All articles in Volume 12 Issue 15

Slow pace of board renewal frustrates directors

6 Aug BRR quote

A recent survey reveals that Australian directors are frustrated by the pace of board renewal in the face of changing demographics and business conditions.

The survey, conducted by Heidrick & Struggles and Women Corporate Directors and entitled The board’s hardest task: How to tell under-performing directors “it’s time to go”,  shows that Australia’s male-dominated boards have recognised a need for renewal which could, in turn, open up opportunities for increasing diversity in a range of areas.

However, it notes that some directors may be reluctant to leave for many reasons, including strong relationships with other board members, financial considerations and prestige.

While many of the 145 Australian directors surveyed believed that the competencies of some of their colleagues were no longer relevant to the business or its long-term strategy, 81.3 per cent described their board’s approach to exiting unwanted members as “less than effective”.

The directors also reported that changes in board leadership – board and committee chairmen – occurred infrequently, with 54 per cent of board chairmen rotating “rarely”. And, while 70 per cent of committee chairmen rotated “every few years”, around a third rarely do so.

Most directors (66.2 per cent) liked the idea of imposing term limits for directors. And while a majority (69.1 per cent) were opposed to a mandatory retirement age, almost 65 per cent of those who were in favour felt that the ideal age was somewhere in the range of 70 to 74.

In interviews following the survey, the researchers found the favoured approach to board renewal was a third party review, followed by independent counsel for individual board members.

“An ‘outside’ view allows the chairman to maintain relationships and friendships. The feedback is also an effective development tool, helping boards to become aware of blind spots and improve their overall performance,” the report notes.

More than half of Australian directors surveyed said they were making good progress in terms of increasing gender and ethnic diversity on their boards. The remainder said it could take up to two years to achieve a minimum of 25 per cent diversity.

The report notes that one of the most promising ways to ensure a full pipeline of diverse, board ready candidates lies in companies grooming their outstanding executives for external board service and helping them secure it.

Nearly 70 per cent of Australian companies surveyed say they allow senior executives to serve on outside boards, with most (62.1 per cent) limiting them to one board, 19.5 per cent to two boards and 27.4 per cent imposing no limit on the number of boards.

“Helping top executives find a seat on an outside board can also increase the likelihood of retaining them in their current roles,” the report notes. However, it also stresses the importance of finding fresh talent.

“In this regard, we suggest the nominating committee, or those responsible for director search, identify slates of diverse candidates. A critical role of the board is to determine multiple criteria required of current and new board members, considering not only diversity of gender and ethnicity, but also of geography, skillset, industry background and other experiences. This process should allow them to look beyond CEOs and ‘well-rounded’ directors to candidates with skillsets and mindsets which speak directly to the strategic needs of the business.”

“Such skills might include digital innovation, strategic talent management, supply chain management, knowledge of emerging markets, experience in global branding and consumer behaviour. In addition, boards can consider how younger candidates can bring fresh thinking to the boardroom.”

Don’t confuse OFR with the integrated report

The Australian Institute of Company Directors has urged listed company directors to exercise caution when preparing disclosures under both the operating and financial review (OFR) and the International Integrated Reporting Framework (IRF). Both, it says, can pose significant risks for directors.

In its submission to the International Integrated Reporting Council (IIRC) in response to a consultation draft of the IRF, the Financial Reporting Council in Australia suggested that an alternative and simpler approach might be to use the OFR as the vehicle for introducing an integrated report.

However, Company Directors believes the OFR, which is included in listed companies’ directors’ reports, is significantly different to an integrated report and, as such, it is not appropriate for the integrated report to be subsumed into the OFR.

Given this, Company Directors has prepared a paper which helps enable directors to compare and contrast the two frameworks and assist them to identify the issues of relevance in their respective directorships.

A key concern for Company Directors revolves around forward-looking disclosures.

It says: “Both the OFR and IRF encourage the use of forward-looking disclosures to provide information about the future prospects of the organisation or entity. In Australia, both the OFR and IRF must be considered in the context of how the required and recommended disclosures interact with other provisions in theCorporations Act and the ASIC Act.

“Company Directors has consistently raised concerns about the potential for personal liability for directors for the forward-looking disclosures within an integrated report. We have similar concerns about the disclosures within an OFR.

“Many accounting experts have stated that neither of these frameworks is seeking disclosure of detailed forecasts of future financial performance. However, the liability regimes in the Corporations Act and the ASIC Act (including the provisions relating to misleading and deceptive conduct) apply whether the statement as to a future matter is a forecast (quantitative information) or any other type of information (qualitative information).

