A New Era In Corporate Governance

Included among the plethora of recent outputs is the United States Sarbanes-Oxley Act of 2002, and the United Kingdom’s January 2003 Higgs’ Report of the role and effectiveness of non-executive directors. And, most recently, the Australian Stock Exchange (ASX) has adopted new corporate governance guidelines following the March 2003 report by the ASX Corporate Governance Council on principles of good corporate governance and best practice recommendations.
The question now, is what should New Zealand do? To stimulate the debate, there have already been number of reports published here by various bodies. Our Securities Commission has published its statement, and the Institute of Chartered Accountants of New Zealand has issued paper. And, most recently, the New Zealand Stock Exchange released its final recommendations for corporate governance, which include listing rule changes with provisions around the minimum number of “independent” directors, separation of chief executive and chairman, director certification, audit committees, and changing the external auditor or lead partner every five years. This is accompanied by best practice code, against which an issuer must disclose any material differences between its practices and the code’s recommendations.
New Zealand is now in an opportune, and perhaps slightly unique, position. While the market performance of some entities may be less than stellar, we can still relish the absence of pressure brought to bear by corporate failures of the monumental scale seen overseas. And, in our decision process we can certainly reap the benefits of learning gleaned from the now extensive overseas reports and regulations.

United States Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley legislation currently represents the international high-water mark in terms of compliance structures. Some of its key provisions include:
* Public Company Accounting Oversight Board: new private board to oversee auditors’ activities. To provide audit services, accounting firms must register with the board, and the board will conduct inspections and investigations of accounting firms.
* Auditor Independence: There are revised auditor independence rules. These include further restrictions on the level of non-audit services that can be provided by an audit firm.
* Audit Committees: Audit committees have composition rules (independence and expertise) and an expanded role, including oversight of audit and non-audit services, and procedures for receiving and dealing with complaints.
* Corporate Responsibility: Certifications are required of CEOs and CFOs to accompany public filings. These address the accuracy of the filings and the effectiveness of internal controls implemented for financial reporting and disclosures. Should any accounting restatement be required because of any material non-compliance, the CEO and CFO have to repay any incentive, bonus, equity compensation or profit from the sale of securities they received.
* Enhanced Financial Disclosure: New disclosures include reporting on (and auditors attesting to) internal structures and procedures for financial reporting. Companies are required to disclose codes of ethics that apply to their key executives (or explain why code has not been adopted).
* Accountability and Penalties: Material fines and prison terms (typically up to 20 years) apply for various corporate frauds. And individuals can be barred from serving as director or officer.

The UK’s Higgs’ Report
The United Kingdom’s Higgs’ recommendations take on different flavour, with Higgs himself acknowledging that “the brittleness and rigidity of legislation cannot dictate the behaviour, or foster the trust, I believe is fundamental to the effective unitary board and to superior corporate performance”.
Recommendations include:
* The Board: The board should be of an appropriate size (not so big as to become unwieldy), and at least half its members, excluding the chairman, should be “independent”; but there should also be strong executive representation.
• The Chairman: The chairman should be “independent”, and has pivotal role responsible for leadership, provision of appropriate information to directors, and in overseeing board performance, development and individual directors’ contributions. It is important the roles of chairman and chief executive are separate, and chief executive should not become chairman of the same company.
• Non-Executive Directors: Non-executive directors should meet once year independently of the chairman and executive directors. They must scrutinise performance, financial controls and risk management systems. Non-executives should normally serve two three-year terms.
• Senior Independent Director: senior independent director should be available to shareholders, if the usual channels (chairman or chief executive) do not resolve their concerns.
• Committees: There are three committees – audit, remuneration and nomination. No one director should be on all three committees at the same time.

ASX Governance Guidelines
The Australian Stock Exchange’s corporate governance guidelines outline good corporate governance principles and more detailed best practice recommendations. Typically these are not compulsory, and companies are required to report whether they have followed the guidelines during the financial year – and, if not, why not. Some recommendations include:
• disclosure of functions reserved to the board and those delegated to management;
• the chairman, and the majority of the board, to be independent;
• separation of the roles of chairperson and CEO;
• establishment of nomination, remuneration, and an audit committee (the latter with at least three members, all non-executives, and majority of independents);
• establishment of code of conduct for the directors, the CEO, the CFO and other key executives;
• establishment of policies on risk oversight and management;
• disclosures of share trading policies for directors, officers and employees;
• written statements from the CEO and CFO as to the financial reports, and as to the soundness and operation of internal compliance and controls;
• having the external auditor attend to answer shareholder questions at the AGM; and
• disclosure of processes for performance evaluation of directors and the company’s remuneration policies.

So To New Zealand…
When decisions are being made as to where our next steps should be, it is important to ensure that few fundamentals are reinforced.
First and foremost, corporate governance is about human behaviour. It is about minimising, if not eliminating, behaviours consistent with greed, power, dishonesty and carelessness, and replacing them with honesty, integrity, and ethical leadership.
No amount of regulation prevents those intent on behaving improperly from taking office, and from the innocent suffering. And, while inherent wrongdoers may remain, over-regulation will seriously discourage some of the very people we would wish to see take active governance roles in our capital markets.
Regulation may achieve more transparent system, making it harder for wrongdoers to do wrong. More rigorous systems for identifying wrongdoers, and meaningful disincentives for those culpable may achieve this. But, care must be taken to ensure form-over-substance approach does not prevail.
Corporate governance is an international phenomenon. New Zealand’s position on the world stage needs to be credible. And many of New Zealand’s larger companies are listed in offshore jurisdictions. Any New Zealand proposition, if not adopting offshore requirements, needs to at least be compatible with those requirements.
Finally, corporate governance regulatory regime should not be panacea. It will not stop under-performance and failure, nor take the risk out of investing in capital markets. It should not be designed to protect the patently ignorant or foolish investor. But properly app

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