6 Corporate Governance

Question 1

Corporate governance

Answer 1

The system by which companies are directed and controlled.

Corporate governance should ensure that all stakeholders’ needs are met.

Question 2

Corporate governance code 2018

Answer 2

The FRC released a revised UK Corporate Governance Code in July 2018. Designed to be ‘shorter and sharper’, it has an increased focus on workforce and stakeholder engagement, culture, succession and diversity and remuneration.
The listing rules require that from 28 September 2018, all UK listed companies (including AIM listed companies) need to report on how they comply with the code and their reasons for any departure from the code.

Question 3

Principles of corporate governance

Answer 3

 Responsibility – the leaders of a company should accept responsibility for acting in the best interests of the company so as to achieve the company’s objectives.
 Accountability – The board of directors should be fully accountable to the company’s shareholders (and other stakeholders). Within the company, executive management should be properly accountable to the board of directors.
 Integrity and honesty – Companies should operate in a way that displays fairness and honesty in their dealings. Good corporate governance has a strong ethical element.
 Transparency – Through reporting or other methods of communication companies should be open and transparent about their policies and objectives, as well as past performance.

Question 4

Elements of effective corporate governance

Answer 4

 An effective Board
 Accountability to stakeholders though financial reporting, other reporting and the AGM
 Effective risk management
 Appropriate remuneration for directors and management
 Good relationships with stakeholders
 Ethical conduct, including corporate social responsibility and sustainability

Question 5

Composition of the Board

Answer 5

A Board of directors should be made up of a diverse mix of people and should have a balance of executive and non-executive directors.

The Chairman leads the Board and the Chief Executive Officer (CEO) leads the executive directors.

These roles should not both be held by one individual, as this would give them unfettered decision making powers.

Question 6

Non-executive directors
Non-executive directors have the same legal duties, responsibilities and potential liabilities as executive directors, even though they are not expected to give the same continuous attention to the company’s business.

The main functions of non-executive directors are:

Answer 6

 To bring external experience and knowledge to the Board
 To constructively challenge the strategy of the business
 To monitor financial and other reporting
 To ensure a robust system of internal control
 To decide upon an appropriate level of remuneration for executive directors

Question 7

Sub-committees
Many company boards establish a number of board committees with responsibility for supervising specific aspects of governance. A committee system does not absolve the main board of its responsibilities for the areas covered by the board committees.

Four types of sub-committee are:

Answer 7

Nomination Committee
Audit committee
Risk committee
Remuneration committee

Question 8

Nomination committee - what does it do?

Answer 8

The nomination committee exists to ensure that the Board of directors has the right balance of executive and non-executive directors with the appropriate skills, knowledge and experience.

It will recommend new appointments to the Board as appropriate.

Question 9

Audit committee - What does it do?

Answer 9

The audit committee is responsible for:
 liaising with the external auditors and monitoring auditor independence and objectivity
 monitoring the external audit and reviewing the financial statements
 Recommending appointment and removal of the external auditors and fixing their remuneration
 monitoring the effectiveness of the internal control system and risk management system
 supervising the internal audit function (or if there is no internal audit function, considering each year the need for one)

Question 10

Risk Committee - What does it do?

Answer 10

Responsible for overseeing the organisation’s risk management systems.

It is not a compulsory committee under most governance regimes.

However, listed companies that are subject to significant financial market risk (such as banks) will usually have a risk committee. This committee should be comprised entirely of non-executive directors.

Question 11

Remuneration committee - what does it do?

Answer 11

The remuneration committee is responsible for setting the remuneration for all executive directors and, usually, senior management. An element of executives’ pay should be performance related.

The remuneration of non-executive directors should be determined in accordance with the Articles of Association or, alternatively, by the board. Levels of remuneration for the chair and all non-executive directors should reflect the time commitment and responsibilities of the role.

Remuneration for non-executive directors should not include share options or other performance-related elements.

Question 12

Companies Act
The Companies Act sets out seven statutory duties of directors which have relevance to corporate governance and so are listed below. These duties apply to NEDs as well as executive directors.

