What does the new Companies Ordinance have to say about conflicts of interest? What should you do if your chairman has declared an interest in a matter under consideration by the board? Does the practice of ‘wearing different hats’, as a method of segregating an individual’s various roles, actually work? This month CSj looks at the management of conflicts of interest and conflicts of roles.

T he listing rules and Companies Ordinance in Hong Kong have a lot to say about conflicts of interest and connected transactions. This makes a lot of sense in a relatively small jurisdiction where most companies are majority shareholder controlled. Given this highly developed regulatory regime, the management of conflicts of interest is firmly entrenched in the company secretary’s compliance function. Peter Greenwood FCIS FCS, former Company Secretary of CLP Holdings, points out that company secretaries can play a central role in ensuring that this area of risk is effectively addressed and managed.

‘No-one should be better placed than the company secretary, by virtue of his/ her role, training, professionalism and objectivity, to promote the effective management of conflicts of interest. An effective and trusting partnership between the company secretary and the chairman is the bedrock of conflicts management,’ he says.

But in addition to assisting in the management of conflicts of interest, company secretaries also need to keep tabs on a related area of risk – conflicts of roles. This is particularly relevant for the company secretary where he or she doubles up in another official capacity within the same company.

Conflicts of interest

Step one: disclosure

The principle for managing conflicts of interest is relatively simple. ‘Fortunately, conflicts of interest are extremely sensitive to light – in this case in the form of transparency and disclosure,’ says Greenwood.

With the implementation of the new Companies Ordinance (Cap 622) last month, the statutory controls in this area have just been upgraded. In particular, Cap 622 widens the application of the provisions on the disclosure of directors’ interests. Directors now have an obligation under the Companies Ordinance to declare the nature and extent of their interests in any transaction, arrangement or contract to the board. These disclosure requirements have also been extended to shadow directors.

In practice there may be some doubt, however, as to when this disclosure obligation is triggered. Sometimes conflicts of interest are glaringly obvious: directors awarding a lucrative contract to a company owned by a connected party, or favouring a close friend or relative in a recruitment exercise, for example.

But conflicts of interest do not always come so conveniently caparisoned with flashing red lights and warning bells. A conflict of interest can arise whenever the private interests of individuals conflict with their fiduciary duties – clearly not an uncommon scenario.

The ICAC’s Good Governance and Internal Control – A Corruption Prevention Guide for Listed Companies points out that it is impossible to list all of the situations that would trigger a disclosure obligation; ‘directors are themselves the best judge of their circumstances which warrant declaration at board meetings,’ the guide says.

Ultimately, an individual’s personal ethics play a central role in conflicts management. ‘Conflicts of interest are highly possible in an environment where there is a predominance of large family or state ownership,’ said one respondent to this article, ‘but a strong moral compass will mitigate such conflicts. Absent that, a good grounding on the duties of directors coupled by adequate enforcement would be the absolute minimum. Thus a “carrot and stick” approach may be necessary. The new provisions on directors’ standard of care in the Companies Ordinance should be helpful in this regard although much depends on the judicial interpretation when implemented.’

If you are in doubt as to whether the statutory obligation to disclose has been triggered, Greenwood believes, the best policy is to disclose anyway. ‘As soon as you think you might have a conflict, you do have one and you should disclose early and fully. In practice, there is rarely, if ever, a substantive downside to disclosing a conflict of interest (and recusal from board discussion on the conflicted issue). And this will always be outweighed by the material risks of non-disclosure,’ he says.

Step two: recusal

It is important to bear in mind that disclosure of a conflict of interest is only step one in the process. Jeffrey Kaplan, Partner of US law firm Kaplan & Walker LLP, pointed out in the February 2013 edition of this journal (see ‘Behavioural ethics’, page 9) that disclosure of a conflict of interest may not always have the mitigating effect you might expect. Firstly, those who disclose conflicts may feel that they are therefore released from the moral restraint that the conflict should impose on them. Secondly, those to whom a conflict has been disclosed may feel the need to accept the conflict out of concern that they would otherwise be suggesting immorality on the part of the conflicted party.

The all-important second step in the process is recusal of the conflicted director from any board discussion and voting on the conflicted issue. This is often where the company secretary becomes closely involved in the process since it requires some key adjustments to the usual board meeting practices. The ICAC’s Good Governance and Internal Control – A Corruption Prevention Guide for Listed Companies has some useful recommendations in this area. Companies should:

  • ensure directors abstain from voting for resolutions in which they or any of their associates have a material interest
  • ensure that, if the chairman has declared an interest in a matter under consideration, the chairmanship is temporarily taken over by a vice-chairman ensure that, if a director has a conflict of interest in a matter to be considered by the board which the board has determined to be material, a physical board meeting is held – the matter should not be dealt with by way of circulation of resolutions
  • withhold circulation of the relevant papers to a director who has a declared conflict of interest, and
  • record all cases of declaration of interest in the minutes of the meeting.

Regarding the last point above, company secretaries often have the task of maintaining a confidential register of directors’ declared interests.

In addition to these administrative tasks, company secretaries also need to consider conflicts of interest in their advisory role. This will usually involve:

  • advising the board on conflicts of interest risks
  • keeping directors informed of the statutory and internal requirements regarding conflicts of interest (at induction and on an ongoing basis), and
  • ensuring directors are kept informed about the effectiveness of the company’s internal controls and any breaches of the company’s code of conduct/ ethics in this area.

