Corporate Governance and Social Responsibility: input from by Business Unity South Africa, and the Institute of Directors

Meeting report

AD HOC COMMITTEE ON CORPORATE GOVERNANCE
5 December 2005
BRIEFING BY BUSINESS UNITY SOUTH AFRICA, AND THE INSTITUTE OF DIRECTORS ON CORPORATE GOVERNANCE

Chairperson: M (ANC) [NA]

Documents handed-out
Presentation by Business Unity South Africa (BUSA)
Presentation by the Institute of Directors

SUMMARY
The Committee was briefed by BUSA and the Institute of Directors on corporate governance. Corporate ethics management in South Africa was healthier than expected. There was a relatively stronger emphasis on ethical values as opposed to technical compliance in corporate governance issues. Business should catch up on technical and effective compliance. Businesses should improve their ethical culture in order to remain attractive to the investment of mobile and risk-sensitive capital.

Non-executive directors were vital to the economy but legislation was chasing them away. The proposed Companies Act Amendment Bill had some problems. There was a proposed clause in the Bill that would oblige members of audit committees to sign a statement to the effect that the annual financial statements complied with all laws. A person would be guilty of an offence should the statement be found not to comply with all laws and be subjected to a substantial fine or period of imprisonment.

Fraud was a major problem and a lot of companies had experienced fraud by employees.

MINUTES
Presentation by Business Unity South Africa
Mr J Marnewicke represented BUSA. (See document attached). He said that corporate governance was about the systems by which companies were directed and controlled. It had to do with the structures associated with management, decision-making and control. It was also related to the governing of an organisation at the top. The key elements of corporate governance included supervising and monitoring management performance and ensuring accountability to shareholders and other stakeholders. Corporate governance measures and legislation would not prevent ethical failure. Legislation, regulation, listing rules or ethical norms would not restrain individuals who were intent on fraud. Legislation and regulation brought about the risk of over-regulation. It was important to promote good business ethics. There were different institutions involved in ensuring that there was god business ethics.

He said that a number of assessments of integrity of corporate sector had been conducted. The assessments measured technical ethical compliance against effective ethical compliance. The findings indicated that corporate ethics management in South Africa was healthier than expected. There was a relatively stronger emphasis on ethical values as opposed to technical compliance in corporate governance issues. Business should catch up on technical and effective compliance. Businesses should improve their ethical culture in order to remain attractive to the investment of mobile and risk-sensitive capital.

On the negative side, it was found that there was a lack of maintenance of a theft-free environment. There was inadequate ethics education and training. A sizeable percentage of both management and staff were not aware of code of ethics.

Discussion
Ms Hogan said that people were aware that there was an incoherent regulatory system.
There were too many regulators. The registrar for companies should be playing a regulatory role and not just an administrative. She asked what was BUSA's view with respect to the role that the registrar should have been playing.

Mr Marnewicke could not give an answer that reflected BUSA's views. He said that one of the problems was that the registrar did not have reliable information. There was a lot of debate within government circles on the number of regulatory bodies.

M Hogan asked what was required to make financial regulators more vigorous.

Mr Marnewicke replied that it might sound strange for business to say that financial regulators should be more vigorous. There should be rules and strong and decisive action against people who abused rules.

Mr V Gore (ID) said that there was a fine balance that had to be achieved between forcing people to be ethical and to adhere to legislation and corporate governance. The presenter had suggested that another way of striking the balance was to instil a code of ethics. One of the problems with ethics was that it was a voluntary process. One could not expect an unethical person to voluntarily become ethical overnight. There was a bit of a dilemma and the central issue was how to encourage some people to become ethical. There was a huge small and medium sized enterprises sector and the issue was how to encourage small and medium enterprises to be part of the process.

Mr Marnewicke replied that he was not suggesting that ethical values should replace formal regulation. There was a place for both. All sectors of the society were proclaiming ethical values and there should be delivery on those ethical values. The more the delivery on ethical values the less the need for stringent regulation would be. One could have rules and over-regulation but still achieve nothing. He was of the opinion that legislation formed the absolute minimum acceptable form of conduct and in most cases did not describe ethical conduct. Legislation only described what was wrong. A person who had complied with legislation had done nothing except avoiding being called a criminal. Legislation described what was wrong. The challenge was to deliver on professed values and this was a huge building process. There was a view that the older generation had already lost the fight because it had already formulated its values and was fixed in a particular way. The suggestion was that the promotion of ethical values should start at school level. It was a long-term process and regulation was needed in the interim. Not all problems could be solved by regulation only. One could not cater for all situations and any attempt to do so would lead to over regulation. Many organisations had adopted a zero tolerance approach to unethical conduct. It would be very much better should all organisations adopt a zero tolerance approach to unethical conduct. This was a big challenge that had financial implications. There was always the issue of trade off between doing what was considered to be ethical and what the competitors were doing. The issue of losing the market share and the impact on revenue came into the equation.

