Tag Archives: King IV

CONFLICT OF INTEREST


All corporate board members have fiduciary duties and a duty of loyalty (care and skill) to the corporations they oversee. If one of the directors chooses to take action that benefits them at the detriment of the firm, they are harming the company with a conflict of interest.

A conflict of interest involves a person or entity that has two relationships competing with each other for the person’s loyalty, such that serving one interest results in working against the other interest. The person’s vested interests raise a question of whether their actions, judgment, and/or decision-making can be unbiased. In a conflict of interest a director chooses personal gain over duties to the organization in which they are a director, or exploits their position for personal gain in some way.

Directors need to manage conflict of interests as these can lead to the transactions and decisions being nullified. It may even lead to prosecution.

Some conflict of interest is fundamental ad pervasive and therefore has to be avoided by a resignation e.g. if a director holds significant shares in a competitor, the conflict of interests will persist making his duty impossible. In that case the a director decides whether to dispose of the equity or to resign form the Board.

In some cases the conflict is temporal and so can be managed. For example if a director holds shares in a company bidding for a once off contract, the director can manage the conflict of interest by declaring his interest and recusing himself from the decision- making process for this contract.

Within the Companies Act (2008) Section 75 there are some specific conflict of interest situations which must be addressed and managed in accordance to the Act. A director must be knowledgeable of these situations and manage himself accordingly.

A conflict of interest must be declared when the matter comes up on the Agenda. The affected directors should make a full disclosure and contribute to the matter without lobbying. Immediately after that he should leave the meeting that will deliberate on the matter.

Some people erroneously believe that by simply declaring the interest they have fulfilled the obligation to manage the conflict of interest. I was once acquainted with an organization in which most of the service contracts awarded by the Company were to the Group CEO’s siblings. The belief in the organization was that since the GCEO had informed everyone of the interest, then everything was okay.

Some conflict of interest matters may not be material enough to be a problem statutorily but they may case a perception challenge that can damage the company’s reputation. For example if an executive director disposes shares that he owned just before a massive loss of stock prize based on an options contract that was due, this may be legitimate but it still cases reputational risks. A disinterested observer would be concerned.

Directors have a fiduciary responsibility to disclose conflicts of interest and to act with unfettered discretion. Where directors breach this duty they stand to attract civil and criminal sanction. Conflicts of interest have the potential to damage the company as any board decision taken in which a director has an undisclosed personal financial interest is void.

The Business Judgement rule


Business Judgement Rule

The key legal roles as discussed in the previous post of the governing body consist primarily of the fiduciary duty and the duty of care and skill towards the company. We stated that if a director fails on this duty, she may be prosecuted.

The South African Companies Act Ch 71 of 2008 introduced a way of establishing that these duties have been satisfactorily met. This is through the business judgement rule. It recognizes that business by nature is assuming risk in return for reward. Consequently some risk undertaken will not be controllable resulting in failure. Directors cannot be judged negligent simply because the desired strategy or goal failed. They should be judged instead based on the process followed in making the decision. That is the essence of the business judgement rule.

It is a two edged sword in that if complied with, it provides protection to directors BUT if violated it becomes basis of litigation against the directors.

In terms of the Act in Section 76 (4) a director is considered to have complied with the duty of care and skill if he satisfies the following:

“(a) will have satisfied the obligations of subsection (3) (b) and (c) if—

(i) the director has taken reasonably diligent steps to become informed about the matter; (Directors have a responsibility to seek and get information from management and not simply and passively rely on board packs. They make decisions based on being fully informed. The diligence to pursue information is the responsibility of the director. In my view it’s better to not make a decisions if information is inadequate. This also requires Directors to study the Board pack in time and get any required information before the Board meeting. By the time of the Board meeting, the director should have taken “diligent steps to become informed”.

(ii) either—

(aa) the director had no material personal financial interest in the subject matter of the decision, and had no reasonable basis to know that any related person had a personal financial interest in the matter; ( The emphasis is to avoid a conflict of interest both personally and in terms of the director’s relationships. Some corporate governance experts insist that the director should find a way to satisfy the aspect of relatives not having a personal financial interest before the Board meeting as well. King IV deals with conflict of interest in the broader sense rather than the narrower sense used by the State here. It’s prudent for directors to work at the higher standard of the King IV Code. We shall discuss the issue of Conflict of Interest in a separate post later )

(bb) the director complied with the requirements of section 75 with respect to any

interest contemplated in subparagraph (aa); and

(b) is entitled to rely on—

(iii) the director made a decision, or supported the decision of a committee or the board, with regard to that matter, and the director had a rational basis for believing, and did believe, that the decision was in the best interests of the company;  (“The minutes of the meeting must also reflect the material points of the discussion that took place and explain why the decision was taken. These minutes must reflect an accurate view of the discussion at the time rather than simply being a justification for the decisions taken. It is also not sufficient to merely record the outcome, without the rationale for the decision being documented. Directors also have an important responsibility to ensure that minutes of meetings appropriately capture the discussions and points of view of both the board and individual directors. Where directors dissent, this should also be recorded.” Source: CGN Guidance Note on Business Judgement Rule.} and

(i) the performance by any of the persons—

(aa) referred to in subsection (5); or

(bb) to whom the board may reasonably have delegated, formally or informally by

course of conduct, the authority or duty to perform one or more of the board’s

functions that are delegable under applicable law; and

(ii) any information, opinions, recommendations, reports or statements, including financial statements and other financial data, prepared or presented by any of the persons specified in subsection (5).

