Corporate governance

Practical Law UK Legal Update 2-101-9149 (Approx. 6 pages)

Corporate governance

Higgs review

The independent review of the role and effectiveness of non-executive directors led by Derek Higgs was launched in April 2002 and a public consultation paper was published in June 2002. The final Higgs review published on 20 January 2003 proposes significant revisions to the Combined Code and also makes non–Code recommendations. The proposals include the following:

The board

It is proposed that the Code include a statement of principle that the board is collectively responsible for promoting the success of the company by leading and directing the company’s affairs, as well as a more detailed provision on the role of the board.
The number of meetings of the board and of its main committees should be stated in the annual report, together with the attendance of individual directors. A description should be included in the annual report of how the board operates.
The board should be of an appropriate size. At least half the members of the board, excluding the chairman, should be independent non-executive directors. To ensure that power and information are not concentrated in one or two individuals, there should also be a strong executive representation on the board.

The chairman

The roles of chairman and chief executive should be separated and the division of responsibilities between the chairman and chief executive set out in writing and agreed by the board.
A chief executive should not become chairman of the same company. At the time of appointment the chairman should meet the test of independence to be set out in the Code (see below).

Role of the non-executive director

A description of the role of the non-executive director is proposed for incorporation into the Code.
The non-executive directors should meet as a group at least once a year without the chairman or executive directors present and the annual report should include a statement on whether such meetings have occurred.
Prior to appointment, potential new non-executive directors should carry out due diligence on the board and company to satisfy themselves that they have the knowledge, skills, experience and time to make a positive contribution to the board.

The senior independent director

A senior independent director should be identified. The senior independent director should be available to shareholders, if they have concerns that have not been resolved through the normal channels of contact with the chairman or chief executive. The senior independent director should also chair meetings between non-executive directors where the chairman does not attend.

Independence

It should be a provision of the Code that all directors have to take decisions objectively in the interests of the company.
A definition of independence is proposed for incorporation into the Code. Briefly, a non-executive director is to be considered independent when the board determines that the director is independent in character and judgement and there are no relationships or circumstances which could affect, or appear to affect, the director’s judgement.
The board should identify in its annual report the non-executive directors it determines to be independent, and should state its reasons if a director is considered to be independent notwithstanding the existence of relationships or circumstances which may appear relevant to its determination.

Recruitment and appointment

There should be a nomination committee of the board to conduct the process for board appointments and make recommendations to the board.
The nomination committee should consist of a majority of independent non-executive directors. It may include the chairman of the board, but should be chaired by an independent non-executive director. A statement should be made in the annual report setting out the composition, terms of reference, and activities of the nomination committee and the process used for appointments.
The nomination committee should evaluate the balance of skills, knowledge and experience of the board and prepare a description of the role and capabilities required for a particular appointment.
On appointment, non-executive directors should receive a letter setting out what is expected of them.
The nomination committee should provide support to the board on succession planning.
The board should set out to shareholders why they believe an individual should be appointed to a non-executive role and how they meet the requirements of the role.
In addition, non-Code recommendations are made to broaden the pool of candidates for non-executive director appointments, including more executive director and senior executives from other companies and directors of private companies, as well as advisers and those from other backgrounds.

Induction and professional development

A comprehensive induction programme should be provided to new non-executive directors and is the responsibility of the chairman.
The chairman should address the developmental needs of the board as a whole with a view to enhancing its effectiveness. Resources should be provided for developing and refreshing the knowledge and skills of directors.
The performance of the board, its committees and individual members, should be evaluated at least once a year. The annual report should state whether such reviews are taking place and how they are conducted.
Supported by the company secretary, the chairman should assess what information is required by the board. The executive directors should assemble it and be ready to validate its accuracy, reliability and compliance with laws and standards. Non-executive directors should satisfy themselves that they have appropriate information of sufficient quality to make sound judgements, and should not hesitate in seeking clarification or amplification where necessary.
The company secretary should be accountable to the board as a whole, through the chairman, on all governance matters, and both the appointment and removal of the company secretary are a matter for the board.

Tenure and time commitment

A non-executive director should normally be expected to serve two three-year terms, although a longer term will exceptionally be appropriate.
On appointment, non-executive directors should undertake that they will have sufficient time to meet what is expected of them, taking into account their other commitments. If a non-executive director is offered appointments elsewhere, the chairman should be informed before any new appointment is accepted.
The nomination committee should annually review the time required of non-executive directors. The performance evaluation should assess whether non-executives are devoting enough time to fulfil their duties.
A full time executive director should not take on more than one non-executive directorship, nor become chairman, of a major company. No individual should chair the board of more than one major company.

Remuneration

The remuneration of a non-executive director should reflect the time and responsibilities of the role.
Remuneration for non-executive directors in share options should be avoided.

