THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES

THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS

International Qualifying Scheme Examination

CORPORATE GOVERNANCE DECEMBER 2011

Suggested Answer

The suggested answers are published for the purpose of assisting students in their

understanding of the possible principles, analysis or arguments that may be identified

in each question

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SECTION A

1. After returning to Hong Kong from Australia in 1987, Mark founded Kram Infrastructure Company Limited (Kram). Kram’s business is to develop and operate roads, tunnels, bridges and related infrastructure projects in the PRC and Southeast Asia. Kram has adopted Table A as its articles of association and its shares were listed on the Main Board of the Stock Exchange of Hong Kong Limited (SEHK) in 2002. In addition to being Kram’s major shareholder (22%), Mark has been the Chairman and Chief Executive Officer (CEO) of the company ever since it was founded. After 21 years at the helm, Mark decided to retire in 2008 and resigned from all the positions he held in Kram. In recognition of Mark’s contributions throughout the years, Kram conferred on him the honorary title of Chairman Emeritus upon his retirement. Although officially retired and no longer a director of the company, Mark continues to exert considerable influence on how Kram runs its business affairs. For example, after a recent drop in Kram’s operating profits, Mark has demanded that the board consult him on business strategy and dividend policy before taking any action. Members of the board resent Mark’s persistent interference in how the company should be run, but they are wary of confronting him openly. As a result, they have gone along with Mark’s suggestions most of the time and allowed Mark to make business decisions on its behalf on many occasions. Only Nick, a non-executive director, has criticised Mark’s dictatorial style and constant interference in the decision-making process. Mark is now demanding that Kram take action against Nick because he (Nick) has not attended board meetings regularly. Neither did he contribute much to the discussions, still less making of decisions, at the few meetings that he attended. In Mark’s view, Nick has breached his director’s duties and thus failed to reach the standard required of a director of a listed company in Hong Kong. Mark reckons that Kram should at least take Nick off the board. About a month ago, directors and shareholders of Kram were shocked and dismayed by a story in the Chinese weekly magazine Follow Me! which alleged that in 2007 Mark had used company funds to bribe the ex-Secretary for Transport and Public Works of the Macao SAR government in return for the contract to build a bridge linking the islands of Taipa and Coloane in Macau. Immediately after Follow Me! published the allegations against Mark, Kram’s share price dropped 30% and has stayed

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low ever since. Mark, however, has vehemently denied the allegations and has initiated legal proceedings to sue Top One Media Limited, which owns Follow Me!, for defamation. In an attempt to reduce Mark’s influence on Kram and expand its presence in the PRC market, the board has chosen Xiao, a PRC national and a total outsider, to act as the company’s new CEO. Although Xiao is an experienced professional and well qualified for the role of CEO at Kram, he has never worked for a company in Hong Kong before. He is therefore unfamiliar with Hong Kong’s corporate governance practices. Xiao has been asked by the board to attend the board meeting on 2 June at which attendees are expected to discuss the issues identified above and come up with solutions to resolve them. Xiao has come to you, the Company Secretary, for advice.

REQUIRED: In your advice to Xiao: 1. (a) Explain the differences between a unitary board and a two-tier board

and discuss whether a unitary board may lead to bet ter corporate governance in the company.

Ans (a) A key issue in corporate governance is that a company must have an effective board of directors dedicated to ensuring that the company achieves its objectives. There are two main types of board structure in the world, namely, unitary board and two-tier board. Definition of unitary board Companies in common law jurisdictions like Hong Kong are governed by a unitary board. Its members comprise all directors, executive and independent non-executive directors (INEDs) alike, who are vested with the authority to make decisions as a unified group for a company. All directors, in turn, bear a collective responsibility for the direction of a company’s affairs which is owed to the company and all of its shareholders equally. Definition of two-tier board A two-tier board structure is usually found in companies in civil law jurisdictions such as Germany and the PRC. It consists of a supervisory board and beneath it, a management board, hence the name ‘two-tier board’.

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The supervisory board is responsible for general oversight of the company and oversees the management board. Its chairman is the chairman of the company. As for membership, half of the members of the supervisory board in Germany, e.g., are appointed by shareholders and comprise entirely non-executive directors (NED). The other half of membership consists of: • Trade union representatives or the company’s employees; • Representatives of a major shareholder; and • Former company executives. The management board, on the other hand, is responsible for the operational performance of the company. It presents strategies, management plans and budgets to the supervisory board for comment and approval. The management board is headed by the CEO and he or she reports to the chairman of the supervisory board. Members of the management board are appointed by the supervisory board and consist entirely of executive directors of the company. General criticisms of the two-tier board • Experience shows that although the idea of separating the performance

function from conformance function is appealing, significant problems arise in practice.

• The two-tier board structure does not always function in the interests of shareholders. Another example is the row over the exorbitant severance bonuses paid to Mannesmann’s executives in the takeover by Vodafone in 2000 which was approved by the Mannesmann’s supervisory board, despite shareholders’ protests.

• The effectiveness of a two-tier board structure depends on whether the CEO can communicate effectively with the Chairman of the supervisory board. This is too unpredictable.

Problems with the supervisory board Specifically, most of the criticisms are leveled at the effectiveness of the supervisory board. The main concerns are: • It is way too big, with up to twenty members. • More layers in the board structure means members are less informed at

the supervisory level. • The supervisory board consists entirely of NEDs, who might not have a

proper understanding of the company. • Many NEDs might not be independent after all. In Germany, e.g., many

NEDs are representatives of the company’s employees and some represent major shareholders. Those directors might be prone to promote the interests of the ‘faction’ they represent.

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• Workers' representatives often lack the competence to consider strategic issues or are not independent of the company. In some instances, worker members of a supervisory board opposing planned initiatives by the company have been accused of leaking confidential information to the press. Concerns about information leaks can damage communication between supervisory and management boards.

• The supervisory board only comments on business plans forwarded by the management board. There is little opportunity for interaction between the two boards due to relatively infrequent supervisory board meetings.

Advantages of the unitary board The main advantage that unitary board has over two-tier board is that the former is more competent in making effective decisions than the latter. This is because decision making is concentrated in the hands of board members as a whole and no other parties except shareholders in a general meeting can override the decisions made by the board. In addition, there are at least two other reasons why the unitary board can make more effective decisions than the two-tier board. • The unitary board may have a good hierarchy, with easier management

of board members given less potential conflict of interests among the members. Decisions taken by unitary boards may be more efficient.

