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Why the unitary board must be preserved

27 August 2018 by Giles Peel

Why the unitary board must be preserved - read more

The move by regulators towards increased individual accountability for directors threatens to undermine the most hallowed of governance tenets – the unitary board

In the course of my work as a governance adviser, and as an active chair and non-executive director (NED), I have always been able to preach the virtues of a unitary board. It is a principle that I hold dear, is sector neutral in terms of its applicability and distinguishes UK corporate governance from many other parts of the business globe.

At the heart of the principle is the aim of achieving consensus among the board of directors. They are charged with the safekeeping of the corporation, and as we see in section 172 of Companies Act 2006, ‘promote the success of the company for the benefit of the members as a whole’.

In spite of this, I believe that this unitary principle is now under direct threat in at least one sector of UK business life – financial services – and from the most unlikely of quarters, the regulators.

Enshrined in law

All chartered secretaries, the majority of lawyers, and accountants are examined in, and then have to operate with, a good working knowledge of UK company law – in particular the Companies Act 2006.

This iteration of company law enshrined directors’ duties (including fiduciary duty) from common law into statute for the first time in sections 171 to 177 and followed Sir Derek Higgs’ definitive work on the role of the NED.

Higgs’ work formalised a clear definition of the NED role and set out to show that the work of the non-executive in scrutinising executive management was a key part of the principle of a unitary board. It is commented on in all aspects of UK corporate governance and the net effect of directors’ duties and company articles is that the concept of unitary boards is universally adopted.

“At the heart of the principle is the aim of achieving consensus among the board of directors”

In law, there is no distinction between types of directors – ‘if you are a poorly-performing NED, it is only mitigation to state that you are a part-time director, not a defence’ as my old company secretary tutor used to say. I have always believed that this was grist to the unitary conceptual mill, namely that all the directors are in it together.

This concept is reinforced by the use of directors and officers insurance cover and general indemnification that is common to all UK boards. You are inducted as a director with this collectively responsible concept at the heart of the way you are briefed, the manner in which you oversee strategy and risk management, and face up to your duties and the consequent liabilities.

The hunt for scapegoats

But something profound happened in 2008. The world of regulation changed course after the banking crisis, taking a path that has since deviated from company law.

At the centre of this change were politicians, who badly needed scapegoats for the crisis and were unable to find them, either because the law offered few opportunities to target those responsible or because regulation had not been designed to identify or pursue individual directors.

In a way that mimicked the lengthy quest for effective corporate manslaughter legislation, governments and regulators were unable to produce a series of guilty directors to face the music for the 2008 crash and failed generally to prove the culpability of boards.

“The world of regulation changed course after the banking crisis, taking a path that has since deviated from company law”

As a result, pressure was brought to bear to find ways of making individuals more accountable and by building on the – by now slightly shaky – foundations of the approved persons regimes (themselves a result of reaction to earlier corporate disasters such as the Barings Bank collapse, WorldCom and so on) and more stringent reviews, banking’s Senior Manager Regime (SMR) was launched by the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) in 2016.

The key tenet of SMR was to align decision-making with individual accountability and also with corporate strategy. Hard on its heels came the Senior Insurance Manager Regime (SIMR) and both are now included in the all-encompassing Senior Manager and Certification Regime (SMCR), which comes into full effect in late 2019.

Individual responsibility

These are enormously complex regulatory regimes, but they do have common elements: a very strong push to identify the responsibilities of individual directors and senior managers, codify certain roles and ensure that the governance arrangements of the companies that employ them clearly identify the lines of accountability and responsibility, using responsibility (formerly called governance) mapping to record this detail.

Each approved senior manager has to have a statement of responsibility, in some cases has prescribed responsibilities, and must abide by conduct rules. There is also a new statutory duty of responsibility, requiring senior managers to take reasonable steps to prevent regulatory breaches.

The cumulative effect of this is to change corporate culture, shifting emphasis very clearly towards individual accountability.

There is also now a requirement for regulatory referencing, placing an obligation on employers to inform the regulator if wrongdoing is identified after an individual has left the company. None of this is wrong in itself and in conjunction with fit and proper requirements has led to a greater focus on the quality of individuals, and identification of some rotten apples, but the overwhelming emphasis is on the ‘me not we’.

Tiered non-executives

The other area of significance is that these regimes have begun to sort NEDs into separate categories, with chairs of board committees singled out as more significant in regulatory terms. These NEDs hold senior management functions in their own right and are subject to regulatory approval under SMCR.

The remaining standard NEDs, who are simply members of the board or committees – known as ‘notified NEDs’ as they only have to be notified to the regulator rather than approved by it – are now clearly identified in a separate tier of responsibility. How does this square with the Companies Act?

It is hard to tell, when the law clearly states that all directors are equal in terms of responsibility, which is a long way from providing a distinction between types of NED.

The effect of this new regulatory emphasis is a rise in the value and remuneration of NEDs as committee chairs and a sense that somehow the notified NEDs have less of a role.

I often end up in vigorous debate on this latter point, arguing that having a NED with no particular committee affiliation is extremely important for board balance and in acting as an effective check and balance for the board when dealing with a strong committee used to getting its own way.

However, this demarcation of types of NED will, without doubt, undermine collective responsibility.

Regulators at odds

Meanwhile, other key influencers such as the Financial Reporting Council (FRC) continue to promote the unitary concept in all of its guidance, including in the revised UK Corporate Governance Code published in July, but increasingly this seems to be at odds with the rhetoric of the FCA and PRA.

“The demarcation of types of NED will, without doubt, undermine collective responsibility”

One revealing statement was published by the PRA in May 2017: ‘The PRA views SIMR as consistent with the principle of collective decision-making. SIMR coexists with the statutory and fiduciary duties of directors under company law.’

But just saying this does not make it so.

I deal with many questions about the rights of individual directors to challenge the direction of committees, requests that minutes of meetings reflect the disagreement of individuals in particular decisions, or advise in instances where companies decide to re-emphasise the rights of boards to overrule directors.

Of these examples, the gradual reduction in influence of board committees, if it comes to pass, will be the most threatening to the unitary principle. Confusion is out there and I believe it is increasing – and all of it serves to challenge the long-held belief in collective decision making at the heart of UK corporate governance.

Fighting the tide

All of my examples come from financial services, but I do not see this being limited to this sector. Fit and Proper Person regulation is already present in sectors such as health and there are sufficient examples of poor governance in the charity sector to make it arguably only a question of time before pressure is brought to bear on other regulators to focus more on individual accountability.

What to do then? It is hard to row against the tide of ever more complex regulation, which is designed solely to produce identifiable individuals in the event of breach or wrongdoing.

We need more dialogue between the FRC and the other regulators, to identify this growing schism and to assess the risks arising from it. Perhaps one way is to challenge the concept of tiered NEDs, in order to strengthen the concept of oversight and performance management of executive directors and their senior managers by a single tier of board-level directors.

A board and its committees should be able to scrutinise this performance, albeit with a clear map of individual responsibilities, and should be able to intervene if a director or manager deviates from the values, culture or strategy of the organisation – or, of course, breaches regulation or breaks the law.

Finally, if an individual director constantly challenges this scrutiny, or regularly wants to record dissent from the direction of the company, then that individual (if, of course, not a whistleblower) is probably in the wrong job!

If this does not happen, then I fear we are at risk of losing a most valuable principle of corporate governance, and the consequences of that do not bear thinking about.

Giles Peel FCIS is head of governance advisory practice at DAC Beachcroft LLP

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