Companies Draft Bill: Workshop by the Department

TRADE AND INDUSTRY PORTFOLIO COMMITTEE
10 May 2007
COMPANIES DRAFT BILL: WORKSHOP BY THE DEPARTMENT

Chairperson: Mr B Martins (ANC)

Documents Handed Out:
Presentation by the Department of Trade and Industry (DTI)
Companies Draft Bill

Audio Recording of the Meeting

SUMMARY
The meeting took the form of a workshop, where Committee members and the department systematically reviewed the draft Bill chapter for chapter with Committee members asking for explanations and clarification on certain aspects of the Bill.

Discussion looked at multiple directorships, executive management salaries, minimum accounting standards in annual reports, shareholder apathy, and it was debated as to whether the draft Bill provides sufficient mechanisms to address this problem. DTI noted that on the matter of the arrangement of shareholder voting rights, it was extremely difficult to implement a policy of ‘voting by hand,’ as one ran the risk of disenfranchising members who held more shares. In this regard, the established company law principle of ‘majority rule’ had to stand. The primary mechanism introduced to increase shareholder activism was the requirement that, for virtually all distributions, shareholder assent was required.  This was particularly noticeable for debt financing, as well as for share options granted to directors.

MINUTES
Mr Tshepo Mongalo (Head of the Corporate Law Reform Project, DTI) presented an overview of the Corporate Law Reform Project and the Draft Companies Bill to the Committee. He indicated it was imperative that a review of the companies law be undertaken as no review had taken place in over thirty years. Moreover, owing to the changing global and local climate it was pivotal to undertake the review as a matter of urgency. Sections of the 1973 Companies Act, still being utilised, were archaic and unnecessarily onerous on companies.

The objectives of the Bill were thus to simplify procedures and reduce costs involved in starting and maintaining a company. The promotion of innovation and investor confidence in the country was to be achieved by increased flexibility in the design and organization of companies and the introduction of a predictable and effective regulatory framework. The Bill furthermore aimed to encourage transparency and increase the levels of corporate governance.

The new Companies Bill had nine chapters, six schedules and included key definitions:
Chapter 1 - Interpretation, Purpose and Application
Chapter 2  - Formation and Registration of Companies
Chapter 3 - Corporate Finance
Chapter 4 - Corporate Governance and Financial Accountability
Chapter 5 –Takeovers, Offers and Fundamental Transactions
Chapter 6 - Business Rescue
Chapter 7  - Remedies and Enforcement
Chapter 8 - Regulatory Agencies and Administration of the Act
Chapter 9 - Offences, Miscellaneous Matters and General Provisions
Schedule 1: Forms of Memorandum of Incorporation 
Schedule 2: Members and Directors of Not For Profit Companies
Schedule 3: Public Offerings of Shares and other Securities
Schedule 4: Consequential Amendments 
Schedule 5: Legislation to be Enforced by the Commission
Schedule 6: Transitional Arrangements.
 
Mr Mongalo elaborated on the first four chapters, highlighting key reforms (see document).

Discussion
Prof B Turok (ANC) indicated that after looking at the King Commission Report, he had a number of concerns and questions about the Bill. Firstly, he enquired whether public interest was of importance to companies as their primary obligation was to their shareholders and stakeholders. He asked this as the financial ruin of Enron not only had an effect on the employees and investors, but also on the general populace as the stock price had crashed subsequent to Enron’s demise and uninvolved third parties had lost their savings. Regarding governance issues, he asked about the implications of bad governance on the country especially in light of the Fidentia and Masterbond scandals. He added that provision needed to be made for this in the Bill. Moreover, he requested a clearer diagram of the corporate structure of South Africa and added that a structure or layout should be prescribed to companies when publishing their annual reports in the newspapers and other media. Lastly, he brought up the issue of multiple directorships and enquired if there was clarification or regulation on how many boards one person may sit on. He felt that multiple directorships may be counterproductive.

Mr Mongalo replied that the draft legislation had been drafted with the realisation that there are other legislative instruments to protect the public interest. On issues of corporate governance, the DTI had robust measures in place to ensure that good governance was adhered to. On the matter of directors and CEOs paying themselves exorbitant salaries, the King Code had made executive management’s salaries part of listing procedure which had seen a significant decline in salaries. As such, disclosure was a disinfectant for unjustifiably high remuneration.

