Tuesday, August 16, 2011

Corporate Secretaries Int’l Endorse Comply or Explain Approach to Corporate Governance in Comments on EU Green Paper

The Corporate Secretaries International Association endorsed a principles-based comply or explain approach to corporate governance codes in a comment letter on the European Commission’s recent Green Paper on corporate governance. A principles-based approach provides flexibility to a corporate governance system, said the Association, because it does not mandate a one-size-fits-all approach. The onus is upon the individual company to explain to their investors why their corporate governance framework and processes are suitable to their circumstances and bring value to shareholders.

Moreover, reporting against corporate governance principles on a comply or explain basis provides insight into board decision-making, allowing companies to meet the spirit of the principles through whatever means they believe are most appropriate to their business, provided they explain their approach. It is for shareholders to understand directors thinking and behavior through shareholder engagement and for boards to be accountable for their decisions to shareholders, given their respective regulatory requirements. Each company is unique, said the corporate secretaries, and its circumstances may change dramatically and suddenly. Thus, companies need the freedom to organize themselves and respond most effectively to the needs of the day. The principles-based comply or explain approach allows them to do that.

The European Commission has begun a significant and historic effort to reform corporate governance with publication of the Green Paper, which could lead to broad EU legislative proposals later this year, including the tightening of the comply or explain model, which has been the bedrock of EU corporate governance. While most EU Members have voluntary corporate governance codes, the Commission has evidence of shortcomings in the application of these codes when reporting on the comply or explain basis.

The Green Paper raises questions as to whether shareholders have been derelict in not holding boards to account, and raises the possibility of legislative intervention to enforce governance standards. In its comment letter, the Association said that a legislative-based approach has an emphasis on a compliance culture rather than one that engages with shareholders to provide transparency and accountability on the stewardship of a company by its governing body. CSIA Members support a principles-based approach to corporate governance, rather than a rules-based approach, as there is often no one right answer to many governance issues facing companies.

The prevalence of shareholder class actions, and derivative lawsuits brought on behalf of the company by its shareholders, and the rights of shareholders to bring such legal actions can be said to have resulted in the compliance culture. It could be argued that another Enron debacle was not avoided through the application of a black-letter law approach to governance. While audit committee independence may have been improved after Enron and the enactment of Sarbanes-Oxley, noted the Association, subsequent events have raised some concerns on risk analysis and oversight at both the management and board levels at some companies.

The principles-based comply or explain approach exists in multiple jurisdictions that have not experienced economic decline due to the financial crisis, said the Association. Therefore, CSIA Members would be very concerned if the EU assumed that a comply or explain regime relating to governance was in itself a contributing factor to the financial crisis.

The Association’s support for comply or explain regimes echoes the UK accounting and auditing regulator’s endorsement of the continuing efficacy of comply-or-explain corporate governance codes in comments in comments on the Green Paper. The comply-or-explain principle is recognized at the European level as an important tool for delivering good corporate governance, noted the Financial Reporting Council. Similarly, German officials recently reiterated their confidence in the voluntary nature of the German Corporate Governance Code. In remarks on the tenth anniversary of the Code’s initiation, Klaus-Peter Müller, Chair of the Government Commission on the German Corporate Governance Code said that the comply or explain principle at the core of the Code allows for the needed transparency and provides listed German companies with a flexible framework for good corporate management.

Sabine Leutheusser-Schnarrenberger, Federal Justice Minister, emphasized that the German Corporate Governance Code will remain a voluntary best practice code and that the federal government fully supports the Code and the work of the Commission. The Minister also specifically endorsed the Code’s comply or explain mechanism, under which companies have duty to disclose if they follow the Code and, if the do not follow it, why not. The Minister is skeptical of the European Commission suggestion of the monitoring of declarations of compliance by the authorities, which, in her opinion, runs counter to a best practices Code. Either the markets and shareholders will react to deviations from the Code or they will not, reasoned the Minister, and monitoring by the authorities and making declarations more substantial will not change that dynamic.