Directors, it’s time for the talk

When it comes to emerging market operations, high-profile governance failures don’t just fire up the regulators. They give boards impetus to press their own CEOs: could it happen to us?
By Robert Thompson

To Carol Hansell, the most fundamental issue facing the directors of Canadian energy, mining and resource companies isn’t happening in the boardroom, but in countries in Africa, South America and Asia. Hansell, a senior partner in capital markets and corporate governance at Davies Ward Phillips & Vineberg in Toronto, says the headline-grabbing corporate governance failures of companies like Niko Resources Ltd. (TSX:NKO) and SNC-Lavalin Group Inc. (TSX:SNC) are forcing many directors to step up their engagement with internal controls and risk management in countries they may initially struggle to find on a map. The fact that lots of Canadian mining and extractive companies now run operations in remote markets is also pushing these issues to the forefront. Suddenly the Corruption of Foreign Public Officials Act, a Canadian law that was rarely enforced for more than a decade, has been taken out of mothballs, its reach expanded—including new amendments announced in early February—and the RCMP are applying it to Canadian companies around the globe.

That means directors of companies operating in emerging markets need to be forcefully pushing for internal controls that address any potential internal failings. And if it gets a little bristly with the CEO, so be it.

“Directors need to push—that’s their role,” explains Hansell. “They need to prep management and be asking the questions about the controls that are in place, and how well do they know the culture in those countries in which they are operating, who do they know there and why do we trust them. They need to know how these things affect a company’s reporting and why the company is certain these controls are in place.”

Davies' Hansell: "Directors need to push—that's their role"

Hansell’s concerns about how directors deal with this situation is prescient considering that suddenly Canadian energy and mining companies are not only facing scrutiny for their actions in remote geographies, but also the occasional criminal charge.

After years with no charges under the corruption legislation, Calgary’s Niko was charged under the law and pleaded guilty in 2011 to bribing an official in Bangladesh. The result was a $9.5-million fine and a probation order that required the company to implement a detailed compliance program to be reviewed by an independent auditor. And more recently a privately held energy company in Calgary, Griffiths Energy Inc., was fined $10.35 million for bribing the wife of Chad’s ambassador to Canada. The company was found guilty of paying $2 million to a company owned by the ambassador’s wife despite being warned by council of the potential implications.

These and other offshore incidents have also attracted the attention of both the Ontario Securities Commission and Toronto Stock Exchange.

In November, the OSC issued a guide for companies with interests in emerging markets, outlining eight “key areas” that management and the board should consider. This followed publication last March of its “Emerging Markets Issuer Review,” based on a review of 24 Canadian businesses operating in these markets—more than half the companies working in emerging markets that fell under its jurisdiction. The findings were relatively far reaching, citing deficiencies and concerns in corporate governance practices, corporate structures, related-party transactions and risk management.

“We engaged in this review in recognition of our increasingly globalized marketplace and the need to protect Ontario investors and the integrity of our markets,” the OSC said in its findings. The OSC also made it clear that it expects directors of the companies in question to step up in a big way.

“Boards, in particular, are expected to adopt appropriate corporate governance practices to facilitate the proper oversight of management,” the OSC wrote. “Faced with the unique challenges of operating in an emerging market, boards of emerging market issuers have to take extra measures to ensure investors’ interests are protected.”

Though some observers interviewed for this story feel companies are making strides in dealing with issues facing emerging markets operations, the TSX isn’t so sure. In December, it issued a public consultation, seeking comment on risks associated with key governance matters for Canadian companies operating in emerging markets and for companies from emerging markets listing in Canada. The comment period is scheduled to close on Feb. 28.

Kevan Cowan, president of TSX Markets and group head of equities, says despite the headlines there’s no guarantee that Canadian boards are moving forward to address the controls needed to function appropriately in emerging markets. “A lot of the stuff we are talking about is corporate governance 101 that you’d expect people to be aware of, but the reality is that these things need to be emphasized,” he says. “Our analysis has shown there’s some necessity for this.”

But not everyone thinks broad guidelines by regulators are enough. Lawyer Roger Taplin, co-leader of McCarthy Tétrault’s global mining group based in Vancouver, says each situation a company faces in an emerging market is likely unique. The regulators, he says, are trying to create rules that can be applied widely, but are in need of interpretation depending on where a company is operating. That interpretation will fall in the laps of company board members.

“I wouldn’t say they aren’t looking at these issues,” he explains.“ But what you see is a wide spectrum of sophistication in how people look at them. People have thought about these issues for a long time—there’s nothing new about it. What is new is the recognition there are systemic implications that haven’t always been adequately been addressed around the issues of internal controls and risk management.”

Hansell agrees.

“Some of this will become rote in time,” she explains. “Audit committees are areas where directors have confidence because they know it. But in the emerging markets space we don’t have a similar road map.”

How companies with interests in emerging markets address their needs for specific controls is unique to each business. Hansell’s concern is that some executives may not be pushing forward as actively as they should in devising policies, leaving it to directors to advance the issue. At the same time there is a delicate balance for boards in advising management without giving an indication they are losing confidence in the executive’s ability to tackle the issue.

“[Some boards] haven’t had extensive discussions with the management team and how do they do that without suggesting they lack the confidence?” she asks. “No board wants to give the impression they aren’t confident in their CEO’s ability to run the company. But they still have this oversight ability that isn’t going away.”

But Cowan says this balance isn’t something directors should be worried about. It is their role as directors to take on issues like those facing companies in emerging markets.

“I’m not as concerned about it,” he says flatly when asked about boards indicating a lack of confidence in executives. “There’s a huge move to regularizing governance discipline about what kinds of questions governors should be asking. I don’t think it implies lack of confidence. I think it implies best practices. I think this is becoming regularized.”

While the politics of board/executive interactions can be tricky affairs, Hansell says it is incumbent on directors to be certain their companies are dealing with the controls and risk management associated with operating in emerging markets. She says this can be done outside of board meetings by providing a company’s CEO and CFO with off-line questions about the state of the business’s controls.

Taplin says recent headlines have provided an impetus for directors to raise the question without making any negative suggestion of the company’s operations. In his experience, if presented appropriately, company executives are more than accepting of a board’s guidance. “The board is there to help them make sure their internal controls are adequate,” he says. “The CEO and CFO have to personally ensure those controls are adequate, so if they see a board is trying to help that by applying a good level of due diligence, then my experience is management teams tend to respond well.

“The role of the board is to support the CEO’s efforts and to guide them,” he adds. “Sensible CEOs respond well knowing they have the support of a board that asks thoughtful questions and is there to improve the thinking, planning and controls the company needs to be more effective in its business.”

The solution may seem self-serving coming from lawyers involved in corporate governance, but even the TSX’s Cowan suggests outside advisers might be key to helping boards move forward with addressing these concerns. Hansell says lawyers often have broad experiences with issues facing companies in politically difficult areas.

“When you are dealing with a new area—you tend to want to get some outside advice,” she says. “They’ll have more experience over a broad range of companies. There are a lot of us who have had interaction with legislation in Canada and the U.S.”

In Taplin’s view, a lot of companies still need a nudge. He says he’s not witnessed any boards reviewing their corporate governance in light of the emerging markets issues. Whether that means boards are comfortable with their current policies or are waiting for the next Canadian company charged, he’s uncertain. “It is clear that there are boards [that] are spending more time asking tough questions than they have in the past,” he says. “The tempo has picked up, but it hasn’t translated into fundamental shifts in policy.”

 

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