The final round of the Financial Services Royal Commission hearings - focusing on policy issues arising out of the previous six rounds of hearings – commenced on 19 November, and has already seen issues that go to the heart of governance and board processes being ventilated.
Questions have been asked in relation to the board’s role with respect to holding management to account, as well as the appropriate use of board discretion to adjust senior executive remuneration outcomes.
There has also been discussion of important board governance matters including director induction processes, board meeting agendas and approach to minutes of board meetings.
These key themes are explored below.
Challenge of management
A core function of a board is to hold management to account. Non-executive directors need to have inquiring minds, and be prepared to challenge and ask probing questions of management.
The role of the board and the non-executive director have been a long-standing feature of the Australia’s corporate governance framework, but the hearings held by the Royal Commission, as well as the APRA Report into CBA, have shone a spotlight on the model and provided valuable learnings for corporate Australia. It is clear that boards are expected to:
- exercise rigor and urgency in mitigating risks and solving issues;
- constructively challenge management and test the trust they must necessarily place in the CEO and other senior executives (“don’t tell me, show me”);
- be more visibly engaged in relation to operational risk, customer issues, and regulatory compliance;
- avoid complacency about risk, even (or perhaps particularly) in the context of strong financial performance and shareholder returns; and
- engage in more rigorous and detailed analysis to justify remuneration outcomes, including through the lens of conduct and risk issues in the organisation.
The evolving commentary on expectations of boards will no doubt prompt introspection at a board level. Questions boards may wish to consider include the following:
- Are board committee structures appropriate, and do they effectively support the board in considering board-level issues?
- Does there need to be greater engagement with senior executives and other stakeholders to ensure there is not an overreliance on one or a small number of individuals? In particular, is the board overly-reliant on its relationship with the CEO?
- Is board reporting adequate?
- What metrics are used to measure culture, and are these adequate?
- How is the customer voice elevated to the board?
- Do we need to conduct external benchmarking to ensure that risk and governance practices are tested in a robust way?
Board composition will continue to be critical in supporting effective board dynamics. Boards should comprise directors with the right mix of skills and experience and cognitive diversity, and strike a balance between retaining institutional experience and ensuring continuity, while promoting ongoing board renewal. It will also be critical to have relevant industry expertise around the table. An AICD Director Tool on board composition can be accessed here.
The policy round of hearings has also picked up a key theme of Commissioner Hayne’s interim report - remuneration.
In AICD’s submission on the interim report, we stated that companies should review remuneration frameworks closely for alignment to desired culture. This involves reviewing the appropriateness of the performance metrics used (including non-financial metrics), robust assessment that considers both what has been achieved and how it has been achieved, and holding individuals to account through remuneration outcomes (including through the application of effective malus or clawback clauses).
It is clear that appropriate adjustments to variable remuneration need to be made at all levels of an organisation where risk failures have occurred. In the context of executive remuneration, this will involve robust challenge of management recommendations by a remuneration committee (or equivalent board committee) and require the committee itself to turn its mind to performance assessments through the lens of risk and conduct issues. In the context of other employees, clearer guidance may need to be communicated to managers throughout the organisation in relation to expectations about variable remuneration and when adjustments need to be made.
While external benchmarking may assist in assessing appropriateness of remuneration outcomes, it may not be sufficient, particularly where there are industry-wide problems. It is important that there is also internal reflection about what is appropriate in the context of a particular organisation.
It is also clear that there is an expectation that variable remuneration be used as a way to reward staff for ‘doing the right thing’ (for example, identifying a breach of the law) and promoting sound risk management.
The role of investors is also critical, and boards and management need to be willing to defend the appropriateness of the structures they have implemented, including inclusion of non-financial metrics.
Director induction processes have also come under the spotlight, which will likely prompt companies to consider their current practices.
Induction processes should encompass not only the nature of the business, but also key risks and issues facing the company. Directors must be given the opportunity to meet with key senior executives, attend site visits, and ask questions of executives, other employees and fellow directors, as needed.
There should be a concerted focus on getting directors ‘up to speed’ as quickly as possible (recognising, of course, that this will necessarily be an involved process in the context of a large and complex organisation). Directors should also be considering what due diligence they are undertaking before accepting a position. Do they know what they are committing to and the amount of time involved? If a business is expected to go through a particularly challenging period, there must be contingency to deal with such issues in amongst other work and personal commitments. Going one step further, directors should be thinking about how they would handle an unanticipated surge in workload from other board roles. The AICD Director Tool on board composition (accessible here) includes guidance on evaluating an organisation before joining.
Although each board will have its own dynamics, the Royal Commission has highlighted the need for each director to bring their own inquiring mind to the issues before them. While the chair’s role is pivotal in allowing the board to operate effectively, other directors should not stay silent where they have concerns.
All directors can potentially incur legal liability, and so must feel empowered to speak up, even when doing so might be uncomfortable. This is even the case where the director may recently have been appointed, and to mitigate against the risk of “group-think” and allowing the chair or any other directors from dominating the discussion. An AICD Director Tool on board performance (including improving board effectiveness) can be accessed here.
Boards and committees should reflect on meeting agendas to ensure they are spending time addressing the most important issues to the company (which will not always be the most urgent), and that they have set aside adequate time to enable constructive debate and reflection.
The inclusion of an in-camera session in the agenda may assist the non-executive directors to raise or explore any issues of concern or clarification prior to the meeting without the presence of management. Greater time for meetings, and increased frequency, may also be necessary at critical times. An AICD Director Tool on board agendas can be accessed here.
Another key issue that has been raised during the current round of hearings relates to the preparation of board minutes.
It is a well-established governance practice that board minutes are used to record the resolutions and proceeding of a board meeting. They should not serve as a transcript of the discussion during the meeting, or a recording of an individual director’s contribution.
However, in the hearing Counsel Assisting, Rowena Orr QC questioned Catherine Livingstone on why the minutes of CBA’s October 2016 board meeting did not contain a record of when Ms Livingstone challenged management in relation to a regulatory report, which contained details of the responses by management to issues of AML/CTF and other regulatory matters.
The minutes recorded that management had presented the regulatory report and that “matters were discussed”. However, the minutes did not contain any reference to any challenge to management by any directors, including Ms Livingstone, about the report.
Specifically, Ms Orr QC appeared to raise the issue of whether the approach taken by CBA to the board minutes was in compliance with s 251A of the Corporations Act 2001 (Cth).
Section 251A of the Corporations Act requires minutes of “proceedings” and “resolutions” of directors’ meetings, including meetings of a committee of directors, to be recorded within one month, and signed within a reasonable time after the meeting by the chair of the meeting or the chair of the next meeting.
This section makes clear that minutes of proceedings and resolutions of directors’ meetings are required by law. However, as stated above, it is generally not required for minutes to record the reasons for the decisions made. As Justice Young stated in John J Starr (Real Estate) Pty Ltd v Robert R Andrew (Australasia) Pty Ltd (1991) 6 ACSR 63 at 89-90, minutes are “not a report” and “speeches and arguments normally do not appear in minutes”.
Given that Ms Livingstone’s challenging of management was not a “resolution”, it will be interesting to see whether Commissioner Hayne considers this issue in further detail, or makes any comments in relation to the established practice of minute taking, particularly in relation to directors who challenge or question management reports. The AICD has recently released a Director Tool on Board Minutes. You can access this tool here.
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