Another corporate governance code for Guyana

The Council of the Private Sector Commission (PSC) of Guyana on April 7, 2011 accepted a Code on Corporate Governance which could have some transformational effect on the way Guyana companies are managed. The code has its origins in the National Competitiveness Council and was identified among eight priority matters at a meeting in 2007. The indications are that organisations representing attorneys-at-law, bankers, accountants, internal auditors, the Deeds Registry and the Guyana Securities Council participated in the preparation of the draft led by an “expert on Corporate Governance.” There is no indication whether the public companies were consulted by way of a draft for discussion or participation in any forum.

There is no effective date for the code suggesting that its principals assume that it is to take immediate effect. Perhaps its authors are unaware that compliance will require some companies to amend their existing by-laws. The sixteen page document contains three sections and an introductory part referred to as the ‘Basis for the Code.’ Not quite correctly, the code describes itself as the “first version” of a Corporate Governance Code for Guyana.

Securities Council
In fact, many years ago, the Securities Council published in 2004 Recommendations for a Code of Corporate Governance in Securities Markets. Unfortunately, those recommendations were ignored by many public companies and the Securities Council was never able to translate the recommendations into a binding code. But not only were the recommendations ignored by many but they were actually challenged by a senior executive of Demerara Tobacco Company Limited, Mr Chandradat Chintamani, now a director of Demerara Distillers Limited, one of Guyana’s premier public companies. Mr Chintamani, echoing the public sentiments of his then boss Mr Michael Harris, wrote in 2004 that he was “unaware of the requirement for a public company to provide a statement on Corporate Governance.”

Bank of Guyana
More recently, the Bank of Guyana, acting under the authority of the Financial Institutions Act of 1995 (FIA) and the Bank of Guyana Act issued Supervision Guideline 8 – Corporate Governance. That guideline which came into effect on January 14, 2008 covers a variety of governance related issues.

I do not recall any occasion on which the Bank of Guyana has expressed concerns about non-compliance with the guideline, no doubt because both bank and non-bank financial institutions require a licence from the Bank of Guyana in order to operate. This is a very useful if coercive tool that almost certainly guarantees full compliance.

Banks, DEMTOCO and DDL
The Chairman of the PSC is Mr Ramesh Dookhoo, who is also an executive of Banks DIH while Mr Chintamani is, (or was up to recently), a member of the executive of the PSC. Would Mr Dookhoo and Mr Chintamani ensure that the companies with which they are associated comply with the code they now recommend? This question is relevant because the PSC’s code does not constitute mandatory or enforceable principles. As the code itself says, it provides a list of the main principles of what is commonly agreed to be good corporate governance practice. Ironically, the PSC code has no more authority than the Securities Council’s recommendations, and it would be interesting to see whether the PSC’s leading members, acting in their company capacity, will take their new code seriously.

The code encourages companies to report on how they apply relevant corporate governance principles in practice, and also to be responsible enough to give an explanation to the shareholders of the reason(s) if they deviate from the code. This is sometimes referred to as ‘comply or explain.’ The code also calls on companies to provide information on their corporate governance policies and principles at the request of shareholders for further evaluation, the very things DEMTOCO said they would only provide if the law so required it.

The PSC code
Let us now look at some of the code’s main provisions that appear to warrant attention.

Section I: The Board of Directors
This section contains eight principles and runs to eight pages.

Principle 1 paraphrases the provisions of the Companies Act 1991 with respect to the powers, functions and duties of the directors. One new and interesting feature is the requirement that the annual report “set out the number of meetings of the board and those committees and individual attendance by directors.”

Principle 2 boldly calls for a clear division of responsibilities at the head of the company and makes it mandatory that the Chairman and Chief Executive Officer (“CEO”) be separate persons. It also requires that the division of responsibilities between the Chairman and CEO be clearly established, be set out in writing, and be agreed by the Board.

This separation of the CEO and the Chairperson has been widely discussed in these columns before. The ‘big man’ culture in Guyana is for a unification of these functions into one holder. Guyana has larger-than-life incumbents in these positions at Banks DIH and DDL, but with the lead persons in the PSC directly associated with those two companies it seems reasonable to assume that those companies are in agreement with the rule.

Interesting too is Principle 3 ‘Board Balance and Independence’ which distinguishes between executive, non-executive and independent directors. In fact the code suggests that there is a rebuttable presumption of non-independence in several circumstances including if the director has been an employee of the company or group within the last five years; participates in the company’s share option or a performance-related pay scheme, or is a member of the company’s pension scheme; has close family ties with any of the company’s advisers, directors or senior employees; holds cross-directorships or has significant links with other directors through involvement in other companies or bodies; represents a significant shareholder; or has served on the board for more than nine years from the date of their first election.