• The unitary board system avoids disruptive management decision-making, particularly relating to sensitive discussions on labour negotiations and salary compensation for the board, since the presence of non-management employees in the boardroom may create problems.

Criticisms of the unitary board It has been suggested that while the executive management is accountable to the board in a unitary board structure, the board includes senior executive managers. This means that in a unitary board structure, individuals are accountable to themselves, which is unlikely to lead to effective decision making. Conclusion on unitary and two-tier boards When a unitary board is compared with a two-tier board, the former appears to prevail over the latter because a unitary board has more advantages and fewer criticisms than a two-tier board. What unitary boards need to improve on, however, is to make the board more accountable to stakeholders.

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Unitary board leads to better corporate governance A powerful board that is vested with the power to manage the company’s business will improve the company’s corporate governance. The following explains why. (a) Greater accountability to stakeholders � Improve board performance by changing board practices and

behaviour with the aim of establishing an effective system of board governance.

� Fully embrace the duty to look after and serve the best interests of all stakeholders and not just to shareholders and to discharge their functions dutifully, to use their time more effectively and develop a new understanding of their roles and responsibilities.

� Assume a more active role not just in accounting-compliance issues but also in setting strategies to achieve the company's purpose and to enhance the company's value, tracking the progress of its plans, assessing the risks involved, developing the leaders and monitoring the long term health of the company.

(b) Communication with stakeholders

• Communicate fairly and effectively accurate and timely information to shareholders and potential investors.

• Hold two-way dialogue with investors.

(c) Proper checks and balances • Ensure greater independence (more truly independent directors

appointed) to show that the board is not a rubber stamp for the management, and to bring independent judgment to bear on the decision-making process.

• Provide rigorous management oversight by asking management tough questions to conduct an independent audit on the operations of the company (to detect irregularities or abuse of powers).

• Review on a regular basis board policy over the frequency, agenda, conduct and duration of the board's meetings and those of its committees. The board should ensure that through a managed and effective process board appointments are made that provide a mix of proficient directors, each of whom is able to add value.

(d) Internal control and risk management

• Ensure that internal controls and risk management procedures and practices are in place that protect the company's assets and reputation.

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• Ensure there is an effective and adequate internal audit function which the audit committee should keep under constant review.

• Understand and fully appreciate the business risk issues and key performance indicators of the business enterprises and monitor these factors.

(e) Disclosure and transparency

• Ensure there is regular, reliable and comparable information in sufficient detail for the board to assess the stewardship of management to enable them to make informed investment decisions.

• Ensure timely and accurate disclosure is made on all material matters regarding the company, including its financial position, performance, major shareholders, remuneration policy for members of the board and key executives, related party transactions, foreseeable risk factors, governance structures and policies.

1. (b) Discuss whether it is acceptable for Mark to give d irections to the board in conducting the company’s business affairs.

Ans (b) Board to run Kram’s business Kram has adopted Table A as its articles of association. Regulation 82 says that the board has a general power to manage the business and affairs of the company, subject to a direction by shareholders, which has been passed by a special resolution in a general meeting. But such direction cannot invalidate any prior acts of directors which would have been valid had that direction not been given. Regulation 82 does not allow board members to let Mark make business decisions on their behalf. If board members have good grounds to disagree with Mark’s views on business strategy and dividend policy, they must try to convince him why their views are in the better interests of the company. If Mark cannot be convinced, board members are entitled to ignore Mark’s views and carry out their business plans as long as a majority of board members votes for those plans at board meetings. Equally, Mark should be told to observe the letter and spirit of regulation 82. While Mark has a right to make his views known to the board, he should not expect it to comply with them all the time since the board has the final say in how Kram should run its business.

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Mark as a shadow director As most of the board members are accustomed to take directions from Mark in managing the company, Mark would be regarded as a ‘shadow director’ under section 2(1) of the Companies Ordinance (CO). It has been argued that a shadow director should be subject to the same duties, which include a fiduciary duty and a duty of care, skill and diligence (DCSD), as would all other directors. The reason is that the law cannot allow a person like Mark, who controls Kram but chooses not to be appointed as a director in the hope of evading liabilities attached to the office to get away with it. The High Court in England, however, held recently in Ultraframe (UK) Limited v Fielding [2005] EWHC 1638 that a shadow director should not be subject to the same fiduciary duties as would a duly appointed director unless a fiduciary relationship exists between the shadow director and the company. Without disturbing the Ultraframe judgment, the Hong Kong SAR government, by way of a recommendation in the Companies Ordinance Rewrite exercise, considers it right to subject a shadow director to the same statutory DCSD as a duly appointed director. The reason is that anyone who interferes in the affairs of a company to the extent that a shadow director would must take on the same responsibilities and duties as those of a director. Having been a director of Kram for over 20 years, it seems unlikely that Mark would want to be subject to the restrictions imposed on directors such as share dealing, fraudulent and insolvent trading all over again. Mark should be advised of his status as a possible shadow director and the legal implications.

1. (c) Discuss whether Nick has breached any laws on direc tors’ duties in Hong Kong. If he has, analyse the actions, legal or otherwise, that Kram can take to stop Nick’s breaches.

Ans (c) Directors’ duties Directors owe duties to their companies and not individual shareholders: Percival v Wright [1902] 2 Ch 421. At common law directors’ duties include fiduciary duty and tortious duty. As a non-executive director of Kram, Nick is subject to the same duties as any other executive directors: Re Boldwin Construction Co Ltd [2001] 3 HKLRD 430. Rule 3.08 of the Rules Governing Listing of Securities at SEHK (Listing Rules) also imposes on directors of listed companies duties similar in content to their common law duties.

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Tortious duty Since the board is the decision-making body in a company, the quality of its decisions is instrumental to promoting good corporate governance. So if an appropriate legal standard of DCSD is imposed on directors, it can help improve the quality of the decisions made by them, hence improving corporate governance. Duty to act with DCSD In Hong Kong, the leading case on DCSD is the English High Court’s decision of Re City Equitable Fire Insurance Co Ltd [1925] 1 Ch 407. In that case, Romer J held that a director: (1) Need display only such skill as may reasonably be expected from a

person of his knowledge and experience. (2) Need not give continuous attention to the affairs of the company. (3) Is entitled to leave the day-to-day running of the company to other

officers of the company and is entitled to assume, if there are no suspicious circumstances, that such officers are performing their duties honestly.

