governing body may continue to serve, in an independent capacity, for longer than nine years if, upon an assessment by the governing body conducted every year after nine years, it is concluded that the member exercises objective judgment and there is no interest, position, association or relationship which, when judged from the perspective of a reasonable and informed third party, is likely to influence unduly or cause bias in decision-making.
The governing body should appoint an independent non-executive member as the lead to fulfil the following functions:
To lead in the absence of the chair.
To serve as a sounding board for the chair.
To at an intermediary between the chair and other members of the governing body, if necessary.
To deal with shareholders’ concerns where contact through the normal channels has failed to resolve concerns, or where such contact is inappropriate.
To strengthen independence on the governing body if the chair is not an independent non-executive member of the governing body.
To chair discussions and decision-making by the governing body on matters where the chair has a conflict of interest.
To lead the performance appraisal of the chair.                                                  
Whether the chair is considered to be independent.
Whether or not an independent non-executive member of the governing body has been appointed as the lead independent, and the role and responsibilities assigned to the position.


According to the IODSA’s practice note regarding the independence of governing body members, having members of the governing body who are independent in appearance is an essential element in most governance codes, in addition while important, structural independence is but one consideration in achieving balance in the composition of the governing body. 

The value of the inclusion of independent directors on the governing body is widely recognised and practised, but it is also important that stakeholders consider and ask whether the governing body is knowledgeable, skilled, experienced, diverse in addition to being independent enough to discharge its role fully, and to ensure that it is acting in the best interest of the organisation.  This is important, and we caution that all factors should be taken into account, and there should not be an over reliance on one factor.  (As we seen with Steinhoff, amidst all the highly qualified members of the governing body, governance was still at risk.)

It is also important to bear in mind that independence may well also be a state of mind, irrespective of the label.

The following questions should, amongst others, be considered in the composition of a governing body of an organisation, to ensure that the independence of directors is taken into account:
  • Does the board have an appropriate balance of knowledge, skills, experience, diversity and independence for it to discharge its governance role and responsibilities objectively and effectively?
  • is there an over reliance on any one factor?
  • What is the mix of executive, non-executive and independent non-executive members?
  • Does the governing body comprise a majority of non-executive members, most of whom should be independent?
  • Have the non-executive members been categorised?  Have independent members who do not have an interest, position, association or relationship in the organisation been identified which, when judged from the perspective of a reasonable and informed third party, is likely to influence unduly or cause bias in decision-making in the best interests of the organisation?
  • If a non-executive member of the governing body has served for nine years, has his or her independence been re-assessed, based on whether the member exercises objective judgment and there is no interest, position, association or relationship which, when judged from the perspective of a reasonable and informed third party, is likely to influence unduly or cause bias in decision-making?
  • What roles do the independent non-executive members fulfil on the governing body of the organisation?
  • Does the governing body have an independent non-executive member as the lead independent, and what is the role and responsibilities assigned to the position?
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