A true Code of Best Practice

It Was Reported that the Malta Financial Services Authority was conducting a process of consultation with all interested parties on the update of the Code of Good Corporate Governance.

The public would surely like to know who is, in fact, representing the private investor in these consultations. The MFSA should be not fail, again, the small investors on this occasion. Unfortunately, the Malta Stock Exchange paid little, if at all, heed to the small fry, when it first came out with this code a few years back.

As one of the founder members of the then Mid-Med Bank Private Shareholders Association, which actually saved the small shareholders from a possible delisting of Mid-Med Bank shares, among other things, when Government sold its majority shareholding in the bank to HSBC Holdings of the UK, and subsequently, as a founder member of the Malta Shareholders Association, I feel the MFSA should seek to include a true representative of the private investors in its consultations, to ensure that their interests are not being ignored once again.

When the code was first being drafted, I, as chairman of the Malta Shareholders Association, together with my council, paid a courtesy visit to the chairman of the Stock Exchange. In the course of the meeting I recommended that to ensure that the private investors' interests were not being neglected the Working Group Committee appointed by the Stock Exchange Council to draft the Code of Good Corporate Governance should include a representative of my association. He agreed without any hesitation but later went back on his word, and denied the association a place on the committee.

In the circumstances, I had no option but to content myself with the MSE's only option offered to my association, and agree to forward to the exchange my association's views and suggestions in writing, when the draft code was actually prepared.

As soon as the document was forwarded to me, I immediately submitted the association's view for consideration. Regrettably, the recommendations fell on deaf ears.

In our view the prepared draft code lacked consideration of local circumstances, and definitely needed further input to take into account particular local situations.

The conspicuous absence of a representative of the private investor on the Working Group appointed to draft the code was evidenced by the fact that the interests of the private shareholders were not really addressed. Rather, the code concentrated on the sectoral interests of those who participated in the group.

Little, if at all, was said on the rights and safeguards of individual private investors. This issue was made more blatantly clear by the fact that public limited companies (plcs) were being encouraged to enter into 'dialogue' with institutional investors and market intermediaries, and disregarding completely the private individual investor.

In the case of companies controlled by majority shareholders, the code did not take into account the fact that many plcs quoted on the local stock exchange were controlled by a majority shareholder who nominates the majority of the board and who is in full control of the executive decisions taken by the plcs.

It was felt that 'appointed' directors do not feel at ease to act independently, and hence were compelled to act in the sole interest of the majority shareholder as directed, rather than in the interest of the company and all the shareholders. This was even more apparent when the appointed directors were employees of the institution concerned.

The issue advocating the division of responsibilities of the company's chairman and those of the chief executive officer had to be more tactfully taken on hand, particularly where the chairman was appointed by the majority shareholder. The division of responsibilities may be visible on paper, but in truth there may be no division at all, since the chairman acts under the direction of the CEO or on instructions, directly or indirectly, of the majority shareholder.

Most importantly, a Code of Best Practice must consider the possibility of abuse and/or misuse of the company chairman's rights (including insider knowledge), particularly in the lobbying for votes to elect to the board persons of his or the majority shareholder's choice. The lack of secrecy of the shareholders' voting rights was of concern to many. Again, this was of great significance where control of the company was in the hands of a majority shareholder.

Experience has shown that in many instances the majority shareholder managed to acquire 100 per cent control of the board of directors, simply by exploiting one's right to proxies and insider information to the detriment of other contestants to directorships, and to the private investor/shareholders generally.

The Code of Good Corporate Governance should therefore cater for such eventualities by forbidding directors appointed by the majority shareholder, as well as executive and staff of the company concerned to lobby among minority shareholders with a view to influence their votes at annual general meetings.

The code must provide for a fair and transparent process in electing/appointing directors to the boards of listed companies. Otherwise the issue of the independent directors in the boardrooms will continue to be hampered seriously. The best safeguard for a truly above-board approach to the situation is the setting up of an election commission made up of, say, a representative of the company concerned, the stock exchange or the MFSA, as regulator, and a representative of the private shareholders.

The commission, which will be bound by total secrecy/confidentiality, should be responsible for receiving proxies and to supervise the whole election process from the moment the AGM is announced.

Directors, particularly non-executive directors, who may sit on other boards, in whatever capacity, and which has a business relationship with one another, should sign a declaration to that effect. Such a declaration should be made public.

It is also imperative that the Code of Best Practice be scrupulously observed by all listed companies. I am inclined to suggest that this code should be extended to include the private limited companies and government-owned/government-controlled companies and/or corporations. I trust that the authorities have been monitoring the observance or otherwise of the code. If the observance of the code is not up to scratch then it is high time that the authorities regulate or legislate without undue delay.

The issue of institutional investors surely deserved a short reference. The code definitely needs to cater adequately for these entities. In the interest of institutional shareholders, the need to protect effective autonomy in the exercise of voting rights by institutional investors, which in many instances are themselves controlled directly or indirectly by the boards of the plcs themselves, or by the majority shareholder of the plc, is imperative.

This issue cannot be overlooked again. At the very least the institutional investor should be obliged to make full disclosure of its voting decisions. Ideally, where the institutional investor has to vote in general meeting of its parent organisation, then such voting rights should be delegated to an independent group of investors, which more widely represent the true identity of the beneficial owners of the investment managed by the institutional investors.

In an endeavour to assist the truly independent director in the exercise of his duties and obligation as a director, the code should grant the independent director the automatic right to revert to the appropriate authority/regulator, in cases where he considers his position on the board as becoming untenable due "to oppression" from other members of the board, particularly in the case of a majority shareholder.

A mechanism should also be in place to enable all or any of the independent directors to communicate with shareholders on issues that they believe are of interest to them (the shareholders).

Independent directors should also have the liberty to seek independent legal advice on how to carry out their duties as directors. Costs in connection with such action(s) are to be borne by the plc concerned.

John G. Borg-Bartolo, FCIB is a former senior Central Bank executive and a former non-executive director on the board of HSBC Bank Malta plc. He also served for eight years as bank inspector, a ministerial appointment.