Reinforcing these stringent conditions, the code requires that at least half the board, excluding the chairman, shall comprise non-executive directors determined by the board to be independent, applying the tests and conditions set out. If applied strictly, this is revolutionary.

Appointments to the Board must be done by way of an Appointments Committee which itself must make available its terms of reference, explaining its role and the authority delegated to it by the board. The terms and conditions of appointment of non-executive directors shall be made available for inspection. The letter of appointment shall set out the expected time commitment.

Principle 5: ‘Information and professional development’ requires among other things that the Board ensure that directors, especially non-executive directors, have access to independent professional advice at the company’s expense where they judge it necessary to discharge their responsibilities as directors.

Principle 6: ‘Performance Evaluation’ is no less important. This principle requires the board to undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors. At least every three years, this evaluation should be externally facilitated.

Principle 8: ‘The Level and Make-up of Remuneration’ requires that a significant proportion of executive directors’ remuneration shall be structured so as to link rewards to corporate and individual performance. Of course the risk here is the manipulation of results to earn higher levels of remuneration.

Interestingly, the code does not address the issue of disclosure so that shareholders will have to assume that everything is alright.

Section II: Disclosure and Accountability
Just when the code was heading in the direction of becoming truly progressive, it begins a dramatic downward slide. Much of what is stated under this section – except for a mandatory Audit Committee – is required by the Companies Act. The section is a misnomer since none of the three principles under the section addresses disclosure. In fact, they address financial reporting, internal control, and audit committees and auditors (barely).

Section III: The Relationship with Shareholders
This section contains three principles: communications with shareholders, constructive use of the AGM and shareholder voting. The code superfluously requires non-executive directors to attend all shareholders’ meetings, a requirement of the Companies Act.

It is a pity that the bankers did not draw the code’s architects’ attention to Supervision Guideline 8. While there are some progressive principles in the PSC’s code, it is not mandatory and there are a number of major omissions from what would be considered a modern Corporate Governance Code.

In these days when everything is about the environment, it would have been encouraging to have seen some nodding acknowledgment to sustainable use of resources and respect for the environment. Risk management, compliance with the law and disclosure are areas which are under-addressed.

The PSC has not indicated whether it will monitor companies for compliance. It should.

Revisiting Corporate Governance

Even accountants can benefit from a periodic encounter with history and as this column revisits the never ending journey to arrive at the Nirvana of Corporate Governance, it is good that we recall a few facts. For example, that the modern quest for good CG began in the UK in 1992. And that the reasons for that search are at least as important as the initiators of the Cadbury Report – the Financial Reporting Council, the London Stock Exchange, and the accountancy profession.

The report came on the heels of the death of Robert Maxwell while cruising on the Canary Islands in 1990, which saw the spotlight coming down on his business empire. It soon emerged that like his modern day counterpart Bernie Madoff, he had been tampering with pension funds to service huge and expensive debt burdens. Like all Ponzi Schemes that one was doomed to failure and soon after, Maxwell’s companies filed for bankruptcy protection in the UK and US. At around the same time the Bank of Credit and Commerce International, at the time the 7th largest private bank in the world with assets of US$20 billion, went bust and lost billions of dollars for its depositors, shareholders and employees. Another company, Polly Peck, received a clean report from its auditors showing healthy profits one year only to declare bankruptcy the next.

Cadbury is sweet
The financial community and the accounting profession recognised that their reputation and that of London as a world financial centre was at stake. They had an interest to act – and so they did, initiating a report that by its very name – Financial Aspects of Corporate Governance – suggest this common interest. The name also confirms that the report was concerned only with the financial aspects of CG and it was left to others to take up the non-financial elements of corporate governance. That continuous effort has been taking place across the world from America to Africa and the most recent revision of the code on corporate governance is in South Africa with the King 3 Report on Corporate Governance.

Developments in Guyana have progressed far more slowly and some very fundamental issues remain to be addressed. We will deal briefly with these in today’s column, influenced by an event abroad which touches directly on an ongoing issue in Guyana – that of having the role of the chairman of the board and the company’s CEO being performed by the same person. But the search for an appropriate corporate governance model for Guyana is bigger and wider than this. There is no one-size-fits-all solution. The search has to be informed by and takes account of the social context and legal framework of the country.

