Corporate Governance in New Zealand

Andrew Brown, Partner and Brynn Gilbertson, Partner | November 2002

New Zealand has watched closely as big corporate failures such as Enron and WorldCom have prompted US authorities to institute significant corporate governance reform, including the Sarbanes-Oxley Act of 2002 and the NYSE Governance Reforms.

The heightened international awareness of corporate governance issues has prompted regulatory authorities in New Zealand (and some individual corporates on a voluntary basis) to review current practices and procedures.

There is a consensus that many measures adopted in the US would be unsuitable in New Zealand due to its relatively small economy. New Zealand regulators have tried to balance investors' needs for transparency and certainty with corporate needs for minimised compliance costs.

This article outlines New Zealand's corporate governance principles and, in light of the Enron and WorldCom collapses, the changes that are taking place in New Zealand's corporate governance landscape.

Regulatory regime

New Zealand's corporate governance regime is an amalgamation of statute, code and common law principles. Responsibility for good corporate governance ultimately lies with directors who are accountable to shareholders.

The Companies Act 1993 provides the fundamental corporate governance framework for companies, codifying and expanding directors' duties and shareholders' rights under the common law. Relevant legislation includes the Takeovers Act 1993 and the Takeovers Code; the Financial Reporting Act 1993; the Securities Act 1978; and the Securities Amendment Act 1988.

The Companies Act also recognises the special importance of the role of independent auditors. It is specifically stated that an auditor of a company must ensure that their judgement is not impaired by reason of any relationship with or interest in the company or any of its subsidiaries.

The New Zealand Stock Exchange (NZSE) offers specific guidance to publicly-listed companies through its listing rules, particularly in relation to the conduct of directors.

The NZSE listing rules also require listed companies to provide a statement of any corporate governance policies, practices and processes adopted or followed by listed companies to be disclosed in their annual report. The NZSE has proposed changes to the listing rules to further stress the importance of corporate governance to market credibility and enhance market confidence. These changes are discussed in detail later in this article.

The Institute of Directors in New Zealand has issued a Code of Proper Practice for Directors and a series of best-practice statements, which contain guidelines for corporate governance structures. The Code of Proper Practice is not exhaustive, and deals more with moral and ethical responsibilities than on those imposed by law. Most New Zealand listed companies adopt the Code's guidelines and publish them in their annual report.

Rights and equitable treatment of shareholders

Under the Act, management of the business and affairs of a company is the responsibility of the company's board. However, shareholders retain ultimate control of a company. Central to that control is the right, conferred on the holder of a share, to a vote on all matters put to the annual meeting of the company. Special shareholders' meetings may be called by shareholders holding at least 5 per cent of the voting rights of a company. At both annual and special meetings, shareholders are entitled to raise proposals for discussion or resolution (however, a resolution relating to the management of the company will not be binding on the board).

The Act reserves certain fundamental governance powers to shareholders. These include:

• appointing the directors of the company;
• adopting or altering the constitution of the company;
• appointing and removing the auditor;
• approving any transaction involving the acquisition or disposition of assets, the value of which are more than half the value of the company's total assets (defined as a major transaction);
• approving an amalgamation of the company; and
• putting the company into liquidation.

In addition, for publicly-listed companies the NZSE listing rules require shareholder approval for:

• directors' remuneration;
• non pro-rata issues of shares of greater than 10 per cent;
• non pro-rata share buybacks of greater than 10 per cent;
• cancellation of unpaid amounts on shares;
• transactions involving the acquisition or disposition of assets which change the essential nature of the business of the company or which have a value greater than 50 per cent of the company's market capitalisation or gross value of assets (whichever is the lesser); and
• material transactions (a 5 per cent threshold) with related parties.

The listing rules are generally focused on decisions where inequality of treatment of shareholders may arise. The NZSE listing rules require such decisions to be approved by all shareholders (other than those shareholders who are interested in the decision) either in ordinary shareholder meetings or, in some instances, by special shareholder meetings.

Responsibilities of the board

The primary legal responsibility of the directors is to ensure that the Companies Act 1993 and the company's constitution are followed at all times. Directors must act in good faith and in the best interests of the company.

The Code of Proper Practice recommends that directors:

• ensure the company's goals are established and achieved;
• establish policies for strengthening the performance of the company;
• monitor performance of management;
• appoint the CEO and fix the terms of employment;
• decide on steps to protect the company's financial position;
• ensure the company's financial statements are true and fair and comply with the law;
• ensure the company adheres to high standards of ethics and corporate behaviour; and
• ensure the company has in place appropriate risk management/regulatory compliance policies.

Who does the board represent and to whom does it owe legal duties?

There had been debate as to whether the company meant the shareholders as a whole or the enterprise independent of its shareholders. The latter formulation would require recognition of future shareholders as parties to whom directors would owe duties.

The Act clarified that the company means the enterprise itself as contrasted with the existing shareholders. This clarification did not introduce additional stakeholders to whom directors would owe duties.

The power to take enforcement actions against directors for failure to comply with their duties lie with both the company and its shareholders. The company may take action to remedy or prevent breaches of the Act or its constitution. Shareholders may bring a personal action against directors for a breach of a duty owed to them or, with High Court leave, may bring a derivative action in the name of the company.