The major problem with Romer J’s propositions is that the duty is largely subjective and the standard is low. It is therefore very hard to find a director in breach except for, say, serious errors of judgment, e.g., Re Denham & Co (1884) 25 Ch D 752 (director recommended dividends be paid out capital). In Re Boldwin Construction, Rogers VP of the Hong Kong Court of Appeal observed, in obiter, that “the standard which he [Romer J] described as being required of a director is, if anything, open to review in the present day circumstances as, perhaps, being too low”. Without attempting to influence the debate on this issue, the Companies Registry, in its publication ‘A Guide on Directors’ Duties’ (Guide) dated 17 July 2009, set out a non-binding test, which is a mix of subjective and objective standards, to determine DCSD. Principle 4 of the Guide says:

A director of a company must exercise reasonable care, skill and diligence. This means the care, skill and diligence that would be exercised by a reasonably diligent person with:

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(i) The general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company.

(ii) The general knowledge, skill and experience that the director has.

The HKSAR government will introduce a statutory statement of DCSD based on the above ‘mixed objective and subjective test’ after the Companies Bill passes through the scrutiny of the Legislative Council in the not too distant future. Until the statutory statement is issued, the Guide remains non-statutory and is not binding on directors. There is also no Hong Kong Court of Appeal decision approving an English decision such as that in Re D’Jan of London Limited [1994] 1 BCLC 561, which prescribes a higher standard of DCSD as law. Accordingly, Romer J’s propositions in Re City Equitable Fire remain good law in Hong Kong. Advice on Nick’s liability The debate on the DCSD and its correct standard will only be settled in Hong Kong after the statutory statement is issued or the Court of Final Appeal sets out its view in a future case. Until this happens, Mark’s allegation that Nick has breached DCSC, and hence failed to reach the standard required of a company director, will not stand if he (Nick) can provide evidence that he has done his honest best to exercise reasonable care and skill in acting as Kram’s director. Nevertheless, as a matter of best practice and in anticipation of the impending issue of the statutory statement on DCSD, Nick is advised to improve his performance as a director to meet the requirements of Principle 4 of the Guide. Other means of dealing with Nick That Nick may not be found to have breached tortious duty, legally it does not follow that no action can be taken against him. If the board shares Mark’s view about Nick, which seems likely, a cheaper and less cumbersome approach in dealing with Nick is to: • Ask him to resign; or • If he refuses to resign, remove him from office. Resignation of directors Under section 157D(1), a director may resign from his office at any time unless • The articles of association (AA) specify otherwise; or • The director and the company agree otherwise. There is no need for him or her to give any reason for resigning.

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If under the AA or an agreement the director has to give a written notice of resignation, he must send it by post to or leave it at the company’s registered office: section 157D(3)(a). Further, the company must notify the Companies Registry within 14 days after receiving notice of resignation: section 157D(2). Removal of directors As per section 157B(1), the company may remove a director before his term of office expires by passing an ordinary resolution (OR) at a general meeting. The steps required to be take to remove the director are as follows: • Shareholders call an extraordinary general meeting (EGM) to pass an

OR to remove the director. • Give the company a notice of the proposed resolution to remove the

director 28 days before the date of the EGM (i.e. special notice). • The company is required to give:

� Its members a notice of the EGM together with the special notice. If it is impractical to do so, the company must put up the special notice as a newspaper advertisement 21 days before the date of the EGM.

� The director a copy of the special notice. • The director is entitled to write to all members and attend / speak at the

EGM to explain why he should not be removed. • If the director is also a member, he can vote on the resolution at the

EGM.

1. (d) If the Follow Me! allegations against Mark are true, discuss whether Kram can bring any civil action against Mark for hi s misconduct. If you were a shareholder of Kram, could you sue Mark and/or the board members for the loss caused by the drop in Kram’s s hare price? [Where appropriate, candidates may refer to case la w to support their arguments in answering Parts (b), (c) and (d).]

Ans (d) It has been alleged that when acting as a director of Kram in 2007, Mark, in breach of the duty of good faith to Kram, caused the company to bribe the ex-Secretary for Transport and Public Works in return for the contract to build the bridge linking the islands of Taipa and Coloane. Mark seemed to have done that for the good of Kram, but in so doing he breached the fiduciary duty owed towards Kram and put the company in an untenable position. Further, Mark also breached the duty of proper purpose as he did not exercise his powers as a director honestly and for the purpose for which they were conferred.

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Civil action against Mark It is a fundamental principle of company law, expressed as part of the rule in Foss v Harbottle (1843) 2 Hare 461, that where a wrong was done to the company, as is the case here, the cause of action is vested in the company and the company alone can sue. A shareholder cannot sue on the company’s behalf because they are separate entities at common law: Salomon v Salomon & Co Ltd [1879] AC 22. Common law derivative action As per regulation 82 the board is vested with the power to manage Kram’s business affairs. One such power is to decide whether or not the company will proceed to sue a person. Since Mark has wielded enormous influence over board members, it is highly unlikely that the board will agree to sue Mark in Kram’s name. Accordingly, where what has been done amounts to a ‘fraud on the minority’ and the wrongdoers are in control of the company, the courts have invented the procedural device of derivative action (CDA) to be brought by a shareholder on behalf of the wronged company. Leave requirement for CDA In Waddington Ltd v Chan Chun Hoo (2008) 11 HKCFAR 370, the Court of Final Appeal affirmed the threshold requirement for a CDA, which provided a useful filter to prevent frivolous actions or actions which it was not in the interests of the company to bring. The threshold test is as laid down in Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1982] Ch 204 that the plaintiff is to establish a prima facie case (a) that the company is entitled to the relief claimed; and (b) that the action falls within the proper boundaries of the exception to the rule in Foss v Harbottle, usually the ‘fraud on the minority’ exception. Kram may be able to bring a CDA against Mark since his misconduct amounted to ‘fraud on the minority’ as it contained elements of: • Abuse or misuse of power on his part: Anglo-Eastern (1985) Ltd v Karl

Knutz [1988] 1 HKLR 322; and • Dishonesty: Pavlides v Jensen [1956] Ch 565. Mark’s domination of the board and his majority shareholding in Kram are evidence that wrongdoers are in control of the company. Because the CDA has many problems, such as the shareholder has to bear his own costs and since no legal aid is granted for the action, the government decided to introduce a statutory derivative action (SDA) by amending the CO with a new Part IVAA, which became effective on 15 July 2005.