Answer 12

 Act within their powers
 Promote the success of the company
 Exercise independent judgement
 Exercise reasonable skill, care and diligence
 Avoid conflicts of interest
 Disclose interests in transactions with the company
 Not accept benefits from third parties

Question 13

Fraud Act
In the UK, the Fraud Act defines three classes of fraud:

Answer 13

 Fraud by false representation
 Fraud by failing to disclose information
 Fraud by abuse of position

An offence has occurred in any of these classes if a person has acted dishonestly and with the intent of making a gain for themselves or for someone else, or of inflicting a loss on someone else

Question 14

Bribery Act
The key points of the UK Bribery Act 2010 are as follows:

Answer 14

 Bribery is an intention to encourage or induce improper performance by any person, in breach of any duty or expectation of trust or impartiality.
 Bribery may amount to an offence for the giver (‘active bribery’) and the receiver (‘passive bribery’).
 Improper performance will be judged in accordance with what a reasonable person in the UK would expect (irrespective of whether the activity took place in the UK).

Question 15

Insider dealing

Answer 15

Insider dealing is a criminal offence. Essentially, insider dealing involves using confidential (undisclosed) information about a company to deal in a company’s shares (or to encourage someone else to deal in a company’s shares) for financial benefit

Question 16

Money Laundering Regulations and the Proceeds of Crime Act
Money laundering is a process where the perpetrator attempts to legitimise the proceeds of any
crime.
Offences include:

Answer 16

 Concealing, disguising, converting, transferring or removing from the jurisdiction any property which is the proceeds of crime which the person knows or suspects represents the proceeds of crime.
 Entering into or becoming concerned in an arrangement which he knows or suspects will facilitate another person to acquire, retain, use or control criminal property and the person knows or suspects that the property is criminal property.
 Acquiring, using or having possession of property which is known or suspected to represent the proceeds of crime.

Question 17

Contract law
Where a party does not perform its contractual obligation sufficiently, it is said to be in breach of contract, unless the contract has been discharged by frustration or it has some other lawful excuse. A lawful excuse may apply in the following circumstances:

Answer 17

 Where they have tendered performance but this has been rejected
 Where the other party has made it impossible for them to perform
 Where the parties have by agreement permitted non-performance

Question 18

Negligence
To succeed in an action for negligence, the burden of proof is on the claimant to prove, on a balance of probabilities, that:

Answer 18

 The defendant owed a duty of care to the claimant to avoid causing injury, damage or loss
 There was a breach of that duty by the defendant
 In consequence the claimant suffered injury, damage or loss

Question 19

Data protection
The EU General Data Protection Regulations (GDPR) – or the Data Protection Act (2018) in the UK –
controls how personal data is used by organisations, and requires them to ensure that data is kept secure, accurate and up to date. (Personal data is any data or information that can be used to identify a person, including their name, address, date of birth, or email address.)

The Act notes that everyone responsible for using personal data has to follow strict data protection principles, and must ensure the information is:

Answer 19

 Used fairly, lawfully and transparently
 Used for specified, explicit purposes
 Used in a way that is adequate, relevant and limited to only what is necessary
 Accurate and, where necessary, kept up to date
 Kept for no longer than is necessary
 Handled in a way that ensures appropriate security, including protection against unlawful or unauthorised processing, access, loss, destruction or damage

Question 20

The principles of GDPR are:

Answer 20

 Consent must be given – Organisations may not process personal data unless they have been given specific consent to do so by the individual whose data is being processed.

 The right to be informed – Individuals must be informed before data is gathered. Customers must consent for their data to be gathered, and consent must be specifically given rather than implied.

 The right to be forgotten – If an individual stops being a customer of an organisation, or withdraws their consent, they have the right to have their data deleted.

 The right to access – Individuals have the right to request access to their personal data and to know how it is being used. The company must provide a copy of the data, free of charge, if requested.

 The right to have information corrected – Individuals can have their data updated if it is out of date, or incorrect in any way.

 The right to object – Individuals have a right to stop their data being processed and used for direct marketing. There are no exemptions to this rule, and any processing must stop as soon as the request is received.

 The right to be notified – If an organisation suffers a data breach which compromises an individual’s personal data, the individual should be informed directly and without undue delay; at most within 72 hours of the organisation becoming aware of the breach.

Non-compliance with GDPR may result in very significant penalties.

Question 21

Remuneration Committee - who should it consist of?

Answer 21

The remuneration committee should consist of at least three non-executive directors and no executive directors.

Question 22

Audit Committee - who should it consist of?

Answer 22

The audit committee should consist of at least three non-executive directors, at least one of which has recent, relevant financial experience, and no executive directors.

Question 23

Nomination Committee - who should it consist of?

Answer 23

This committee should be composed of a majority of independent non-executive directors and will recommend new appointments to the Board as appropriate