Ms Hogan said that 58% of companies in the KPMG survey had given the decline in society value as one of the reasons for fraud. She asked the presenter to elaborate on this.

Mr Marnewicke replied that he did not have details on the report but from his own experience, there was a shift in society in respect of what was acceptable. One big issue was the whole 'term business ethics'. There was view that it implied that there was a different set of ethics that applied to business. People would say that it was acceptable to use crooked methods at work and dubious sales practices to get sales figures up as long as one would not go back home and teach children to conduct themselves in a similar manner. People had become more creative in the justification of their actions. They were convincing themselves that there were justifications for their actions. People would say that their neighbour was also doing the same thing and that it was not really bad. Some would say that tax evasion was a legal sport and that tax was about law and not morality. There was growing justification of unethical conduct and this was leading to a decline in values. People were not really consciously lowering their values.

Mr L Labuschagne (DA) said that the whole discussion around values reminded him of a story he had once heard. The police had phoned the father of a kid they had found stealing pens from a local shop. The father asked the kid why he had not told him he needed pens because he would have brought some from the office. There was a very big debate around ethics and self-regulation. The issue was what are ethics. Looking at the KPMG survey, it seemed that people were saying that ethics policies were being communicated but the efficacy of self-regulation was something that needed to be addressed. Business could put flyers on the notice boards but the central issue was whether businesses were carrying it forward and explaining what was understood by ethics. He took the point that there was a need to focus on the new generation and educate them on ethics. The current generation had already defined and formulated its ethics but this did not mean that it did not realise that there was something wrong. There was a danger that the next generation might take their cue from the current generation. He wondered what were the effective steps that business was taking in relation to self-regulation. He did not know if the public was confident in the efficacy of self-regulation. It seemed like unethical doctors and lawyers, for instance, never faced serious consequences flowing from their conduct and this made people to be suspicious of self-regulation. Business should be seen to be enforcing self-regulation.

Mr Marnewicke replied that the issue was what was ethics. People saw ethics in different ways but there was a universal concept of good and bad. People knew if they were doing something that was wrong. They could be very creative in justifying their actions but the bottom line was that they knew that what they were doing was wrong. In any organisation the Chief Executive Office (CEO) knew what was ethical and such ethics had to be applied in the whole organisation. The Board should be able to remove the CEO should it find the CEO's values and the way they were enforced to be unacceptable. Ethics could also be described as what the company did and the reasons it gave for its actions. One could not simply say that there was a need to teach the young generation good ethics but then leave the old generation to continue with their unethical conduct.

He said that his organisation had a discussion on whether a company's code of ethics was something in addition to its disciplinary code and communication policy with shareholders. The conclusion was that it was not and it was something that had to be the fibre of other polices. The other polices should be audited against the code of ethics and see if they were compliant with the code of ethics. One could not advocate for self-regulation when there was no form and structures for it. The organisation should have an ethics Committee and every person in the organisation should have the right to raise any ethics issue before the Committee. South Africa was not very mature when it came to ethics management. In the UK and US ethics officers were very highly ranked positions in an organisation. South Africa had a long way to go but the foundation was already in place.

With regard to small and medium enterprises, he said that there was a big challenge relating to the kind of resources that they had. It was difficult for them to comply with regulations even though they had the will to do so. He was not sure how to address challenges facing such enterprises. He was also unsure if a lot of attention had been paid to the regulation of small and medium enterprises.

Mr I Mfundisi (UCDP) asked if there was any thought given to making sure that people who conducted themselves in an unethical manner could be barred from continuing to practise.

Mr Marnewicke replied that there was some attention being given to the issue. It was one of the resolutions of the second national anti-corruption summit. The government, business and the civil society were looking at having a register similar to the one provided in corruption legislation. The register could contain records of companies that had conducted themselves unethically. The impact of the Constitution on such a list still had to be clarified. It would warn people who would like to business with such companies that they did not practice good ethics. With regard to debarment, one had to be careful when dealing with placing an embargo on the whole company. Ethical failure and lack of integrity in an organisation could be attributed to certain individuals. If it was an individual who was corrupt or lacked ethics and the whole organisation was punished, then one would be punishing many innocent shareholders in the organisation.