(5) To the extent contemplated in subsection (4) (b), a director is entitled to rely on—

(a) one or more employees of the company whom the director reasonably believes to be reliable and competent in the functions performed or the information, opinions, reports or statements provided;

(b) legal counsel, accountants, or other professional persons retained by the company, the board or a committee as to matters involving skills or expertise that the director reasonably believes are matters—

(i) within the particular person’s professional or expert competence; or

(ii) as to which the particular person merits confidence; or

(c) a committee of the board of which the director is not a member, unless the director has reason to believe that the actions of the committee do not merit confidence.”

The IoDSA CGN Guidance note on the Business Judgement Rule provides clarification on the matter of reliance on other persons or committees as follows:

“In considering what information to rely on, directors should consider both the quality and relevance of the information. The quality of the information refers to the robustness of the process that the information goes through before it reaches the board and speaks to its credibility. The relevance of the information refers to what information was considered necessary to present to the board and what the process was of determining what information was relevant to the board’s decision and what was not. Where directors discover inconsistencies in the information presented to them, the directors have a responsibility to probe these inconsistencies and obtain appropriate answers and explanations. These inconsistencies may also be indicative of a lack of an appropriate process to ensure that directors receive the relevant information which is of a high quality.”

The Board can delegate wok but cannot delegate accountability and responsibility for its decisions. I remember having to vote against the recommendations of one of the Board committees because I was not comfortable with it. It is however unusual to go against the recommendations of a committee unless there are significant gaps in the way it handled the matter. My point here is mainly that the directors have finally accountability for approving recommendations and so cannot claim they were simply going on the basis of expert opinion. The expert can also be wrong.

ethical and effective corporate leadership


Now having dispensed with those formalities let us continue looking at the definition.

“Corporate Governance -is the exercise of ethical and effective leadership by the governing body towards achievement of the following governance outcomes: ethical culture, good performance, effective control and legitimacy.” King IV Report.

The Governing Body is expected to exercise ethical and effective leadership.

Effective leadership is seen as leadership that adequately accomplishes the desired outcomes and performance with minimum expenditure of time, resources, waste and effort. A governing body has exercised effective leadership when it has achieved the strategic goals cost effectively, and timeously. That is why Boards are responsible and accountable for corporate performance. The governing Board is supposed to be results-driven. The organization has to create and maintain value to all stakeholders. It is the responsibility of the governing body to ensure that value is created and not destroyed through the policies and strategies that the organization adopts. We will take a closer look at Board responsibilities to the organization in a later blog.

I have observed that often Boards will take the credit for great performance and yet blame management for poor performance.

Leadership requires taking responsibility of both successes and failures.

Indeed there are management systems that try to frustrate the Board by giving it misleading information or through powerful CEO who intimidate the Board.

The fact is that a Board which has no control over the management is a poor and ineffective Board. It is used only to rubber stamp decisions made elsewhere.

I once sat on a Board of an NGO where management reported primarily to parallel internal Executive Committee structures led by the Group CEO. Because of those parallel and non accountable structures the Board could not assert its control, and direction on the management. This is very unwise because the legal liability rests with that Board. The net result was consistent strategy and financial underperformance. In hindsight the Board should have asserted itself or if it could not, it should have gracefully considered resigning. It is critical in corporate governance that the Board has effective control of the direction of the organization so that it is accountable for the organization.

Whenever you have one party being in control and another being accountable for what they do not control and direct, you have a recipe for corporate disaster.

Ethical leadership of the governing Board primarily implies that the governing Body is responsible for creating an atmosphere and culture within the organization that favors ethical behavior.

According to King IV ethical corporate leadership is characterized by integrity, competence, responsibility, accountability, fairness and transparency.

If there is rot in the organization that persists, the responsibility lies with the governing body. Full stop.

Most corporate governing bodies operate like some governments where one observes significant levels of corruption and yet the President makes noise about the corruption without holding the responsible ministers and technocrats to account. That is irresponsible.

One reason that governing bodies often wink at unethical behavior maybe that they are mesmerized by the supposedly good performance of executives or that they are too nice to hold people to account. I have discovered that one does not sit on a governing body for purposes of being liked. It’s not a beauty contest or popularity contest. A board member has a duty of care to the organization. If he proves negligent in this duty, he can attract criminal/civil censure.

While a governing body can delegate execution, it cannot relegate its responsibility or delegate its accountability.

We live in an era of radical transparency where any corporate mistake will be flighted on social media and the reputation of the organization destroyed within hours. It is therefore important for the governing body to be transparent and fair in its dealings with all stakeholders. There is also increased stakeholder activism to contend with.

Suffice to say that it is important that the governing body takes control of the ethical and effective leadership of the organizations. No excuses!