Step three: disinterested shareholders’ approval

Where corporate actions are involved, companies need to consider this third stage in the management of conflicts of interest and this is another area where the statutory requirements have been tightened by the new Companies Ordinance. Cap 622 attempts to close a number of loopholes in the old Companies Ordinance (Cap 32) relating to shareholder approval of corporate actions where connected parties and potential conflicts of interest are involved.

For example, Cap 622 now requires disinterested shareholders’ approval for many such corporate actions of public companies and their subsidiaries. The old Companies Ordinance (Cap 32) required shareholders’ approval, but where the directors proposing, and the shareholders approving, such transactions were one and the same, as was the case in some majority shareholder controlled companies, such an ‘approval’ process was in form only.

Conflicts of roles

The statutory and regulatory requirements relating to conflicts of interest tend to focus on directors, but the underlying principles of transparency and recusal should be applicable to all employees – company secretaries included. A related area of risk – conflicts of roles – is particularly relevant for the company secretary where he or she doubles up in another official capacity within the same company.

‘Segregation of duties of similar key positions in a company, such as internal auditor, company secretary, chief financial officer, treasurer and so on, is one of the methods to manage role conflicts effectively. This will ensure an effective check and balance within the company,’ says Ken Chan, Company Secretary and General Manager of the Board Office, China Aerospace International Holdings Ltd.

It used to be relatively common in Hong Kong for company secretaries to undertake dual executive roles, often doubling up as the chief financial officer, but the workload of a company secretary is now so extensive, and has increased so significantly in recent years, that it has become very difficult for individuals to combine the company secretary role with another senior executive position.

‘On balance it is difficult to see how a company secretary’s role can be genuinely and effectively combined with any senior executive role,’ says Greenwood, ‘other than one which has some functional link, such as head of the legal department.’

There has been an increasing trend, however, for company secretaries to join their own board as a director and this arrangement can result in role conflicts. While both the director and the company secretary roles owe the same fiduciary duties to the company as a whole, the roles are far from being identical. In particular, will a dual director/ company secretary be in a position to provide independent advice to the board?

‘There is definitely a conflict between the company secretary’s role in serving the board and the chairman, including through the provision of objective and independent advice on all aspects of governance, and his or her role as a director with individual rights and responsibilities,’ says Greenwood.

He adds, however, that this type of conflict exists for every executive who also serves as a director and is particularly acute for any executive, such as the company secretary or chief financial officer, who reports to the chief executive. He believes that the only way the company secretary can manage this is through an excellent working relationship with the chief executive and chairman.

‘You can scarcely disagree with your own boss at a board meeting, but as a director you are entitled, possibly obliged, to offer your own view,’ he says. ‘It helps of course if there is an awareness on the part of the chief executive that, in the last resort, the company secretary’s highest duty is to the chairman and the board.’

Does ‘wearing different hats’ work?

Conflicts of roles are difficult to avoid, particularly in smaller companies with fewer resources, and the most common method individuals in this situation adopt is to ‘wear different hats’ depending on which function they are performing. Respondents to this article point out that the success of this gambit relies on the ability and willingness of others, be they executive or board colleagues, to recognise and respect the differences between the two functions.

‘The role conflict cannot be solved unless there is an awareness of the importance of corporate governance by each of the directors,’ says Ken Chan. He adds that there can be advantages where company secretaries join their own board as a director. ‘If company secretaries act as directors simultaneously, it will enhance their seniority in the company and may strengthen the corporate governance of the entire company.’

Another relatively common practice in Hong Kong is for companies to have a dual chief executive/ chairman. While this practice is now discouraged and sometimes prohibited in jurisdictions outside the US, it is still not uncommon. This is certainly true in Hong Kong – the code provision (A.2.1) in Hong Kong’s Corporate Governance Code calling for the chief executive and chairman roles to be performed by separate individuals has the lowest compliance rate of the whole code.

According to the Analysis of Corporate Governance Practice Disclosure in 2012 Annual Reports issued by Hong Kong Exchanges and Clearing in November 2013, the most common reason listed companies gave for non-compliance with code provision A.2.1 was that one person performing the roles of both chairman and chief executive can provide strong and consistent leadership, and can enable more effective planning and better execution of long-term strategies.

Respondents to this article point out, however, that having a separate chairman provides independent oversight of the chief executive. Having a dual chief executive/ chairman, Ken Chan says, deprives the company of an important check and balance on the chief executive’s power.

‘The root of the issue is the inherent conflict between the board’s vital role in overseeing management and the chief executive’s role in leading, speaking for and embodying that management,’ says Greenwood. ‘Solutions such as having a senior independent director are palliative or cosmetic, given the scale of that conflict,’ he adds.

 

Kieran Colvert, Editor, CSj

The ICAC’s ‘Good Governance and Internal Control – A Corruption Prevention Guide for Listed Companies’ is available online at: www.icac.org.hk.

The ‘Analysis of Corporate Governance Practice Disclosure in 2012 Annual Reports’ issued by Hong Kong Exchanges and Clearing (HKEx) in November 2013 is available on the HKEx website: www.hkex.com.hk.

Jeffrey Kaplan’s CSj article can be found online at: http://csj.hkics.org.hk (see the cover story ‘Behavioural ethics’ in the February 2013 edition).

 

SIDEBAR: Managing conflicts of interest: checklist

  • Do you have effective internal controls for the management of conflicts of interest?
  • Are conflicts of interest dealt with by your company’s code of conduct/ ethics?
  • Does your company offer training to ensure that employees and directors understand the issues and follow procedures?
  • Does your company have a designated officer tasked with managing conflicts of interest and to whom employees and directors can address queries?
  • Does your company take effective disciplinary action in cases of noncompliance?

 

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