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Statutory derivative action Under this new Part, a shareholder of Kram can bring a SDA on behalf of the company in respect of misfeasance committed against it. As per section 168BB(2), misfeasance means • Fraud • Negligence • Default in complying with law; or • Breach of duty. Leave of the court must, however, be obtained to bring a SDA. Pursuant to section 168BC(3), the court may grant leave if it is satisfied, inter alia, that (i) it appears to be prima facie in the interest of the company that leave be granted, and (ii) there is a serious question to be tried. Except where leave is granted by the court to dispense with the service of a written notice, the applicant must serve a notice in writing on the company stating his intention to seek leave to bring a statutory derivative action and the reasons for his intention. Thus, irrespective of whether a CDA or a SDA is brought, there is the safeguard of a filter, by the threshold requirement or the leave application, to prevent unmeritorious claims or claims which it was not in the interest of the company to pursue. Advice on Mark’s liability Since the term ‘misfeasance’ is statutorily and more clearly defined than the vague common law definition of ‘fraud on the minority’, Kram should be advised to bring a SDA against Mark on the ground of breach of fiduciary duty. If successful, the court is given a wide discretion under section 168BG(1)(d) and (2) to make an order, e.g. for payment of compensation or for the grant of restitution to Kram. Other civil remedies against Mark Shareholders who have suffered loss as a result of the drop in Kram’s share price caused by the Follow Me! revelations can conceivably petition the court for an order under section 168A of the CO if Kram’s affairs have been conducted in a manner unfairly prejudicial to their interests. According to Fuad J in Re Taiwa Land Investment Co. Ltd. [1981] HKLR 297, ‘unfairly prejudicial’ meant conduct departing from accepted standards of fair play which amounted to unfair discrimination against the minority. The conduct complained of must be both unfair and prejudicial at the same time.

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The petitioner is likely to rely on Mark’s unlawful conduct as evidence of the manner in which he had conducted Kram’s affairs as a director to satisfy his own purposes and in disregard of the interests of minority shareholders. If successful, the court has a wide discretion under section 168A(2)(a) to grant an order to the petitioner like a compensation order. Although the Court of Final Appeal in Re Chime Corp Ltd (2004) 7 HKCFAR 546 held that if the essence of the complaint was of director’s misconduct rather than mismanagement, the proper vehicle for relief would be a derivative action and not a section 168A petition, it is still possible for the same set of facts to found either a derivative action or a petition: Re a company (No 005287 of 1985) [1986] BCLC 68. Accordingly, the court may, as a matter of case management, consolidate both proceedings or order them to be heard at the same time, or even stay one set of proceedings. See the Court of Appeal judgment in Tan Man Kou v Chime Corp Ltd, Unreported, CACV 124/2003, 20 February 2004. Legal action against board members Shareholders who have lost money from the drop in Kram’s share price may want to sue other board members for failing to detect Mark’s misconduct. Recall that board members were shocked and dismayed by Follow Me!’s story which suggests that they were not aware of Mark’s misconduct until Follow Me!’s story surfaced, which may well be the case since they have always been compliant towards Mark and let him have his way. In other words, board members, despite regulation 82’s requirements of managing Kram’s business affairs, may have acted negligently. But the standard of DCSC, as discussed in part (c) above, is subjective and low. That the board failed to stop Mark’s misconduct in 2007, unless the circumstances gave rise to suspicion which was not followed up (we have no such evidence from the case facts), is unlikely to be actionable. Even if a court did find the board members to have acted negligently by failing to detect and prevent Mark’s misconduct, their personal liabilities, not to mention legal defence costs, would be covered by D&O insurance. So interests of the board members would not be affected to a significant extent even if they lost the legal action. Conclusion For the reasons above, Kram and its shareholders are advised to focus on the SDA and, to a lesser extent, the section 168A petition against Mark, but not to bring any action against the board members.

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SECTION B

2. Phil is the CEO of a locally listed company. In a meeting with the company’s senior executives two weeks ago, Phil expressed concern over the recent dramatic growth of insider dealing activities in listed companies. Phil has asked you, the Company Secretary, to organise a training session on insider dealing for colleagues in the firm.

REQUIRED: Prepare the contents of the training session, focus ing on: 2. (a) definition of insider dealing at law;

Ans (a) Definition of insider dealing

In general insider dealing concerns the deliberate exploitation of confidential price-sensitive information about a company by using some privileged or special relationship or position, for the purpose of making profits or avoiding losses. Specifically, under the section 270(1) of the SFO, insider dealing occurs when a person connected with a listed company, e.g. a director, an employee or substantial shareholders (holding over 5% of the company’s shares), possesses information which he knows to be relevant information and then deals in the shares. Relevant information, in turn, is defined in section 245 to mean information that is specific or precise and has not been disclosed to the public and, if it were made public, would be likely to have a significant effect on the price of the listed company’s shares. Insider dealing also occurs if a person possessing inside information discloses such information to another person whom he knows or has reasonable cause to believe will deal in the listed company’s shares subsequently. Further, if that other person, amongst others, knows the information that he has received indirectly from a connected person of the listed company is relevant information and then deals in the shares, he is also guilty of insider dealing.

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2. (b) possible penalties for insider dealing; and

Ans (b) Penalties Depending on the strength of the evidence, insider dealing can be prosecuted criminally or civilly. The maximum penalty for a criminal conviction on indictment is ten years in jail and a fine of $10 million. Summary conviction, on the other hand, carries penalties of imprisonment of up to three years and a fine of up to $1 million. Civilly, the Market Misconduct Tribunal (MMT), an independent body chaired by Justice Lunn and two lay members, can impose a number of civil orders on the identified insider dealers such as a disgorgement order, disqualification order or cold shoulder order. The SFO has also introduced a new statutory right to compensation: investors aggrieved by insider dealing can rely on a MMT determination or criminal conviction to claim against wrongdoers. The court is bound to accept the determination or conviction as prima facie evidence of wrongdoings by the persons involved.

2. (c) good practices and policies that can be adopted in the company to minimise the risk of insider dealing occurring.