“Any statement which includes a forward-looking element, if not made on reasonable grounds, is at risk of causing a contravention of the relevant provisions. The existing provisions in the Corporations Act and ASIC Act are arguably premised on the basis that only limited statements as to future matters are required.

“If a statement as to a future matter is unreliable, based on uncertain information or at risk of not being made on reasonable grounds then the company making the statement must carefully consider whether it is appropriate to include it in a corporate disclosure. A director’s ability not to include particular forward-looking disclosures is under increased pressure in light of ASIC’s guidance on the OFR and IRF.”

Company Directors is also concerned that the disclosures in an integrated report may lead to confusion as to what is “material” for the purpose of Australia’s continuous disclosure regime. This is because the IRF has a different definition of materiality than that set out in Australia’s continuous disclosure regime.

The IRF states: “An integrated report should disclose information about matters that substantively affect the organisation’s ability to create value over the short, medium and long term.” It then explains how an organisation would go about setting this materiality and then determining which relevant items should be included within an integrated report. The IRF adds: “Ordinarily, matters related to value creation that are discussed at meetings of “those charged with governance” are considered relevant.”

In contrast, the Australian Securities Exchange’s Listing rule 3.1, concerning continuous disclosures, states: “Once an entity becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, the entity must immediately tell ASX that information.”

Company Directors is concerned that the manner in which IRF sets its materiality thresholds may inadvertently suggest the lowering of the threshold for triggering announcements pursuant to Australia’s continuous disclosure regime. This, it says, has the potential to significantly extend the range of disclosures an organisation would be required to continually monitor to ensure compliance with the continuous disclosure regime should one of the key disclosures within an integrated report change.

“The integrated report has a different underlying methodology which at its centre is the organisation’s business model. It looks at the interaction between the multiple capitals and the organisation’s strategy and focuses on how the organisation creates and sustains value over the short, medium and long term. This methodology is much broader than the OFR, which on the other hand, provides a narrative and analysis that accompanies an entity’s financial statements and provides a context to this financial information,” says Company Directors.

Directors cannot afford to be complacent about class actions

While claims relating to the global financial crisis and market shocks seem all but over, Australian boards have been warned to brace themselves for a new wave of class actions.

recently released report on class actions in 2013-14 in Australia by law firm King & Wood Mallesons (KWM) shows that class action filings are on the rise, with 27 new class actions filed since January 2013.

More than half of these new actions related to financial products and services. Seven shareholder class actions alleged breaches of the continuous disclosure obligations and/or misleading or deceptive conduct. A further seven concerned misleading or deceptive conduct or negligence in relation to financial products or investments.

Of the remaining 13 actions, five were linked to catastrophic events, such as equine influenza, bushfires and the explosion of a jet engine during a Qantas flight from Singapore to Australia. Five had a public interest element – for example, representing the interests of people with disabilities. Three were consumer-related actions.

Significant judgments in the 18 months to June 2014 concerning matters of both substance and procedure include:

  • ƒ The dismissal of the appeal by Standard & Poor’s, confirming that a ratings agency can owe a duty of care directly to investors.
  • ƒ The Cash Converters claim, which produced a decision that does away with the requirement that all group members have claims against all respondents and could (if upheld on appeal) vastly broaden the cases that may be pursued as class actions.
  • ƒ In the Willmott Forests class action, the court has shown for the first time that it is willing to consider ordering group members to provide security for costs where the claim is not supported by a third party litigation funder.

“We expect 2014-15 to be equally lively, with the very first weeks already including the announcement of Australia’s largest class action settlement ($500 million for Black Saturday bushfire victims) and the filing of one of Australia’s largest class action proceedings, in relation to the 2011 Queensland floods,” observes report co-author and KWM partner, Moira Saville.

The report warns that directors and other corporate officers can no longer afford to ignore, or be complacent about, the risk of a class action suit.

“It is no longer about being ‘unlucky’. For some companies, lightning has now struck twice, or even three times, as they are faced with more than one class action in their corporate lifetime. Companies and directors must be vigilant and be aware that a potential suit is always on the radar,” says Saville.

The report’s co-author and KWM partner Peta Stevenson partially attributes the rise in class actions to new and diverse players in the market.

“Entrepreneurial companies are seeing the potential for large windfalls in litigation funding and taking advantage of low barriers to entry,” she says.

“Law firms with a strong reputation in commercial litigation are beginning to push into the plaintiff space in recognition of the growing profit potential in class action suits.”

The report also notes that the Australian litigation funding “model” is also becoming an export product, with established players looking overseas for investment opportunities.

