Director independence – time for a change?

Oscar Wilde knew all about conflicts of interest, whether he realised it or not.

His play The Ideal Husband highlights a conflicted individual taking advantage of sensitive information for personal gain. Whether or not Wilde would have been in a position to write the current NZX policy settings related to Director Independence is a different question – although it’s possible that the writing style might attract a whole new generation of enthusiasts.

I live in hope.

This week, NZSA has made an extensive submission on a consultation paper released by the NZX relating to Director Independence. We’ve made many comments – including proposals to introduce a minority shareholder regime to better validate director independence in companies that have a major shareholder and to separate Resolutions relating to director election into two separate single-issue resolutions.

We think our proposals will place greater importance on how companies assess ‘independence’ and provide improved validation, trust and value of both independent and non-independent directors for investors.

While Oscar Wilde recognised conflicts of interest, NZSA has tended to talk about the criticality of ‘independence’ in slightly broader terms, perhaps more aligned to the more traditional definition of the word. For most minority investors, the ability for a Director to form independent judgements – unfettered by persuasive executives and passionate fellow Board members – is a key protection that ensures representation for minority investors.

But that doesn’t dilute the importance of managing conflicts of interest. Naturally enough, identifying, disclosing and managing existing (and potential) conflicts of interest is a key facet that underpins independence – and should be the first question in a Director’s internal monologue when considering any board paper or decision.

Patronage and independence

A key question for NZSA, is to consider whether shareholder interests are being effectively represented on the issuer’s Board – and there’s one specific circumstance where we think there could be improvements. Where a company has a major or majority shareholder, any independent directors serving on that Board are essentially under the patronage of said shareholder.

Conceivably, if an independent director makes decisions or contributes to discussions in a manner that frustrates the major shareholder, that director is unlikely to survive a shareholder vote – as the votes of a major shareholder will impact the outcome. We saw that play out with NZ Automotive Investments (NZX: NZA, now NZX: 2CC) in 2022, with the entire Board resigning en masse following a lack of support expressed by one of the major shareholders. There are other examples where independent directors may be at risk of being “captured” by the interests of a major shareholder.

I can hear the howls of protest from Directors already: “Of course I’m independent”. And that may well be true – but wouldn’t it be good to have a regime that put this beyond undisputed doubt, rather than merely defensive justification?

As much as anything, director independence is about improving market confidence; perceptions have a nasty habit of becoming reality, even though they may be unfounded in fact.

NZSA is proposing the introduction of a minority shareholders regime related to director independence and a ‘split’ within director election resolutions as part of an annual shareholder meeting.

Minority Shareholders Regime

Simplistically, what we are proposing would prevent a ‘controlling shareholder’ with 30% or more of voting power from voting on the election and re-election of independent directors.

Interestingly, this is not entirely without precedent on the NZX – that’s the situation today at Synlait (NZX: SML), where major shareholder Bright Dairy is unable to vote on the election of independent directors under the company’s constitution. There are other aspects of that company’s governance that NZSA is less keen on, with the constitutional arrangement part of the ‘waiver’ deal reached with the NZX on Synlait’s listing – but nonetheless, NZSA believes that this is a useful mechanism to provide effective representation for minority shareholders.

Perhaps there will be concern about the impact of this proposal on establishing different “shareholder classes. What, do you mean like in a Scheme of Arrangement? Amazingly, the concept of ‘shareholder class’ seems to be quite acceptable in that context.

NZSA thinks the outcome of this regime would be to improve trust and confidence in ALL directors, whether independent or non-independent. Just like a major shareholder including their representatives on the Board, this offers a true vote by minority shareholders on their representatives – all of whom need to act in the best interests of the company.

Resolutions and Voting

Currently, it is difficult for shareholders to challenge a Board’s assessment of a director’s independence. From an objective perspective, unless an investor is able to observe every Board meeting, it is difficult to assess the level of ‘thought independence’. We all know a strong and constructive Board culture is critical to a company’s access – good governance is directly correlated to good performance – but it’s not something investors can assess easily (at least, not without the Board’s co-operation).

To overcome this, we are proposing a slightly different approach to Resolutions that propose a director’s election or re-election at a company’s annual meeting.

Rather than conflating two aspects (the election of the director and their status), NZSA is proposing these are managed as two separate resolutions: the first on the election itself, the second on the independence status. This offers greater clarity on specific issues and say for investors when it comes to the assessment of independence undertaken by the Board – and is likely to improve the quality of disclosure and assessment when it comes to the Board’s recommendation.

There’s plenty of other commentary and specific responses that we’ve made – you can read our full submission to the NZX at this link.

The current NZX settings – an explainer

Currently, the Listing Rules stipulate some compliance requirements for any listed company on the exchange. The definition of an Independent Director is someone “who is not an employee of the issuer and has no disqualifying relationship“. The definition of disqualifying relationship specifies interests, positions, associations or relationships that could influence a Director’s ability to bring independence to decision-making, act in the best interests of the company or represent securityholders effectively. Furthermore, the Rules refer to the (voluntary) Corporate Governance Code for the factors that should be considered in determining independence.

Under the Rules, an NZX-listed issuer is required to have at least two independent directors and must disclose how they have determined directors to be independent (or not) within 10 days of their appointment. Any change in independence status needs to be announced to the market “promptly and without delay“. The company’s annual report also needs to state which directors are independent and “the factors relevant to that determination“. Also, an issuer’s Audit Committee must comprise a majority of independent directors and there are some specific rules and processes to follow when it comes to related-party transactions.

The Corporate Governance Code is a voluntary regime supporting the Rules. Issuers that choose to adopt the recommendations or standards within the Code are committing to a greater level of disclosure to support investors – and in some cases, a greater level of support for minority investors. For example, recommendation 2.8 of the Code recommends that a majority of the Board should be independent directors and recommendation 2.9 states that the Chair should be an independent director.

Critically, the Code also contains the factors that should be considered by Boards in determining director independence – but also notes these are non-exhaustive factors. So if a Board thinks a director cannot be considered as independent for a different reason to that envisaged by the NZX Policy suite, they are still bound to consider the director ‘non-independent’. Interestingly, it’s the Code that uses the term independent judgement as a key outcome (or purpose) of Director independence, rather than the Listing Rules.

Definition and Purpose

We’re pleased to see the NZX question whether the definition of ‘Independent Director’ within the Listing Rules should be changed to reflect both conflicts of interest and independent judgement. In a similar vein, NZSA believes that the inclusion of a purpose statement – highlighting why independence matters – will increase focus of both investors and issuers on the value of independence.

From NZSA’s perspective, the value and benefits brought by independence go far beyond managing conflicts of interest. We would hope that any purpose statement highlights the value of independent judgement, unfettered by relationships. At its core, evidence relating to director independence validates the trust investors place in their representatives -a fundamental attribute that drives market confidence across the NZX.

It’s in everyone’s interest to ensure that trust in our capital market is maintained.

Oliver Mander

Oliver is the Chief Executive of NZSA. He is also a member of the NZX’s Corporate Governance Institute (CGI) that provides advice to the NZX on its Listing Rules, Corporate Governance Code and other policy settings.

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