Ms S Seaton (IFP) said that there were two sides of the story. In transactions between organisations and government, there were bound to be unethical business proposals from government to business. She asked if this was reported and what was being done about it.

Mr Marnewicke replied that people were obliged to report such action in terms of the Prevention and Combating of Corrupt Activities Act or else they would be guilty of an offence. He was not sure about the level of reporting. Typically, corruption was very difficult to investigate and prove. There would always be difficulties in trying to get enough evidence of what had happened because both parties to the act were guilty of the crime. Most codes of ethics and codes of conduct required people to report unethical conduct.

Ms Hogan said that two-thirds of companies surveyed in the KPMG survey considered fraud a major problem. They expected an increase in fraud. 76% of the companies had experienced fraud by employees. The figures were significantly high. One got a sense that the corporate environment (including government) did not have a healthy ethical environment at the moment. She asked for the extent to which the interface between government and companies was receiving focus. The way South African companies were behaving abroad, particularly in Africa, was another issue. Anglo-America had problems in the Democratic Republic of Congo.

Mr Marnewicke replied that it was a reality that businesses in South Africa had experienced major fraud problems. One only had to look at the number of forensic departments in organisation, especially those operating in the financial services sector. One would not find an insurance company that did not have a forensic Department. Banks were spending a lot of money on forensic departments. One could not say that such acts were indicative of the corporate culture in the country. It certainly reflected negatively on the type of people employed. There was a crime problem in the country and companies should not be judged on the basis of the number of incidents they had experienced but by what they were doing after becoming aware of the problem. More and more companies were saying that they would prosecute offenders irrespective of the financial implications to them. Some people would try to plea bargain and promise to repay the money should the proceedings be stopped. Companies were now saying that the person had stolen from them and therefore cannot use the company's money as a bargaining chip. They would rather forfeit the money and go to court.

Ms Hogan said that the KPMG findings had indicated the prevalence of fraud in organisations. When talking about the ethical behaviour of corporate organisation, one was also talking about the way business was done in the country. They way that business were related to politicians and government was a major issue. Another important issue was how businesses conducted themselves in Africa. It seemed like spending money in trying to buy politicians was regarded as a taxable expense.

Mr Marnewicke replied the problem with economic crimes was that they were considered to be crimes that had no victims. Corruption was wrong and people suffered from corrupt activities. Recently there was a case wherein a person was given a very light sentence. The question asked by the presiding officer was how did the stakeholders suffer as a result of the corrupt activities. There was a knock on effect from corruption. It could easily lead to the impoverishment of the society.

Mr Gore said that legislation was beginning to include stakeholders in the issue of regulation. The questions were whether South Africa was moving towards the right direction and whether the involvement of stakeholders was becoming an important component of a sustainable business practice. He also asked what had to be done to improve the situation.

Mr Marnewicke replied that one should accept that business did not operate in a vacuum but in a community. An organisation could not do business at the expense of the community in which they operated. There was a move towards accepting certain responsibilities towards the community.

Presentation by the Institute of Directors in Southern Africa (IOD)
Mr Tony Dixon (Executive Director) and Ms Angela Oosthuizen (Director Development) represented the Institute. Mr Dixon made the presentation. (See document attached). Mr Dixon said that the perception was that Africa was unstable, corrupt, crime ridden and susceptible to despotic rule. South Africa was contaminated by such perception. The reality was that South Africa had a stable economy, sound macro economic policy, an outstanding Constitution and world class infrastructure. There was excellent corporate governance. The King report on corporate governance was regarded as one of the best in the world. One could not have a sustainable operation unless there was good corporate governance in place. South Africa was doing well with respect to accounting standards and had a good level of disclosure. Businesses were beginning to show a huge vote of confidence in the South African market. This was illustrated by the R30 billion foreign direct investment by the Barclays bank. A question could be asked why a lot of investment was not flowing into the country. Africa was facing the challenge of over-regulation.

Surveys had indicated that governance was at the heart of investment decisions. Corporate governance was put on a par with financial indicators when evaluating an investment decision. An overwhelming majority of investors were prepared to pay a premium for companies exercising high governance standards. Companies with good governance produced more sustainable and better long-term results than those that did not. There should be zero tolerance against lack of compliance with good corporate governance.