Ans (c) Recommended practices to be adopted Induction programme The company should put together an induction programme presented by legal practitioners who have a profound knowledge of the SFO for all staff including directors (executive and non-executive), senior management and the employees (regardless of their seniority) for the purpose of giving them a better understanding of insider dealing. The programme should cover issues such as the essential elements of insider dealing, the penalties and exemptions, etc., and should be provided when the directors and employees join the company and subsequently on a regular basis. Code of ethics The company should ensure that avoidance of insider dealing has been fully addressed in the code of ethics. For instance, prevention of leakage of confidential or sensitive information which is highly pertinent to insider dealing should be covered by the code. This code of ethics should be fully communicated to all staff (by way of ethics training or otherwise) in order to be successfully implemented. Circulation of the code of ethics to outside parties such as suppliers, contractors and business partners are also important as it helps to ensure that they are aware of the good business ethics which the company is determined to uphold.

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Policy for handling price-sensitive information The company should put in place a clear policy detailing proper ways and procedures for the handling of price-sensitive information such as the information related to any takeover offer, mergers and acquisitions and fund-raising exercise (regardless of whether a notification obligation will be triggered pursuant to the Listing Rules). A policy to prevent the leakage of price-sensitive information should contain, inter alia, the following: • Identification of a project by a code during the initial stage of the project

and before the public announcement. • Dissemination of the information related to a project to staff on a ‘need

to know’ basis. This should be to people who are responsible for or involved with the project and the professional advisers such as lawyers and accountants who advise on the project.

• A clear record documenting the audit trail of the distribution of the information, including the identities of the recipients and the time of receipt, should be kept by the company.

• The directors and responsible persons meeting with securities analysts on behalf of the company to provide a briefing on the business and prospects of the company should be wary of any possible disclosure of unpublished price-sensitive information.

• There should be no disclosure of any price-sensitive information to any business partners in the normal course of business before entering into a confidentiality agreement.

• Directors and senior management who are likely to have access to price-sensitive information about the company should get approval from the chairman or the CEO before they deal in the company's securities (including the exercise of options).

• The company secretary should always send a reminder to the directors and those who have access to the price-sensitive information or who are privy to any important and price-sensitive negotiations or transactions to keep the relevant information confidential and to refrain from share dealing either in their own name or through any third parties as well as procuring or counselling others to deal until proper disclosure is made in accordance with the Listing Rules.

• The Listing Rules requirement prohibiting directors dealing in the company’s shares during the one month period prior to results announcements should be extended to all senior executive and staff who are likely to have access to price-sensitive information.

The company secretary, given his important role in the information disclosure and the promotion of good corporate governance of the company, should actively participate in the implementation of the above recommended practices, which are crucial for the avoidance of insider dealing as well as the promotion of good corporate governance.

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3. Jim is a leading corporate lawyer in Hong Kong. Two weeks ago he received an invitation from Mike, Chairman and controlling shareholder of the Crown group of companies, to act as an independent non-executive director (INED) of one of the listed companies in the Crown group. Jim is unsure if he should accept Mike’s invitation because he has read press reports criticising INEDs, particularly for their lack of independence from the controlling shareholders of the company in which they act as directors. Jim would like to talk to you, his high school friend and the Company Secretary of another listed company, about Mike’s invitation.

REQUIRED: Discuss with Jim: 3. (a) His specific concern that INEDs lack independence a nd how the

Listing Rules have addressed this issue.

Ans (a) INED’s Independence Independence refers to an ability to express or reach a point of view in the best interests of the company, unaffected in any way by personal gain or personal interests or motives. Independence also means not being subject to the influence of another person, e.g. the CEO and substantial shareholders. According to Sir Adrian Cadbury, "Independence is more a matter of character than of the elapse of time. Provided that the nomination process is clear, that the reasons for selecting individual directors are explained, and that shareholders have confidence in the chairman, proposals for board membership will receive their support." Jim’s concern over the independence of INEDs has been addressed by the Listing Rules. Specifically, the SEHK takes into account several factors in assessing the independence of an INED as set out in Rule 3.13 (1) to (8) of the Listing Rules. In its view, independence is likely to be questioned if the INED: 1) Holds more than 1% of the total issued share capital of the listed

issuer.

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2) Has received an interest in any securities of the listed issuer as a gift, or by means of other financial assistance, from a connected person or the listed issuer itself.

3) Is a director, partner or principal of a professional adviser which currently or in the last year provides services to the issuer.

4) Has a material interest in any principal business activity of or is involved in any material business dealings with the listed issuer or its related companies.

5) Is on the board specifically to protect the interests of an entity whose interests are not the same as those of the shareholders as a whole.

6) Is or was connected with a director, the chief executive or a substantial shareholder of the listed issuer within two years immediately prior to the date of his proposed appointment.

7) Is, or at any time during the two years immediately prior to the date of his proposed appointment has been, an executive or director (other than an INED) of the listed issuer or its related companies.

8) Is financially dependent on the listed issuer, its holding company or any of their respective subsidiaries or connected persons of the listed issuer.

Each INED shall submit to the SEHK a written confirmation which must state: • His independence as regards each of the factors referred to in rule

3.13(1) to (8); • His past or present financial or other interest in the business of the

issuer or its subsidiaries or any connection with any connected person (as such term is defined in the Listing Rules) of the issuer, if any; and

• That there are no other factors that may affect his independence.

Each INED shall inform the SEHK as soon as practicable if there is any subsequent change of circumstances which may affect his independence and must provide an annual confirmation of his or her independence to the listed issuer. As per Rule 3.14, where a proposed INED fails to meet any of the independence guidelines set out in Rule 3.13, the listed issuer must demonstrate to the satisfaction of the SEHK, prior to the proposed appointment, that the person is independent. The listed issuer must also disclose the reasons why such a person is considered to be independent in the announcement of his appointment as well as in the next annual report published after his appointment.

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3. (b) The other grounds on which INEDs are usually critic ised.

Ans (b) Usual criticisms leveled at INED • Some INEDs hold too many directorships in listed companies, more than

they can possibly serve effectively since they cannot give sufficient and equal time to any of his or her companies.

• The law makes no distinction between an executive director and an INED. They bear the same liabilities.

• INED directorships have frequently been given to the executive directors of other listed companies, giving rise to the concerns about a "you scratch my back and I'll scratch yours" mentality. INEDs are reluctant to criticise a fellow executive director.

• Also the relationship between an INED and the company can become too cosy over time.