Resignation

Where a non-executive has concerns about the way in which a company is being run or about a course of action proposed by the board, these should be raised with the chairman and their fellow directors. Non-executive directors should ensure their concerns are recorded in the minutes of the board meetings if they cannot be resolved.
On resignation, a non-executive director should inform the chairman in writing, for circulation to the board, of the reasons for the resignation.

Remuneration committee

The remuneration committee should comprise at least three members, all of whom should be independent non-executive directors. It should have published terms of reference.
The remuneration committee should have delegated responsibility for setting remuneration for all executive directors and the chairman. The committee should also set the level and structure of compensation for senior executives. The committee should be responsible for appointing remuneration consultants.
No non-executive director should sit on all three principal board committees (audit, nomination and remuneration) simultaneously.

Liability

Companies should provide appropriate directors’ and officers’ insurance and supply details of their insurance cover to potential non-executive directors before they are appointed.
The Review notes that the City of London Law Society and the Institute of Chartered Secretaries and Administrators (ICSA), together with the Association of British Insurers (ABI) and the British Insurance Brokers Association (BIBA), have agreed to draw up guidance for directors for companies to use in obtaining appropriate directors’ and officers’ insurance.
Guidance is provided for incorporation into the Code on the position of a non-executive director, which it is intended that Courts may consider relevant to a determination of liability.
In addition the Review includes a non-Code recommendation that a company should be able to indemnify directors in advance against the reasonable cost of defending proceedings from the company itself, without trying to establish in advance the prospects of success of the case. The director should then be bound to repay the costs if they lose.

Relationships with shareholders

All non-executive directors, and in particular chairmen of the principal board committees, should attend the Annual General Meeting to discuss issues that are raised in relation to their role.
The senior independent director should attend sufficient of the regular meetings of management with a range of major shareholders to develop a balanced understanding of the themes, issues and concerns of shareholders. The senior independent director should communicate those views to the non-executive directors and, as appropriate, to the board as a whole.
Boards should recognise that non-executive directors may find it instructive to attend meetings with major investors from time to time and should be able to do so if they choose. Moreover, non-executive directors should expect to attend such meetings if requested by major investors in the company.
On appointment, meetings should be arranged for non-executive directors with major investors, as part of the induction process.
A company should state what steps it has taken to ensure that the members of the board, and in particular the non-executive directors, develop a balanced understanding of the views of major investors.
Institutional shareholders should attend AGMs where practicable. The Review endorses the Government’s approach to more active engagement by institutional shareholders with the companies in which they invest, and the ISC’s code of activism.

Smaller listed companies

The recommendation that no one individual should sit on all three principal board committees at the same time should not apply to smaller listed companies. With this exception, there should be no differentiation in the Code’s provisions for smaller and larger companies.

Smith report

The Financial Reporting Committee (FRC) set up an independent group to clarify the role and responsibilities of audit committees and to develop the existing Combined Code guidance in 2002. Changes to the Combined Code proposed in the Smith report include the following:

Composition of the audit committee

The committee should include at least three members, all independent non-executive directors.
At least one member should have significant, recent and relevant financial experience, and suitable training should be provided to all.

Role of the audit committee

To monitor the integrity of the financial statements of the company, reviewing significant financial reporting judgements.
To review the company’s internal financial control system and, unless expressly addressed by a separate risk committee or by the board itself, risk management systems.
To monitor and review the effectiveness of the company’s internal audit function.
To make recommendations to the board in relation to the external auditor’s appointment; in the event of the board’s rejecting the recommendation, the committee and the board should explain their respective positions in the annual report.
To monitor and review the external auditor’s independence, objectivity and effectiveness, taking into consideration relevant UK professional and regulatory requirements.
To develop and implement policy on the engagement of the external auditor to supply non-audit services, taking into account relevant ethical guidance regarding the provision of non-audit services by the external audit firm.

Resources

The committee should be provided with sufficient resources to undertake its duties.

Reporting to shareholders

The audit committee's activities should be reported in a separate section of the directors’ report (within the annual report).
The chairman of the committee should be present to answer questions at the AGM.

The two reports propose a consolidated revised Combined Code on Corporate Governance. Listed companies are required by the Listing Rules to comply with the Code or to explain in their annual reports why they have not done so. The FRC keeps the Combined Code under review and decides on changes to the Code. The FRC requests comments on the consolidated revised Code by 14 April 2003 (the FRC does not intend to re-open the substance of the recommendations and only seeks comments on fatal flaws in the proposals or specific drafting matters). The new Code is expected to come into effect on 1 July 2003.

End of Document

Also Found In

Resource ID 2-101-9149

Law stated as at 20-Jan-2003

Resource Type Legal update: archive

Jurisdiction

United Kingdom