He said that non-executive directors were vital to the economy but legislation was chasing them away. They were normally very experience and retired professions. They could add too much value to an organisation. The problem was that most of them did not have a clue about their roles when appointed to the Board. He referred to the proposed Companies Act Amendment Bill. He said that the proposed Bill would oblige members of audit committees to sign a statement to the effect that the annual financial statements complied with all laws. This was a huge and onerous obligation. A person would be guilty of an offence should the statement be found not comply with all laws and be subjected to a substantial fine or period of imprisonment. With the best will in the world there was no director who was fully conversant with the 120 acts that affected business. There were retired directors who were refusing to be directors of companies. They did want to serve on audit committees and boards because of the risks attached. They were becoming very selective and there was a preference for companies that appeared to be less risky. They were willing to take appointments only as directors of blue-chip firms with little financial risk, and not on those where their skills were really needed, such as companies that were doing badly or were badly managed because the risks were too high. This was not in the country’s best interests. Companies would not get the best people to serve on their boards.

The Public Finance Management Act (PFMA) and the Municipal Finance Management Act (MFMA) had made the King report more onerous. In terms of the Acts members of audit committees could be found personally liable for financial mismanagement. Some municipalities were badly managed and required skilled and experienced people sitting on the audit Committees and asking the right questions. For some strange reasons, municipalities could not get anyone to sit on their audit Committees. The Institute had a database of people who were willing to serve on boards and committees but could not get a person to serve in a municipality in Gauteng. The problem was not about money but the risk to go to jail. There was a need for a system that would encourage people to sit on audit committees. Unless there was negligence or fraud there should be some sort of limitation of liabilities. The audit committee should not go to jail if the negligence or fraud lied with the municipal management. The liability could be limited to the multiple of the fees that they had earned.

There was another clause that provided that any person who knew or should have known of any misleading or false information in the financial statement was guilty of an offence. The clause was placing a very onerous responsibility to members of the audit committees.

Discussion
Ms Hogan said that the 2003 International Monetary Fund (IMF) report on corporate governance in South Africa had noted some fields wherein there was partial compliance. She asked if the Institute was aware of areas where there was stringent or weak compliance. She also asked if the Institute was in agreement with the IMF.

Mr Dixon replied that the assessment would have been correct in 2002. The IMF would have a different view if they were to come back now. Governance was now being taken very seriously. A lot of work still had to be done in the sporting environment. The rating of South Africa by international rating agencies had also improved a lot and this was a result of governance and economic policies.

Ms Hogan said that there was very little shareholder action in South Africa. She asked for a comment on this.

Mr Dixon replied it was a pity that there was little shareholder activity in the country. In some countries shareholders were very active in monitoring companies in which they had invested. South Africa had not seen such kind of activism. The biggest compliance officer had to be stakeholders in order for governance to work. Stakeholders should hold management accountable and responsible for things they say in the financial statements.

Ms Hogan said that the whole issue depended on shareholder accountability. Shareholders were no longer individuals. It had been said that corporate governance was in a healthy state in the country but the reality was that any kind of shareholder activism was resented. It seemed like there was good corporate governance in relation to audit and risk committees but not to the true line of accountability.

Mr Dixon replied that shares were widely held than they were before and institutional funds held about 78 % of the shares in the Johannesburg Stock Exchange. The shares were owned by every employee who had a pension or provident fund. People were not putting pressure on fund managers and this was leading to poor returns on investments. He agreed that this was one area of governance that could be criticised. However, there was more and more activism creeping in and Chairpersons were not getting things their way like they used to. Funds managers must become more and more accountable.

Ms Hogan said pension funds were big businesses and were the biggest shareholders in the country. There were trustees of pension funds which were boards. The issue was whether one could say that those engines that were supposed to drive the whole process were working properly.

Mr Dixon replied that this was probably the weakest area of management. Pension funds trustees often did not know what was expected from them. Badly managed area. The Institute would introduce a series of courses to deal with this next year. It was a badly managed area of even though it was not supposed to be because it was concerned with the livelihood of too many people.

Ms Oosthuizen replied that a lot of trustees were aware that they needed a lot education and training. A lot of them had requested the Institute to assist them in understanding their roles.

Mr Hogan said that it seemed like it was a dark hole because pension funds trustees were found to be asking for training everywhere and yet trade unions, businesses and the civil society were all providing the required assistance.