Mr Mongalo acknowledged that annual reports were an issue that could be dealt with within the bounds of this law. Multiple directorships had been a problem for a while and have not been addressed in any legislation. It was the prerogative of the company to appoint whoever it wanted to its board and a person could hold as many directorships as they wanted, given they performed their fiduciary duties. He would have a look at this, while at the same time maintaining the autonomy of companies and without placing onerous regulations on them.

Mr S Rasmeni (ANC) asked whether it was correct, regarding corporate efficiency, for the Bill to undo only the “locking in of investors in inefficient companies”. He felt that those in efficient companies ought not to be locked in either. He wondered where the distinction between efficient and inefficient companies lay.

Mr Mongalo noted that the corporate efficiency clause in the Bill referred to efficient companies as well. This provision was to decrease the difficulties faced by those in private companies wishing to sell their shares.

Mr S Njikelana (ANC) commented on the minimum accounting standards in annual reports. He felt that there was a paradigm shift away from considering only financial issues and that annual reports ought to include a framework on the performance standard of companies.

Mr J Maake (ANC) requested clarity on the definition of a public interest company and requested that an example be provided.

Mr Mongalo stated that a public interest company would be defined in section nine of the presentation. Nonetheless, he indicated that it was a company that according to its size and structure was of such importance that it required increased regulations and accounting standards.

[Thirty minutes of this workshop was not minuted by PMG at this point]

The Committee asked how the DTI was going to encourage shareholder activism, and in doing so, bridge the gap between the first and second economy. The Committee emphasized that this was an important aspect of the Bill which has not yet gained the attention it deserves.

The DTI responded that at a later stage, guidelines would be implemented which would assist in accomplishing this. The problem, however, was that the shareholders needed to be able to enforce such regulations. It was submitted that shareholder apathy was not caused by the existing companies legislation, and appears to be a general problem within South Africa’s economy. New mechanisms encouraging shareholder activism would have to be investigated. The commission and the companies ombudsman would have to play an active role in this regard, and would also have to ensuring compliance.

The DTI ensured that the memorandum of incorporation would be easily understandable to those entering the corporate environment. It would not be wise to restrict advanced financing models for those companies already established, but companies would be required to disclose reasons for adopting certain financing models.

The DTI continued that the Corporate Laws Amendment Act had been assented to, and would be promulgated soon. However, the Companies Draft Bill would be revamping the old Companies Act. It would repeal all existing legislation, including the Corporate Laws Amendment Act.

With regard equitable voting powers, all holders of the same class of shares had to have the same voting power unless otherwise stated in the memorandum of incorporation. The Bill also provided for pre-emptive rights, and every shareholder would have the right to buy shares preferentially when, for example, a company increased its share capital.

A member of the Committee asked whether this provision was not wide open for manipulation by small groups of directors. The Committee also asked how share options work, and also requested some clarification with regard tax implications.

The DTI stated that the provision on preferential shares was introduced due to problems with equity financing. It was explained that a share option was ultimately a contract entered into between the company and its directors. For example, a company agrees with one of its directors that, come 2010, it would sell him shares based at a fixed premium, say R80 per share. If the shares were currently (in 2007) selling at R75 per share, this would obviously be very beneficial to the director, and he would increase his performance in order to make sure that, when he sold the shares, the shares were worth much more than R80. The whole notion of share options was that they were used as performance incentives. Throughout the history of South African company law, these incentives had always been allowed, and it would be unwise to change this. The Bill maintained these incentives, but required that they be subject to approval by the shareholders, and thus safeguard against abuse.

The Committee pointed out that some directors make billions from such agreements, and asked whether this did not allow for directors to manipulate the company’s performance to alter the share price. In some cases, such practice encouraged directors to be concerned only with the bottom line, and not necessarily with the efficiency of the company. This type of practice should be actively discouraged, and would put CEOs in awkward positions.

The DTI emphasised that there were no solutions to the above mentioned problems, but that this was a phenomenon experienced worldwide. The DTI admitted that, frequently, the share price was unrelated to the performance of the company. Often, share options do create unjustifiable windfalls for directors, and recently, a director of a UK telecoms company received somewhere in the vicinity of 90 million pounds in share options.

