First published in March 2003
This edition of INSURANCE & REINSURANCE concentrates on the rapidly changing D&O landscape. A series of spectacular bankruptcies in the USA following in the wake of the collapse of Enron, and the notorious Sarbanes-Oxley Act have turned this market on its head. In the UK there has been considerable corporate governance activity, the Financial Services &Markets Act 2000 is making itself felt, a new Companies Act is in the pipeline added to which the EPL field has seen some colossal awards.
Introduction óthe current governance landscape
The Combined Code ("the Code ") is the key source of guidance in respect of corporate governance for UK listed companies.
There is no direct legal sanction for failure to comply with its provisions. The approach taken is "comply or explain". All quoted companies must in their annual reports give a "disclosure statement "in relation to their compliance with the Code.
The disclosure statement must include:
An explanation of how the company has complied with the broad principles of the Code;
Confirmation of whether the company has complied with the specific provisions of the Code, specifying which provisions have not been complied with reasons.
In this way, investors and underwriters may see the extent to which a company has effective corporate governance procedures. Institutional shareholders have a well developed understanding of governance issues and scrutinise disclosure statements in deciding where to place their funds. We now assess the changes to the Code that are proposed, together with the wider recommendations of three recent governance reports.
Changes In The Way UK Companies Will Be Run -
What Are The Main Considerations For The D&O Market?
Article by Ed Smerdon
In January 2003,three reports were published which, when implemented, will have a major impact upon UK corporate governance.
Mr Derek Higgs has released his report on the role and effectiveness of non- executive directors ("NEDs "),whilst a group appointed by the Financial Reporting Council ("FRC")and chaired by Sir Robert Smith reported in relation to audit committees. The Smith report emanated from a recommendation in the interim report of the Coordinating Group on Audit and Accounting Issues ("CGAAI"),whose Final Report was the third governance-related report of January 2003.
The reports have been endorsed by the Government and the changes they propose to the Combined Code are scheduled for early summer, once the FRC has consulted on the precise wording, ready for implementation by companies with accounting periods beginning on 1 July 2003.
NEDs are part time employees of the company who attend board meetings and sit on board committees (audit, remuneration and nomination).They have no day-to-day role in the company, but have traditionally added variety to the board's expertise, and, since Cadbury, played an increased role in the governance and internal safeguards of the company. It is established law (and there are no proposals for change)that the same standard of care is applicable to NEDs as to their executive counterparts. Higgs talks in the introduction to is report of the "important" role of NEDs being "largely invisible and poorly understood", but he rejects the option of legislation, in favour of changes to the Code. In some areas he advocates tightening existing rules, and in others, entirely new rules are proposed.
His report has made recommendations in the following areas:
1 Board composition óat least half of the members of the board (excluding the Chairman)should be independent NEDs. This is a substantial change from the existing Code, which provides that only a third need be NEDs (with only a majority being independent).
2 Role of NEDs óa description of the role of the NED should be incorporated into the Code for the first time. Their objectives will be to:
contribute to strategy;
monitor the performance of the executive management;
assess financial controls and risk management; and
contribute to the appointment/ removal of executive management, and determine their remuneration.
In addition, the Code should provide:
prior to appointment, NEDs should carry out due diligence on the company to ensure they have the knowledge, skills and experience necessary;
NEDs should have a strong command of all issues affecting the business on an ongoing basis;
the NEDs should meet at least once a year without the Chairman and executives present.
3 Independence of NEDs óa tighter definition of independence than is contained in the existing Code is proposed, as follows:
A NED is considered independent when the board determines that the director is independent in character and judgment, and there are no relationships or circumstances which could affect, or appear to affect, he director's judgment.
as to how the test will be applied in practice, Higgs provides illustrations of relationships which would not meet the test of independence;
the Code should expressly state that all directors must take decisions objectively in the interests of the company;
not all NEDs will have to be independent but the annual report must disclose which ones are;
a senior independent NED should be appointed who meets the test of independence and is available to shareholders where concerns have not been resolved via the usual channels of the Chairman or Chief Executive.
4 Chairman and Chief Executive óthe Code already discourages the combining of these two roles in one person. Only 10%of listed companies still adopt this practice. Higgs goes further in recommending:
these roles should always be separate, and defined in a written document approved by the board;
the Chairman should meet the test of independence.
5 Appointment and training ósteps are to be taken to broaden the pool of NEDs available and from wider walks of life.
on appointment, NEDs should receive a letter setting out what is expected of them;
a comprehensive induction programme should be provided;
the performance of the whole board should be assessed and described in the annual report.
6 Tenure and time commitment óthe Code currently does not provide any guidance in this controversial area. Higgs proposes new principles, as follows:
a NED should be expected to serve two three-year terms, exceptionally longer;
on appointment, NEDs should confirm they will have sufficient time to meet their obligations. If a NED is offered a post elsewhere the chairman should...