Mr Dixon said that the role of trustees was equivalent to that of directors. They had a fiduciary duty to act in the best interest of the fund. Directors had the same responsibilities and acted as trustees for their companies. They would not be fulfilling their duties should they not act in the best interest of the company. Eight years ago a survey conducted in the UK revealed that more than 90% of directors appoint to companies had no formal induction or training on their roles and responsibilities. Trustees of pension funds also did not receive training.

Ms Hogan said that the presenter had identified the sporting field as one area that still required a lot of work. She asked for the presenter's views on corporate governance in sporting bodies. She said that she had been concerned with State Owned Enterprises (SOEs) for some time. There was some very quaint corporate governance arrangements and these were related to the role of government as the majority shareholder. There were endless problems about who was driving the process. Was it the Chairperson of the Board or the Minister in the Department? She asked if the Institute had any concerns about the corporate governance structure in SOEs given their size in this country.

Mr Dixon replied that there were concerns. Part of the concern had to be that there was a Board appointed by the State. Management and the boards were appointed independently. He thought that maybe the unitary board structure was not the best structure for SOEs. There might be a need to look at other models where there was a supervisory board. Having the State hands on in managing a business when there was an executive trying to run it was not good. It was equally not good to have a person running a business with nobody monitoring the process. He did not think that the PFMA was the solution. The issues probably required a unique solution.

Ms Hogan agreed that need for unique solution. The performance of SOEs like Denel was not good enough. Some SOEs were making very big losses. The whole model depended on the shareholder holding the company to account and yet all what the shareholder was doing was to finance the deficit.

Mr Dixon said that it was a weak model. Boards were changed overnight and this was not the solution. Executives were not held accountable in those institutions. In many cases the appointment of the board was also problematic. Some people did not have the required expertise to manage the enterprises. A lot of them were political appointments and this did not help because one needed people with the right skills.

With respect to the sporting community, he said that he was fortunate to be involved in the management of sport at a senior level. Every sporting body was run and managed by people with vested interest. Every person who sat on the board had vested interests either in a club, province or some sector of the sport. There was no one concerned with best interest of the sport nationally. The King report had recommended that at least half of the board should be independent non-executive directors and this meant people who did not have vested interests in the organisation. All boards of sporting bodies were not independent and board members were all driving their own agendas and this created havoc. They should have a majority of independent people sitting on the Board. The question was how to do this. The Natal Rugby Union had done this for ten years and had the best ten years of their history. There were huge problems in sports.

Mr Labuschagne asked if the boards of SOEs of were subject to the same penalties contained in the Companies Act.

Mr Dixon replied that he would never accept an appointment as a director of an SOE. SOEs were governed by the Companies Act and the PFMA which was even more onerous. The PFMA included individual liability for people who sat on audit committees. People who were directors on SOEs were running serious risks although the State would probably not sue them. The directors had onerous responsibilities. He wondered who was managing those responsibilities. The MFMA talked about wasteful expenditure and the members of the audit committee were guilty of an offence if there any wasteful expenditure but nobody was holding people to account. There were laws in place but no proper enforcement. This was one problem with governance in South Africa. Some directors should have been in jail by now. He referred to the problems experienced by Parmalat. Some people were arrested three weeks after Parmalat went down.

Ms Hogan presumed that the presenter was talking about regulatory authorities when he referred to enforcement. She asked who should take actions following corporate failures.

Mr Dixon replied that it would depend on the sector in which the business was operating. The Financial Services Board was responsible for banking issues. It was a great pity that the Leisurenet case never really happened otherwise it would have been a great test of what directors' liabilities were. It was a great pity that the matter was settled. It would be surprising if the non-executive directors do not go to jail.

Ms Hogan said that Socially Responsible Investment was being monitored by a number of people. However, there was still a number of activists on the ground who were dissatisfied with the lack of response to issues of the employment of the disabled and environmental issues. He asked for the presenter's views on the issue.

Mr Dixon replied that there had been a lot of movement towards the right direction on all fronts. The issue whether the developments were happening fast enough was another matter.

Mr Gore asked how on could speed up the developments.

Mr Dixon replied that he was not a legislator. On the environmental front there was a plethora of legislation but there was no one to enforce the legislation. It was not good enough to make law if nobody would enforce them.

Ms Hogan asked why there were so few women on the boards.

Mr Dixon replied that it was legacy issue but the numbers were increasing.

The meeting was adjourned.