Growth in private ancillary funds offers charities new opportunities

The growth in popularity of private ancillary funds (PAFs) presents charities with an opportunity to engage with wealthy Australian donors in a different way, says Chris Cuffe FAICD, chairman and founder of Australian Philanthropic Services.

He notes that the latest figures from the Australian Tax Office’s Deductible Gift Recipient (DGR) listing reveal that in the past financial year, the largest number of new PAFs were established since the start of the global financial crisis. Of the total number of PAFs in Australia (1,233) 149 were established last year.

According Australian Philanthropic Services (formerly known as Social Ventures Australia), PAFs are likely the fastest and largest growing segment of philanthropy. PAFs held $2.93 billion in funds as at 30 June 2012 and distributed $250 million to the community across welfare, education, culture, research and other sectors during 2011/12.

A PAF is a type of charitable trust which must be managed by a corporate trustee and allows individuals, families or associations to establish and manage their own charitable fund in the way that best matches their philanthropic goals. It can offer donors tax deductibility, flexibility and deeper engagement in their charitable giving.

Cuffe says: “PAF founders are rarely new to giving money away to charity. However, once they set up a PAF, their thinking and approach to giving often shifts and they move from being ad hoc donors to being more structured and thoughtful.

“Previously people might have given away whatever money they had left in their bank accounts at the end of the year. With a PAF, the thought process is different. Once you set up a PAF you become a compulsory giver and have to give away at least five per cent of the value of the PAF each year. This often leads to people getting more involved with particular initiatives or programs that a charity is running and actually giving away more money because they are donating with the long-term in mind.”

Cuffe’s top tips for charities hoping to access funding from PAFs are:

  • Know your DGR status – PAFs can only give to organisations with DGR Type 1 status.
  • Do your research – Individuals are much more likely to give if they have a connection to the cause or the organisation.
  • Make a personal approach – Don’t just send off unsolicited requests for funding.
  • Peer referrals are important – If you know someone who may be interested a charity in which you are involved, set up a meeting with the CEO or fundraiser and make sure you attend.
  • Report on impact – Clearly demonstrate the impact of donations and report back to the donor.
  • Be open to engagement and involvement – PAF founders like to see and hear first-hand what the charity they support is doing. 
  • Follow up, keep in touch and, most importantly, say thank you.

For more on the tax status of PAFs, click here.

Don’t turn a contract into a handcuff 

While signing contracts is part of doing business, not everyone understands the full implications of what they are signing, says Adrian Kitchin MAICD, managing director of insurance brokers Insurance Advisernet Australia.

He warns that owners of small and medium-sized enterprises (SMEs) could expose themselves to potential financial difficulty by entering into contracts without understanding the full implications or checking with their professional advisers.

“The business owner is typically focusing solely on the perceived benefit and not necessarily appreciating the liabilities and other consequences of what is being signed,” he says.

“More than ever, large organisations are transferring as much risk as possible from their organisation to the other party to the contract.”

Kitchin adds: “Even an experienced director who is well versed in commercial dealings, including contract negotiation, can sometimes make mistakes that are not immediately apparent.

“Best practice would be for a director to seek advice from his or her solicitor, accountant and insurance adviser prior to signing any commercial contract that binds the company. Quite often, seemingly innocuous terms can have far reaching effects that a director may not readily be able to establish from the wording of a contract.”

He believes the business owner or board of directors should ensure there is a policy in place that deals with the signing of contracts.

“At best, unwittingly entering into a contract with unintended consequences would be considered unwise. To knowingly do so could be considered reckless,” he says.

“Any board-driven policy that is put into place need not be onerous. We would suggest that the policy sets out that commercial contracts require review by the legal, accounting and insurance professionals that are retained by the firm. By doing so, a board in effect transfers its liabilities to its advisers who are charged to provide relevant and accurate advice on the consequences of signing a contract.”

Kitchin says the board should also adopt a sound risk management approach to ensure it does not knowingly or unknowingly enter into risky contracts.

“In addition to the policy of referring the contracts to external advisers for review, the board should actively consider the suppliers and business partners with whom it does business regularly.

“Where possible, it should have its own ‘standard’ commercial contract for its suppliers and another version for its customers that has been pre-approved by its external advisers rather than relying on another party’s contract which is unlikely to be as favourable.

“When the company signs other non-standard contracts, it should have a checklist setting out various matters, in particular, the external sign-off that needs to be followed by the management team which is generally responsible for negotiation for approval by the board. Even where the board and the management team are one and the same, the checklist will still be of great value in avoiding potential mistakes.”

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