The Committee stated that share options were offered to employees too. Discrepancies between those share options granted to directors, and those granted to other employees should be reduced, particularly with regard to remuneration.

The DTI continued that the eradication of par value shares and nominal capital was following international trends.

The Committee asked the DTI to explain what a par value share was.

The DTI continued that a par value was simply an arbitrary value given to a share when the share capital was issued, and had nothing to do with the actual economic or market value of the share. The Bill was to do away with par value shares, and shares were therefore only to have an economic or market value. One could find this economic value in the financial statements of companies. Eliminating the par value share had been problematic, as, for reasons uncertain to the DTI, the European Union requires all member states to maintain the par value share.

The Committee asked what would happen if the company was owned 75% by foreigners and 25% by local stakeholders.

The DTI responded that one determined the jurisdiction of the EU by way of where the company was registered.

The Committee asked, with regard issuing shares to a director at a lower price, what the Bill intended with regard the phrase ‘non-cash consideration.’

The DTI stated that this practice was not new, and it was also just a matter of regulation. The Bill required shareholder approval for this too, and also in respect of property, which was what was meant by the term’ non-cash consideration’. The ‘shareholder approval’ mechanism inserted in this section of the legislation was a way of encouraging shareholder activism.

The DTI moved on to discuss the new financial assistance section, which moved away from the current Section 38 of the Companies Act. There was currently a blanket prohibition on financial assistance, but the Bill introduced increased flexibility. Such assistance would be permitted as long as the company was liquid/solvent; it was reasonable for the company to do so; and it has been approved by the shareholders. It was important to note that this was not an absolute right, and could be excluded in the memorandum of incorporation if so desired.

The Bill provided increased scope for debt financing, primarily in the form of debentures. The DTI emphasized that this method of debt financing could play a significant role in economic mobility. The Bill took a very flexible approach to debt financing, and all that was required was the appointment of a trustee, who was solely responsible for administering such debentures. Debt finance was, however, also subject to the same solvency/liquidity tests, which were applicable in respect of all distributions.

Shareholder activism was inhibited by the current provisions of the Companies Act as there were very low thresholds required for the passing of an ordinary resolution. In a private company the requirement was two members, whilst in a public company, only three members were required. The implications of this were that, in a large public company with millions of shareholders, it only required three members to pass a resolution which was binding upon all the rest. This was very problematic, and has been the topic of much debate. In the draft Bill, for the purposes of passing a resolution, the holders of 25% of the shares need to vote in order to validly pass an ordinary resolution.

The Committee asked whether it should rather be 25% of the number of shareholders, as opposed to 25% of the actual shares.

The DTI admitted that this was rather problematic, but that a voting by poll of hands was often not equitable. If one individual had 60% of the shares of a company, he did not want his vote to count the same as a member who owned 1% of the shares.

The Committee suggested a dual provision which would combat the above problem, providing for two alternatives subject to requirements. This would, the Committee suggested, strike a better balance. The Committee also asked how the DTI reached the figure of 25%. The Committee noted an uneasiness with this provision, and flagged it for later discussion.

The DTI stated that this could be catered for, but emphasized that this was an alterable provision. It explained that this meant that the company could alter the default rule by adopting another provision in its memorandum of incorporation. The 25% figure has been in use for at least a decade, and first emerged in the King Report on Corporate Governance. It was added that this figure may be inappropriate in countries such as the US and UK where there were large numbers of minority shareholders. However, South Africa had, to its detriment or otherwise, a high proportion of dominant or majority shareholders. The DTI stated that this was ‘as democratic as the Companies Bill could get,’ and added that it was very difficult to balance all the interests of various parties. Although it was important to entrench the concept of democracy within the bill, one had to be careful not to arrange voting rights in such a way as to disenfranchise certain individuals. This, on the contrary, would be completely unconstitutional. The Bill attempted to strike a balance, and the DTI emphasized that a fundamental principle of company law was that of ‘majority rule.’

The workshop was to continue on 16 May 2007.

[PMG only minuted this workshop until 16h00]