One-man shows
Our very own constitution seems to feel that there is nothing wrong with combining a host of roles burdening us with an Executive President that chairs Cabinet but not accountable to the National Assembly or to the people other than by periodic elections. GECOM also has an entrenched Executive Chairman; while the private sector organisations have structures and chairpersons or presidents who for all practical purposes are also the CEO. To be fair, there is no hard evidence that splitting the functions automatically makes for a more successful company. As the Economist of October 17, 2009 reminds us, academics over the past two decades have produced more than 30 studies comparing the financial performance of companies that divide the two roles with those that combine them. Enron and WorldCom of which readers of this column are all too familiar both split the two jobs, and so too did the Royal Bank of Scotland and Northern Rock, which had to be bailed out in the 2008/2009 financial crisis in the UK.

Principle and pressure
The case for the splitting of the jobs which started with Cadbury is however based strongly on principle – some may even say theory – democracy, and widespread practice in Canada, Australia, much of continental Europe and Britain where 95% of companies in the FTSE 350 list have an outside chairman. The corresponding number among America’s Standard & Poor’s top 1,500 companies is 47%. Yet, the economic crisis that has hit and cost the US trillions has put the defenders of the joint role on the defensive. Earlier this year, shareholders forced Ken Lewis to surrender his second hat as chairman of Bank of America.

More recently, following on their success in persuading Sara Lee – the American global fast moving consumer goods company with one of the world’s best-loved and leading portfolios of food, beverage, household and body care products – to split the two jobs, the managers of (Norway’s) Norges Bank Investment Management which manages a state pension fund of $400 billion, are trying to persuade four American companies—Harris Corporation, Parker Hannifin, Cardinal Health Incorporated and Clorox—to do likewise. They may yet succeed.

Some companies are taking action rather than be pushed. One of the first things that some of America’s troubled banks, including Citigroup, Washington Mutual, Wachovia and Wells Fargo, did when the crisis hit was to separate the two jobs. It did not matter whether the losses they suffered could have been averted by separation or that their action may be purely cynical – something had to be done and the least cost option that offered up itself was the split.

A skit
Yet the theory or the logic cannot be dismissed and therefore bear repeating. It can well be demonstrated by a skit in which the chairman who instructs the company secretary on the contents of the Agenda, calls the meeting to order and soon calls on the CEO to present the report on operations for the preceding period. At that point the Chairman takes off one hat, puts on another and addressing fellow directors through the Chairman begins “Thank you, Mr. Chairman, …..”. Since the most informed and powerful person in the room is (also) the Chairman he then directs all the questions to himself. If the boss is chairing its meetings and setting its agenda, the board cannot discharge its basic duty under the Companies Act 1991, nor can it act as a safeguard against corruption or incompetence when the possible source of that corruption and incompetence is sitting at the head of the table.

Huge Personalities
There are only a handful of public companies in Guyana with a few of them having separated the functions of chairman and those of the CEO, mainly the commercial banks. Banks DIH, DDL, Stockfeeds and Guyana Stores have not, either because of history or in the case of the latter two because of the overwhelming stake the chairman and CEO has in the company. Messrs. Clifford Reis and Yesu Persaud are such huge personalities that it is hard to expect or imagine them other than as supremo, despite the potential dangers and obvious conflicts of interest. America has not ignored the problem and its boardrooms are now more democratic than they were when Jack Welch, described by Warren Buffett as the Tiger Woods of management, ran General Electric. To reduce the concentration of power and authority in one man (it is hardly ever a woman), more than 90% of S&P 500 companies have appointed “lead” or “presiding” directors to act as a counterweight to a combined chairman and chief executive. This person is invariably chosen from among the independent directors, referred to by Cadbury as Non-Executive Directors.

The problem for us is that there is no culture of independence and directors are more often than not selected rather than elected. If a vacancy arises on a board, the directors are empowered under the company’s rules and the law to fill it as a “casual” vacancy and on every case I know of, that person’s election is a formality at the next meeting of the shareholders.

And that selection is done under the majoritarian concept known in politics as winner takes all. In business once a shareholder controls the votes at the AGM, s/he has almost unfettered powers over the company, notwithstanding the minority protection mechanisms in the Companies Act. Better, or worse for the other shareholders, if the shareholder has 51%.

The independent director
Directors’ powers derive from section 59 of the Companies Act while their duties are set out under section 96 of the Act. This requires them to act honestly and in good faith with a view to the best interest of the company, including the interest of the employees in general as well as the shareholders. In a country where it appears that the President is unaware of the provisions of the Constitution, members of the National Assembly argue about basic procedures, and leading attorneys-at-law argue over whether a magistrate can hold a voir dire, it is not unlikely that the majority of directors may never read, let alone understand the Companies Act and the “fiduciary duty” the Act imposes on them.