• An INED is responsible for making the board more accountable to the shareholders. However, shareholders have only limited opportunities to discuss the company's affairs with INEDs in a formal setting.

• Lacking the ‘insider knowledge’ of executive managers about the business operations and having to rely on the integrity of the information supplied on them by management and executive directors restricts the scope for INEDs to make a meaningful contribution to board decisions.

• INEDs fail to stand up for shareholders' rights and to prevent domination of the company against over-powerful executives for self-perpetuating reasons.

• A founding family or a close-knit shareholding group has the controlling shares of the company so that they can dominate the company. They have the right to appoint and remove any directors. INEDs have insufficient power to counterpart the widespread influence of those family corporations.

• INEDs are poorly remunerated, and their pay is not proportional to the responsibility or risk they take.

• The opinion of the executive directors is likely to carry greater weight as they know the company more. INEDs may be put under pressure to accept the views of their executive director colleagues.

3. (c) The attributes that Jim should possess to become an INED; in

particular by reference to the criteria set out in any of the corporate governance reports published in the UK.

Ans (c) INED’s necessary attributes The Higgs Report published in the UK in 2003 addresses the role of non-executive directors. According to that report, non-executive directors perform the following roles:

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• Develop strategy

� Non-executive directors should constructively challenge and contribute to the development of strategy of the company.

• Monitor performance � Non-executive directors should scrutinise the performance of

management in meeting agreed goals and objectives and monitor the reporting of performance.

• Reduce risk � Non-executive directors should satisfy themselves that financial

information is accurate and that financial controls and systems of risk management are robust and defensible.

• Remunerate staff � Non-executive directors are responsible for determining appropriate

levels of remuneration of executive directors and have a prime role in appointing, and where necessary removing, senior management, and in succession planning.

The Higgs Report points out that, in order to fulfill their role, INEDs must acquire the necessary expertise and knowledge to discharge their responsibilities properly. INEDs must be well-informed about the company's business and the environment in which it operates and the issues it faces. This requires knowledge of the markets in which the company operates as well as a full understanding of the company itself. Understanding the company is essential to gaining credibility and reducing the inevitable disparity in knowledge between the INEDs and executive directors. Whilst it is true that the Listing Rules require at least one of the three INEDs to have appropriate professional qualifications or accounting or related financial management expertise, if all the INEDs are accountants then it is not certain whether they can bring a diversified mix of expertise to the board of directors. Therefore, the role of INED is complex and demanding and requires skills, experience, integrity, and particular behavioural and personal attributes. The Higgs Report identifies the following as the ideal personal attributes of the effective INED: • integrity, probity and high ethical standards; • sound judgment; • the willingness and ability to probe. They should have sufficient

strength of character to seek and obtain full and satisfactory answers within the collegiate environment of the board; and

• strong interpersonal skills which enable them to exercise influence and establish a high level of trust.

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Another point that the Higgs Report has emphasised is that the INEDs should confirm that they are able to allocate sufficient time to meet the expectation of their role. For example, new INEDs must attend the induction programmes (e.g. site visits and meetings with senior executives and employee representatives) designed for them. Although the Code on Corporate Governance Practices only requires a listed company to have at least four full board meetings, the time to be spent on the preparation for one meeting should not be underestimated. It should also be noted that, although the INEDs' strong business networks might be useful to the company, those business connections may cause the INEDs to fall into conflicts of interest with the company. The chairman should make sure that the new INEDs know that if they become aware of any potential conflicts of interest, they have to disclose all the relevant details to the chairman and company secretary as soon as possible.

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4. Jenny has been busily organising the first annual general meeting (AGM) of Filon Company Limited (Filon) since its shares were listed on the Main Board of the SEHK last November. But Jenny is unsure of the role and benefits of an AGM.

REQUIRED: Discuss with Jenny: 4. (a) How an AGM can benefit Filon’s shareholders.

[Where appropriate, candidates may make reference t o some of the AGM requirements set out in the Code of Corporate G overnance Practices and the Listing Rules]

Ans (a) Functions of AGM As per section 111(1) of the Companies Ordinance Filon must hold an AGM every year. AGMs have three principal functions: � Inform the shareholders about the financial performance of the

company as well as about important management decisions. � Gain the consent of the shareholders for decisions that do not lie within

the managerial discretion of the board of directors. � Provide a forum for discussions between directors and shareholders

about past performance and future business policies. Roles performed by directors and shareholders in AGMs Paragraph E.1 of the Code on Corporate Governance Practices (Code) requires listed companies to maintain an on-going dialogue with shareholders and, in particular, to use AGMs or other general meetings to communicate with shareholders and encourage their participation. The directors thus have the responsibility to inform the shareholders of the position and situation of the company via the AGM. The AGMs, on the other hand, give all shareholders, whatever the size of their shareholding, direct and public access to their boards. Reports and accounts are presented to shareholders at the AGM, when shareholders have the opportunity to comment on them and to put their questions to the board. Shareholders can make their views known to the boards of the companies in which they have invested by communicating with them directly and through their attendance at general meetings.

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However, very often shareholders do not present their views at these AGMs, and, in some cases, boards do not encourage them to do so. Effective exercise by shareholders of their powers of intervention and control is a very important component of the corporate governance system. In sum, an AGM should be seen as a principal forum in which the directors and senior management account to the shareholders for their stewardship of the company, and where shareholders can raise issues before voting on matters which require their approval. In this regard, the Code and the Listing Rules lay down certain requirements: Current requirements for AGMs Encouraging attendance The company should arrange for the notice of the AGM and the related papers to be sent to the shareholders at least 20 clear business days before the meeting: paragraph E.1.3 of Hong Kong Code. The notice should also be published on the HKEx website. In Hong Kong, the minimum notice for an AGM required by the Companies Ordinance is 21 calendar days: section 114(1)(a). Shareholders might be more willing to participate in voting at a general meeting if they are able to submit proxy forms conveniently by electronic mail or via the company's website rather than by voting form and post. Giving shareholders an opportunity to ask questions The board chairman should arrange for the chairmen of the audit, nomination and remuneration committees to be available to answer questions at the AGM: paragraph E.1.2 of the Hong Kong Code. Voting procedure Before the AGM commences, the chairman should ensure that an explanation is provided of the detailed procedures for conducting a poll and then answer any questions from shareholders regarding voting by way of a poll: paragraph E.2.1 of the Hong Kong Code. It should be noted that voting by a show of hands for resolutions at general meetings of listed companies in Hong Kong has been abolished since 1 January 2009. At the AGM, there should be a separate resolution for each substantially separate issue: paragraph E.1.1 of the Hong Kong Code. This requirement is intended to prevent the practice of combining two or more issues, one popular and the other(s) more controversial, into a single resolution. Each issue will then be voted on separately. In relation to proxies, listed companies should ensure that all valid proxy appointments received are properly recorded and counted.

