Is the independent director really independent?

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Introduction

Independent directorship has gained considerable significance in modern corporate governance, especially in developed economies. A basic feature of corporate governance codes in most jurisdictions is the use of non-executive directors who are usually independent of management. The non-executive director is a member of the board who does not have any executive management role. Thus, he is not involved in the day to day running of the business and has no contract of employment other than that by which he is appointed as a director hence he is referred to as an ‘outside director’. Independence broadly connotes the absence of interest in the enterprise which could affect the exercise of objective judgement. In Nigeria, there is no statutory provision for independent directors however, the practice is recognised and covered, albeit sparsely by the various corporate governance codes in the country. In this regard, the code with the broadest provisions on the issue of independent director is the Securities & Exchange Commission (SEC) code of corporate governance for public companies, 2011.

Definition

An independent director has been described by the SEC corporate governance code as –

“A non-executive director who:

i) Is not a substantial shareholder of the company, i.e. one whose shareholding directly or indirectly does not exceed 0.1% of the company’s paid up capital;

ii)  Is not a representative of a shareholder that has the ability to control or significantly influence management;

iii)  Has not been employed by the company or the group which it currently forms part, or has served in any executive capacity in the company or group for the preceding three financial years;

iv) Is not a member of the immediate family of an individual who is or has been in the past three years employed by the company or in the group in an executive capacity;

v) Is not a professional adviser to the company or the group other than in a capacity of a director;

vi) Is not a significant supplier to or customer of the company or group;

vii) Has no significant contractual relationship with the company or group and is free from any business or other relationship which could materially interfere with his/her capacity to act in an independent manner; and

viii) Is not a partner or an executive of the company’s statutory audit firm, internal audit firm, legal or other consulting firm that have material association with the company and has not been a partner or an executive of any such firm for three financial years preceding his/her appointment”

Apart from this detailed description, the code further provides that “an independent director should be free of any relationship with the company or management that may impair or appear to impair the director’s ability to make independent judgements”. The description given by the code highlights various criteria for the independence ‘litmus test’ which ought to be applied in the process of choosing an independent director; i.e. shareholding test, employment test, family relationship test, business relationship test, professional, advisory or consultancy relationship test, and a general omni-bus test that covers any form of relationship between the independent director and the company not specifically mentioned. These may not be exhaustive but they constitute a good foundation to guide the process of appointment of independent director.

For banks, there are some additional criteria that must be considered in appointing independent directors[i]. The person must not be a borrower of funds from the bank, its officers and affiliates; must not be part of an institution, charitable or otherwise supported by the bank in any form; should have sound knowledge of the regulation of listed companies, relevant laws and regulations guiding the industry; minimum academic qualification of first degree and not less than ten years relevant working experience with proven skills in their chosen field. In addition the benchmark period is five years for all other criteria such as employment test as stated above. The SEC code of corporate governance provides that where there is a conflict between the code and any other code in relation to a company covered by the two; the code with stricter provisions will apply. Although the Central Bank of Nigeria (CBN) guideline is not a code, it will apply to the extent that it would enable banks comply with the provisions of the code which has no detailed provision covering the issue. Thus in the case of banks, these additional provisions must also be taken into cognisance in order for the appointment of an independent director to be valid.

Fetters on the independence of the independent director

Despite the detailed provisions of the SEC code of corporate governance regarding independent directors, there are other issues that call for consideration in an attempt to ascertain the independent status of a director. These are appointment and tenure of independent directors and will be considered in turn. There are no specific provisions relating to the appointment of independent directors. Thus the provisions of the corporate statute relating to appointment of directors generally would apply. For the first directors, the law provides that they should be appointed by the subscribers to the memorandum of association of the company, a majority of them or they may be named in the articles of association of the proposed company. For subsequent appointments generally, it is the shareholders in a general meeting who are empowered by law to appoint directors by ordinary resolution.

The board of directors of a company could also appoint other directors subject to the approval of the shareholders at the next annual general meeting where a vacancy arises from death, resignation, removal of a director. This is referred to as filling a casual vacancy and where the newly appointed director is not approved by the shareholders in a general meeting, he would cease to be a director. Where all shareholders and directors of a company die, any of the personal representatives may apply to court to convene a meeting of all personal representatives of the shareholders entitled to attend and vote at a general meeting to appoint new directors to manage the company. Where the personal representatives of the deceased shareholders fail to do so, the creditors of the company, if any, shall be able to appoint a director.

In practice, the independent director, like other directors would normally be appointed by the board subject to ratification by the shareholders in a general meeting. Herein lies the first dilemma on the issue of independence. Nomination of a candidate for independent directorship may be influenced by personal relationship rather than the ability of such a person to contribute productively to board deliberations. Although the SEC code outlines some provisions to facilitate the process of appointment of directors; i.e. furnishing shareholders with the details and qualification of the nominee, as well as other relevant information; the board of directors still play a major role in the appointment process in Nigeria. That being the case, the independent director cannot be said to be truly independent. In the case of banks, however, there is some measure of external influence as the appointment of an independent director is usually subject to regulatory approval. It is suggested that this practice should be adopted by other regulatory authorities to ensure that the right calibre of persons are appointed as independent directors considering that they are agents of checks and balances for more effective and productive boards.

Another dilemma is the fact that the longer an independent director serves on the board, the more restraint there will be on his independence. On the other hand that the greater the director’s independence, the less he would know about the company. As such there is need for a balance. There is no specific provision for the tenure of an independent director in the SEC code of corporate governance and this is a major flaw in the code. The only relevant provision relates to non-executive directors which group covers the independent director. The code simply provides that the non-executive directors should serve for ‘reasonable periods’ on the board and the board should ensure periodic appointment of new directors to replace existing ones bearing in mind the need to reinforce the board by injection of new energy, fresh ideas and perspectives. In the circumstance, public companies are left to decide the duration of tenure of their independent directors. In the case of banks, the CBN stated the duration of office of independent non-executive directors for banks to be four year single term and a maximum of eight years of two consecutive terms[ii]. It is suggested that the CBN should consider a review of the duration especially the issue of a second term as an independent director who has served for more than four years may become too familiar with the system to remain independent and objective.

Conclusion

The practice of appointing independent directors has not been well entrenched in the Nigerian corporate architecture and their impact is yet to be felt. It is therefore important for the reviewers of the corporate governance code to consider and address the issues raised in order to maximize the benefit of independent directors on boards of companies.

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