Delegation by board to management and board committees

Although directors may delegate powers and functions, they are not permitted to delegate the management function itself. The Act lists certain board powers that cannot be delegated, including the power to:

• issue shares;
• make distributions and provide shareholder discounts;
• offer to acquire the company's shares;
• make stock exchange acquisitions of the company's shares;
• redeem shares;
• provide financial assistance; and
• transfer shares.

Independent directors

The NZSE listing rules require that listed companies have at least three directors, two of which must be ordinarily resident in New Zealand. Beyond this, there are no requirements prescribed or guidance given by statute or regulations.

The Institute of Directors in New Zealand's Code of Proper Practice for Directors recommends that the chairman and the majority of directors should be non-executive. A non-executive or independent director is usually a person not recently employed by the company, not representing a major shareholder or creditor of the company, independent of management and free from any business or other relationship that could materially interfere with the exercise of their independent judgement.

Separation of board chairman and CEO

There is no legal or regulatory requirement for the separation of board chairman and CEO in New Zealand. However, the Code of Proper Practice recommends the separation of these roles.

Board committees

Currently there are no mandatory requirements for board committees.

The Code of Proper Practice recommends that each company should have three standing committees: audit, remuneration and nomination. The audit and remuneration committees should consist of three directors all of whom, if possible, should be non-executive. The nomination committee should comprise the chairman, deputy chairman and CEO.

There is no legal or regulatory requirement for a minimum or set number of board meetings each year. The Code of Proper Practice makes a number of recommendations regarding frequency of board meetings, recognising that this will depend on the company's involvements and situation from time to time.

The New Zealand Stock Exchange - proposed reforms

The NZSE has proposed a set of corporate governance rules (the NZSE Code) that in essence is a reflection of corporate governance best practice. In recognition of the pressures companies face, only some of the policies contained in the NZSE Code are reflected in corresponding changes to the listing rules.

Code of ethics

The NZSE recommends that:

(a) companies formulate a code of ethics addressing matters such as compliance standards and procedures, establishment of mechanisms to report unethical behaviour and disciplinary measures for breaches; and

(b) consideration should be given to conflicts of interest, use of corporate information, assets and property and fair dealing with customers, suppliers, contractors, professional advisors, stakeholders and competitors.

Directors

The NZSE proposal defines an independent director as a director who is not an executive of the company. He or she must also have no material relationship with or interest (direct or indirect) in the company which could reasonably interfere with that person's ability to freely act in the best interests of the company and its shareholders. A six-month cooling off period has been included to recognise the period of time that must elapse before a person can be considered independent of their previous interest.

Other proposals include:

The minimum number of independent directors should be two or one-third of the total number of directors, whichever is greater. Companies with boards of eight members should have at least three independent directors and those with less than eight or more than nine members may round down to the nearest one third.

Preventing the potential conflict of interest that may arise when the role of chief executive officer and chairman of the board of a publicly listed company are vested in the same individual.

Improve the standard of directors by requiring directors to successfully complete an NZSE director certification course. There will be an exemption for already adequately qualified directors.

Directors should be encouraged to take a portion of their remuneration under a performance-based stock compensation plan or to invest a portion of their cash director's remuneration in purchasing shares in the company through the NZSE.

Audit committee

The NZSE proposal recognises the benefit of having an audit committee to review the financial strategy and performances of publicly-listed companies, as well as monitor the independent auditors. The proposed rules would require that a majority of the audit committee be independent directors and that at least one member should have an accounting or financial background. Responsibilities of the audit committee should include:

• ensuring processes are in place so that the board of an issuer is regularly informed and updated on financial matters;
• responsibility for recommending the appointment and removal of the independent auditor;
• monitoring and reviewing audit practices;
• ensuring processes are in place to maintain accurate financial and accounting records; and
• direct communication with and unrestricted access to both the independent and internal auditors.

Auditors

The NZSE proposal would prohibit auditors from providing non-audit services. From overseas experience, the NZSE recognises the potential for conflict where external auditors also provide non-auditing services to the company. Despite initial resistance to this proposal, most audit firms are coming to accept the merits of this approach.

Other committees

The NZSE recognises that the extent to which it is practical to form other committees depends on the size of the company. Where possible, companies should establish a remuneration committee, comprising a majority of independent directors, to recommend remuneration packages for directors.

Companies should establish a nomination committee, comprising a majority of independent directors, to recommend director appointments to the board.

Audit remuneration and nomination committees should each produce a written charter outlining their responsibilities, authority and duties and each committee should be subject to regular review in accordance with the charter.

The NZSE Code will require publicly listed companies to disclose how their corporate governance policies, practices and processes deviate form the NZSE Code. Such disclosure intends to create greater transparency and accountability by allowing investors to assess the corporate values of publicly listed companies.

Conclusion

The desire to avoid corporate collapses in this country has resulted in modification to New Zealand's corporate governance regime.

Given the wide diversity of New Zealand companies, the policy changes have focused on developing a best practice code that preserves flexibility. The changes to New Zealand's regime are not as far reaching as other jurisdictions. However, they are an appropriate measure given the historical independence of New Zealand companies' boards of directors and the comparatively small size of the country's economy.

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This article was first published in the IFLR Guide to Corporate Governance 2002. For further information, please go to www.iflr.com