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Poll results As per Rule 13.39(5) of the Listing Rules the issuer must announce the poll results as soon as possible but in any event at least 30 minutes before the earlier of the commencement of the Exchange’s morning trading session or any pre-opening session on the business day following the general meeting. The results should include: • The total number of shares entitling the holder to attend and vote for or

against the resolution at the meeting. • The total number of shares entitling the holder to attend and vote only

against the resolution at the meeting. • The number of shares represented by votes for and against the relevant

resolution. • Whether or not any parties that have stated their intention in the circular

to vote against the relevant resolution or to abstain have done so at the general meeting.

4. (b) How to enhance the effectiveness of an AGM.

Ans (b) Possible initiatives Measures to enhance effectiveness of AGM and other general meetings may include:

(1) Providing forms in annual reports on which shareholders could send in written questions in advance of the meeting, in addition to their opportunity to ask questions at the meeting itself, and the circulation of a brief summary of points raised at the AGM to all shareholders after the event. A presentation of the review of company's operation and performance during the financial year could be given at the AGM. A copy of the presentation, along with other investor relations material could be made available at the company's website.

(2) Dispatching a circular accompanying the AGM notice which contains comprehensive information on the business to be transacted at the meeting together with summary procedures governing voting at AGM and frequently asked questions regarding the voting procedures. These documents should be posted to shareholders well in advance of the meeting.

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(3) Given the importance of personal two-way interactive communications between board members and shareholders, the company may explore using audio-visual communication and webcast technology to augment and complement the AGM. A live webcast may be provided during the AGM through the company's website. Objectives for the online AGM include expanding participation of members in the meeting and leveraging technology and new channels to add value to the event. A telephone dial-in facility could also be provided on a listen-only basis. All AGM materials, including presentation slides, recorded webcasts and meeting documents should be available at the company's website. AGM discussion forums can enable shareholders to use their e-mail to engage in key deliberations. The online forums may contain questions that were submitted during the AGM webcasts and through post-session questionnaires, along with answers either provided during the webcasts or addressed by company's staff afterwards. Continued follow-up by the company's staff with individuals who requested further contact or information should be provided.

(4) Reviewing and evaluating the post-event feedback (via an evaluation questionnaire) the satisfaction of AGM participants could offer insights to the board for holding future AGMs.

(5) Voting in the general meeting should be improved by electronic communication. Companies, with the permission of their articles of association, can communicate with their shareholders electronically, and provide a greater range and depth of information more quickly and effectively than by post. Shareholders might be more willing to participate in voting if they are able to submit proxy votes conveniently by e-mail or via the company's website, rather than by voting form and by post. Shareholder information should be posted electronically on the company's website; this could include the date, time and location of the meeting, the deadline for a proxy vote submission, as well as the details of any special business to be raised at the meeting.

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5. “Good corporate governance will enhance shareholders' value and ensure the entity is better run … Generally speaking, we look to experiences from other jurisdictions when designing our own set of rules … Good corporate governance is a way we can continue to add value and differentiate ourselves as a global financial centre”. (Professor KC Chan, Secretary for Financial Services and the Treasury, 22 October 2010)

REQUIRED: In light of what was said by the Secretary, discuss : 5. (a) The arguments in favour of a strong corporate gover nance regime for

a listed company.

Ans (a) Definition of corporate governance Corporate Governance is the system by which business corporations are directed and controlled. A Corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders, and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance. Strong corporate governance regime The main arguments in favour of having a strong corporate governance regime for listed companies are: 1. Good governance will eliminate the risk of misleading or false financial

reporting, and will prevent companies from being dominated by self-seeking chief executives or chairmen. By reducing the risks of corporate scandals, investors will be better protected. This should add generally confidence in the capital markets and help to sustain share prices.

2. Failure to achieve appropriate and efficient corporate governance could result in sub-optimal allocation of resources, abuses and theft by management, expropriation from outside shareholders and creditors, financial distress and even bankruptcy.

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3. Companies that comply with best practice in corporate governance are also more likely to achieve commercial success. Good governance and good leadership and management often go hand-in-hand. It also brings about more prudent allocation of company resources. Well-governed companies will often develop a strong reputation and be less exposed to reputational risk than companies that are not so well governed.

4. Good governance encourages investors to hold shares in companies

for the longer term, instead of treating shares as short-term investments to be sold for a quick profit. Companies benefit from having shareholders who have an interest in their longer-term prospects.

5. As more and more companies in any market are noted for their good

corporate governance practices, coupled with the presence of good corporate governance regulations that are constantly monitored and actively enforced in that market, the market will attract more and more capital from the international investment community. On the other hand, if the market perceives poor corporate governance in many companies, the reputation of the market as a whole suffers and investor confidence is reduced.

6. International investment managers’ claims that they will only invest in

companies or markets with a good corporate governance reputation would make it difficult for companies competing for capital to ignore good corporate governance.

5. (b) The six main areas covered by the OECD Principles o f Corporate Governance (2004).

Ans (b) The OECD Principles of Corporate Governance cover the following six areas: 1. Ensuring the basis for an effective corporate governance framework

• The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities.

2. The rights of shareholders and key ownership functions • The corporate governance framework should protect and facilitate

the exercise of shareholders' rights.

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3. The equitable treatment of shareholders • The corporate governance framework should ensure the equitable

treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights.

4. The role of stakeholders in corporate governance • The corporate governance framework should recognise the rights of

stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.

5. Disclosure and transparency • The corporate governance framework should ensure that timely and

accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.

6. The responsibility of the board • The corporate governance framework should ensure the strategic

guidance of the company, the effective monitoring of management by the board, and the board's accountability to the company and the shareholders.

5. (c) How the OECD Principles address the issue of treatm ent of shareholders belonging to the same class.