Non-executive directors are mainly drawn from the shareholders’ other companies and the community to bring some particular expertise or even an element of acceptability to the company. Only the most sophisticated company encourages or tolerates real independence of its independent directors who are hardly ever known for engaging publicly in controversial issues.

The price of failure
Yet with a market for share trading that is far from transparent; a media that is generally not interested in or au fait with the jargon of investing; a consequently under-informed public and under-resourced regulators including in some cases professional bodies, the non-executive directors have an important duty and function to perform. Unfortunately conflicts of interest brought on by self-interest often mean that that function is not only not discharged but more seriously is often compromised. A most telling and very recent case of this compromising of the role and duty of the non-executive director involved a Chartered Accountant who one day after clearing key directors of a company of a complaint about financial impropriety, accepts a position on their board. That not only hurts the shareholders of the company but it undermines confidence in the company and loses further respect for the accounting profession.

There are of course other issues relating to corporate governance that will require attention. These include: their application to non-public companies and if so, how; whether or not corporate governance is better dealt with under principles or guidelines; whether the Companies Act and its administration will be improved by bringing into operation the Deeds Registry Act; the nature of sanctions given that they often hurt the small shareholders who are already victims; and whether there should be protection for whistle-blowers.

For us in Guyana, the dawn may have broken in 1992. We have made little progress since.

Truth Made-off leaving trail of cooked books

Over the years this column has reported on its fair share of scandals in the financial world, often in the biggest this and biggest that. Today we report on two such biggest – one from, you would have guessed, New York and the other India. The ingredients that make up these frauds are the usual suspects – persons too clever for their own good; greed; an unsuspecting public; poor oversight and accountants sleeping on the job. The historical economist and author Charles Kindleberger expressed it in slightly more elegant language, writing that “swindling is demand-determined, following Keynes’s law that demand determines its own supply, rather than Say’s law that supply creates its own demand. In a boom, fortunes are made, individuals wax greedy, and swindlers come forward to exploit that greed.”

Whatever it is, the vehicle used in the Madoff scandal is one that came to be known as a Ponzi scheme, a swindle offering unusually high returns, with early investors paid off with money from later investors. The scheme got its name from the Italian-born American resident who promised clients a 50% profit within 45 days, or 100% profit within 90 days.

While Ponzi was a known itinerant crook who served time on more than one occasion, Bernard Madoff, was a star of Wall Street, former chairman of the Nasdaq Stock Market and founder of Bernard L Madoff Investment Securities LLC, which had operated successfully for over four decades. And to support Kindleberger’s theory, the victims of what may turn out to be a US$50 billion swindle were not the small-town residents buying postal coupons, but top names in banking, show business, the intellectual class and many on the list of the wealthy. HSBC said its losses were about one billion US dollars while the Royal Bank of Scotland estimates its losses at US$600 million.

Investigators estimate that it will take more than two years to complete their work, but it is unlikely that they will ever come up with even reasonably precise figures. It is the nature of a Ponzi scheme that early investors do benefit, quickly receiving their initial capital from subsequent investors.

What must surely annoy is that once again there is failure of regulatory oversight. Last month, SEC Chairman Christopher Cox expressed grave concern at the “multiple failures over at least a decade to thoroughly investigate these allegations [at Madoff] or at any point to seek formal authority to pursue them,” ordering belatedly an internal review into the agency’s failure. And it is the same SEC that facilitated a three-employee accounting firm to audit Madoff on an annual basis. Brokerage firms like Madoff Securities are required to be audited by firms that were registered with the Public Company Accounting Oversight Board created after Enron to help prevent frauds.

Amazingly, the SEC allowed a waiver, which it extended on numerous occasions, to the audit requirement in respect of privately held brokerage firms. It is not surprising therefore that the auditors Friehling & Horowitz failed to detect the large Ponzi scheme run by Mr Madoff. Ironically, in its latest extension of the rule, issued December 12, 2006, the SEC said it had determined that allowing such firms not to register was “consistent with the public interest and the protection of investors.” Well, well, well.

Now to India
India was not too long ago held up as the country where the Beatles would go to seek spiritual renewal. The country lost its innocence with the Indira Gandhi emergency of 1975, but still the myth of innocence prevails with former Australian cricket captain writing in the aftermath of the Mumbai bombing in November that India had been “robbed of its innocence.”

