1. INTRODUCTION .......................................................................................................... 1 2. CORPORATE GOVERNANCE DEFINED ................................................................... 1 3. EVOLUTION OF CORPORATE GOVERNANCE IN THE UK..................................... 2 4. THE COMBINED CODE .............................................................................................. 2 4.1 Section 1 Companies ....................................................................................... 3 4.1.1 Directors ............................................................................................... 3 4.1.2 Directors’ Remuneration....................................................................... 3 4.1.3 Relations with Shareholders................................................................. 4 4.1.4 Accountability and Audit ....................................................................... 4 4.2 Section 2 Institutional Shareholders................................................................. 5 4.2.1 Institutional Investors............................................................................ 5 5. THE POWER OF COMPLY-OR-EXPLAIN .................................................................. 5 6. PROPOSED UK REFORMS ........................................................................................ 6 6.1 Higgs Report ..................................................................................................... 6 6.2 Smith Report..................................................................................................... 8 6.3 Secretary of State for Trade and Industry Comments ..................................... 9 6.4 Law Commission .............................................................................................. 9 7. CRITIQUE OF PROPOSED REFORMS.................................................................... 11 7.1 The Higgs Report: Discussion........................................................................ 11 At Least Half of the Board Should be Independent NEDs............................. 12 Refined Definition of Independence............................................................... 12 Separation of the Roles of CEO/Chairman.................................................... 13 Nomination Committee Chair to be Independent NED, not the Chairman ............................................................................................ 13 Expansion of the SID’s Responsibilities ......................................................... 14 Separate NED Meetings ................................................................................. 14 Remuneration ................................................................................................. 15 7.2 The Smith Report: Discussion........................................................................ 15 Duties Related to External Auditors: Non-Audit Services .............................. 15 Financial Expert on the Audit Committee....................................................... 16 8. COMPARISON HIGHLIGHTS WITH US REFORMS ................................................ 16 9. CONCLUSION............................................................................................................ 19 Corporate Governance: UK Proposals and US Comparisons 17 April 2003 by Sarah La Voi & Peter Borrowdale 1. INTRODUCTION Recent public company crashes in the US and the UK have left a devastating wake. Regulators across the globe are setting reforms in motion to improve standards of corporate governance in public listed companies with the aim of protecting against a recurrence of Enron, Worldcom, or Maxwell–style company breakdowns. While reforms to corporate governance procedures are inevitable, members of the business community must monitor proposed changes and consider their practical effects to ensure that the sound, flexible UK approach to corporate governance is not lost. This report will first discuss corporate governance generally, outlining the course of UK Corporate Governance evolution. Next, this report will raise the key points of emerging UK corporate governance reforms, discussing the benefits, criticisms, and implications of each. Pushing further, it will also consider the comparative issues, analysing similarities and differences in UK and US trends and how specific proposed rules may impact business. 2. CORPORATE GOVERNANCE DEFINED In its narrowest sense, corporate governance deals with the manner in which a corporation is controlled and directed. To define corporate governance, it may be necessary first to clarify what it is not. Corporate governance is distinct from the notion of "corporate social responsibility", yet people often confuse the two concepts. Corporate social responsibility pertains to a corporation's implied, external duties to society as a whole, including for example public safety and environmental concerns. Alternatively, corporate governance deals with the internal control and direction of public listed companies only. In the wake of high profile corporate collapses, the modern commercial climate demands expansion and clarification of these principles for listed companies and, perhaps, more prescriptive best practices. Thus corporate governance across the globe is in a process of re-definition. Earlier UK models of corporate governance laid down general principles to steer corporations away from fraud, mismanagement, and lax administration. Reformed corporate governance models will encompass the broader issues of improving shareholder returns while employing ethical, transparent management practices that promote accountability and fairness. To achieve this goal, UK corporate governance ideology could shift towards a more proscriptive, rules-based approach. Secretary of State Patricia Hewitt vehemently denies that UK corporate governance will evolve into an exercise in box ticking. This forecast has divided the UK business community into different camps; each sees the destination of improved corporate governance yet all have different ideas on the best route there. 3. EVOLUTION OF CORPORATE GOVERNANCE IN THE UK 2 LONLIB-0108750.01-HALSHAHI 02 May 2003 10:12 The UK has pioneered corporate governance reforms for over a decade, constructing an episodical framework that will shape future reforms. Spurred by the Maxwell pension scandal in the 1990s, the government commissioned researchers to investigate UK corporate governance standards and to propose ways to reinforce the system. Foundations laid by the 1992 Cadbury report, the 1995 Greenbury report, and the 1998 Hampel report resulted in the Combined Code Principles of Good Governance and Code of Best Practice (Combined Code). The Code, which applies to UK listed companies, sets out the widely accepted "comply-or-explain" doctrine of corporate governance that promotes transparency, accountability, fairness, and responsibility. Companies listed on the London Stock Exchange's Alternative Investment Market (AIM) are not required to comply with the Combined Code, yet adherence is encouraged. The recent Higgs and Smith reports aim to develop the Combined Code even further, calling for non-executive directors to take on more corporate leadership responsibility and to monitor keenly auditor activities. The Department of Trade and Industry (DTI) initially commended both the Higgs and the Smith reports and, after compromising certain recommendations, will probably support their incorporation into the Combined Code. The DTI has also announced plans beyond Higgs and Smith to restructure the UK accountancy profession and to implement a major overhaul of UK regulatory body structures and responsibilities, which will take effect immediately. Heavy-handed amendments to the non-legally binding Combined Code are not the end of proposed UK reforms; legislative action may also be on the horizon. The UK Law Commission has proposed drafting a statutory statement of directors' duties and amending Part X of the Companies Act (Enforcement of Fair Dealing with Directors) to reflect stricter corporate governance standards. The Department of Trade and Industry's Steering Group issued the Company Law Review in 1999 which supports the Law Commission's position on corporate governance reforms. The Company Law Review, officially entitled Modern Company Law for a Competitive Economy: the Strategic Framework, assessed core company law and advocated reinforcement and clarification of the law with respect to directors' duties. Further, the report pointed to the Law Commission's recommendations to draft legislation in the area of directors' duties. 4. THE COMBINED CODE In its current form, the Combined Code regarding companies establishes the principles of good governance laid out below. The full Combined Code1 also lays out detailed best practice guidelines. If public listed companies do not comply with the code, they must publicly explain the deviation. The Combined Code Principles of Good Governance (May 2000) 4.1 Section 1 Companies 4.1.1 Directors 1 The full Combined Code in its current form includes the preamble and the code of best practice. It will likely change by July 2003, yet the current version (from April 2003) is available at http://www.fsa.gov.uk/pubs/ukla/lr_comcode.pdf. 3 LONLIB-0108750.01-HALSHAHI 02 May 2003 10:12 The Board Every listed company should be headed by an effective board which should lead and control the company. Chairman and CEO There are two key tasks at the