Ans (c) The third area of the Principles state that all shareholders of the same series of a class should be treated equally. Specifically, the Principles refer to the following situations: • Within any series of a class, all shares should carry the same rights. All

investors should be able to obtain information about the rights attached to all series and classes of shares before they purchase. Any changes in voting rights should be subject to approval by those classes of shares which are negatively affected.

• Minority shareholders should be protected from abusive actions by, or in the interest of, controlling shareholders acting either directly or indirectly, and should have effective means of redress.

• Votes should be cast by custodians or nominees in a manner agreed upon with the beneficial owner of the shares.

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• Impediments to cross border voting should be eliminated. • Processes and procedures for general shareholder meetings should

allow for equitable treatment of all shareholders. Company procedures should not make it unduly difficult or expensive to cast votes.

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6. Institutional investors, because they own large block of shares in a company, can promote shareholder activism and help improve corporate governance standards in companies.

REQUIRED: Critically analyse this statement by discussing: 6. (a) The relationship between shareholder activism and i nstitutional

investors.

Ans (a) Institutional investors may lead to shareholder activism Shareholder activism refers to shareholders being more active in making their views known to the companies they invest in by engaging in an active dialogue with board of directors in the hope of influencing its decisions. It also refers to shareholders’ using their votes at general meetings against the board of directors if the board fails to respond to their concerns satisfactorily. It is appropriate to explain shareholder activism in terms of encouraging shareholders to have a more active involvement with the companies in which they invest. To do this effectively, active shareholders above all need a majority of votes. Since most shareholders in a large listed company hold a relatively small percentage of the total number of shares and they all have different concerns of their own, it is difficult to organise a group of dissident shareholders into a voting majority. Institutional investors, because of the larger shareholding that they own, are in a better position to monitor the company’s performance. In fact, there is evidence suggesting that institutional shareholders are active monitors of a company as they have the incentive and the power to act as such. Institutional shareholders have an incentive to develop specialised expertise in monitoring investments because they own large blocks of shares and therefore have more power to hold management accountable for actions that do not promote shareholder welfare. Their greater access to information on the company, coupled with their concentrated voting power, can enable them to more actively monitor the company's performance and to make changes in the board's composition when performance is not up to par. Institutional shareholders effectively, through active and regular dialogue with investee company's board and

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senior management on corporate governance matter, monitor performance of the investee companies. They will ensure that the whole board, led by the chairman, responds to issues that could give rise to concerns about shareholders' value and will intervene where necessary. But may also forestall development However, institutional investors may also forestall the development of shareholder activism in the following ways. • Free-riding problem

� When an activist shareholder applies effort to improve the company's value through activism, he must be compensated appropriately in order to employ the extensive efforts required. This at the same time benefits all shareholders, although efforts put in by the sole activist. Small activists are discouraged as their share of the reward will not match the cost of obtaining it. Large shareholders, however, may receive a sufficiently large share of reward to offset the cost of activism. Consolidating activist efforts in coalitions could help solve the problem.

• Cost concerns

� Cost is a problem as the aggrieved shareholders concerned may have to bear the cost of organising a group of dissident shareholders to solicit enough majority votes. Organising the collective action of a substantive group of shareholders is often difficult. Thus, there is a strong incentive for the individual shareholder and even the institutional shareholder to do nothing.

• Institutional investors’ bias

� Institutional investors aim to achieve their business goal rather than to protect the minority shareholders’ interest. They may also have a business interest in or business connection with the company which proposed corporate actions and therefore avoid criticising its management.

• Liquid stock markets lead to exit

� Highly-liquid stock markets diminish large shareholders' incentives to monitor the companies in which they have invested as the liquidity allows them to exit their investments more easily.

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6. (b) How institutional investors can help improve corpor ate governance standards in a company.

Ans (b) Generally it is not the intention of institutional shareholders to micromanage affairs of companies in which they invest. What they want is to derive value from their investments by dealing effectively with concerns over under-performance In short, taking on an activist role. In order to carry out the activist role, institutional shareholders may adopt the following measures. (1) Considered use of votes of institutional shareholders

• Institutional shareholders should attend general meetings where appropriate and practicable. They have a responsibility to make considered use of their votes. They should take steps to ensure their voting intentions are translated into practice.

(2) Proactively monitoring investee companies

• Institutional shareholders should review annual reports and accounts, circulars issued by companies and general meeting resolutions. They may attend general meetings where they may raise questions about investee companies’ affairs.

(3) Requiring compliance with corporate governance codes

• Investee companies are required to comply with the corporate governance code which may be laid down by the regulators or institutional investors. Since the Code on Corporate Governance Practices is silent on the role of institutional shareholders, reference can be made to the UK Corporate Governance Code. The UK Code encourages institutional shareholders to take a reasoned and flexible approach when judging the compliance of companies with corporate governance requirements: � When evaluating company disclosures on corporate

governance, particularly those relating to board structure and composition, institutional shareholders should give due weight to all relevant factors drawn to their attention.

� Institutional shareholders should carefully consider the explanations given by companies for any departure from the Combined Code provisions and make a reasoned judgment in each case.

� If they do not accept the company's positions, they should explain their views in writing to the company, and be prepared to enter into a dialogue on this matter if necessary.

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� They should avoid a box-ticking approach to checking compliance with the Combined Code and to assessing a company's corporate governance.

(4) Meeting an investee company's board and senior management

• There should be an active dialogue with the company's board and senior management. However, institutional shareholders must remain aware that they should not become too involved in the company's affairs. For example, if they find themselves in receipt of information that has not been publicly disclosed, they might be made liable for insider dealing under the SFO.

(5) Setting strategies on intervention

• Effective monitoring of investee companies will enable institutional shareholders to exercise their votes and, where necessary, intervene objectively and in an informed way. Institutional shareholders should set out the circumstances (e.g. bad company performance, internal control failure, inadequate succession planning) when they will actively intervene and what the nature of that intervention might be. If boards do not respond constructively when institutional shareholders intervene, then they will consider on a case-by-case basis to escalate their action, for example, by making a public statement in advance of the AGM or an EGM or requisitioning an EGM, possibly to change the board. Institutional shareholders should vote all their shares held directly or on behalf of clients at general meetings wherever practicable to do so. If they have been unable to obtain a satisfactory outcome of their concern through active dialogue, then they will register an abstention or vote against the resolution. They may notify the company about their voting intention in advance and give the reasons underlying that intention. Institutional shareholders should also monitor and evaluate the effects of their activism.

END