Now in a twist of irony, one of its top information technology companies that have led the way in the in-sourcing credited with the country’s economic boom, Satyam Computer Services Ltd, has found itself embroiled in a scandal dubbed by commentators as “India’s Enron.” The word ‘Satyam’ in Sanskrit means ‘truth.’ Last week the company’s founder and chairman, B. Ramalinga Raju, resigned amid revelations of widespread accounting fraud in the company.

Mera Naam Raju
The resignation came in a five-page letter to the company’s board in which Mr Raju apologised to the shareholders, taking personal and sole responsibility for the fraud involving bogus accounting over several years, including inflating profits by more than tenfold between July and September of last year. As if making a concession the soft-spoken Raju with trademark paternal charisma, said he was prepared to face the law.

Raju was like a corporate deity in India, not only for having built a $2 billion IT empire bringing in foreign currency, but also for launching the Emergency Management and Research Institute, a national, not-for-profit 911-like emergency-response service funded by $50 million of his and his family’s money. Three months ago his company received the Golden Peacock award from a group of Indian directors for excellence in corporate governance.

Juxtaposed against Satyam or Mr Raju’s personal accounting misdeeds, such benevolence raises doubts about human nature and the philanthropy with which we associate businesspersons. In his letter Mr Raju disclosed that Satyam had inflated its operating profit for the three months ended September 30, 2008 to 6.49 billion rupees ($136 million) from 610 million rupees reported previously, while revenue was inflated to $565 million from $443 million. It had reported an operating margin of 24 per cent which was actually 3 per cent. On the asset side, Satyam’s balance sheet as of September 30 had a non-existent cash balance of over $1 billion (remember Parmalat?); nonexistent accrued interest of $79 million; an understated liability of $258 million and an overstated debtor position of $103 million.

Several investors in Satyam were considering suing PricewaterhouseCoopers LLC, the company’s auditors, which like all the top auditing firms benefited from the fall of Enron’s auditors, Arthur Andersen. The investors say the auditors are supposed to check on the accounts and that they rely on the auditor’s report. In a careful meaningless statement PWC said that they had worked “in accordance with applicable auditing standards and were supported by appropriate audit evidence.” That statement really says nothing since it is no more than a repetition of the standard words used in any audit report.

Creative explanation
While the firm was right to explain that their obligations for client confidentiality precluded the possibility of commenting on the alleged irregularities, how do they expect the public to have any confidence in a profession where top auditing firms repeatedly fail to detect massive frauds year after year? Like Raju, Pricewaterhouse’s assurance that it “will fully meet its obligations to cooperate with the regulators and others,” seems neither a concession nor an option.

Raju’s explanation was a bit more interesting and philosophical, even if far too defensive. His letter which will go down as one of history’s most creative and longest resignations states in part that what had begun as a small gap between real and reported profits continued to grow over the years, like “riding a tiger, not knowing how to get off without being eaten.”

It is probably too early to assess the impact of the scandal described by PC Gupta, the federal minister for company affairs as a “shameful act” while Jagdish Malkani, country head at TAIB Capital Corp described it as “a monumental scandal [that] is terrible for the Indian IT industry.”

Some things, however, are fairly certain. There will be calls for more oversight and regulation of public companies, which happened in the aftermath of Enron and the other Dotcom failures. Indeed Mr Gupta has already said that government would take coordinated action with the Securities and Exchange Board of India. Meanwhile and more immediately, there are two major risks making India very uncomfortable – the likelihood that the Satyam is not unique in creative accounting and the same thing is happening in other public companies. That would scare away foreign investors. Equally serious is the potential disruption of services to the lucrative US outsourcing market. The timing could not be worse. As the Obama administration responds to the highest unemployment rate in the US for decades, tempted by protectionist instincts, outsourcing must be high on the agenda.

Satyam was already facing a World Bank ban for improper financial dealings with a top bank official. Along with the World Bank, Satyam’s clients include General Electric Co, General Motors Corp, Nissan Motor Co, Applied Materials Inc, Caterpillar Inc, Cisco Systems Inc. and Sony Corp. Will the other Indian IT firms be chosen to take up any slack or will these customers go elsewhere?

The almost co-incidental revelations of Madoff and Satyam have no doubt come about because a bear market drives the chickens home to roost while no one cares about corporate governance in a bull market. In Guyana here in the nether world – neither bull nor bear – we never seem to care. The scandals show that those who appear as good guys may be putting on a front. Madoff is described on his company’s website as having “a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm’s hallmark.” Raju was the personification of piety and generosity.