THE INDEPENDENT DIRECTORS’ ROLE IN EUROPE: DEVELOPMENTS AND OPEN DEBATES IN ITALY
Serena Scarabotti
I. INTRODUCTION
On July 17, 2007, the European Commission published a report (the “Report”)[1] on Member State implementation of Recommendation 2005/162/EC (the “Recommendation”). This Recommendation addresses the role of non-executive or supervisory directors of listed companies and that of the (supervisory) board’s committees. It was adopted to promote standards ensuring that the boards of listed companies offer sufficient guarantees of independence. In doing so, it promotes the convergence of the national corporate governance codes enacted in the Member States, so that investors may benefit from an equivalent level of protection and transparency within the European Community. In addition to contributing to the business efficiency in the internal market, the Recommendation is also a response to recent corporate fraud scandals.[3] As the Member States were invited to implement the Recommendation by June 30, 2006, the purpose of the Report was to evaluate whether Member States have developed the necessary legal framework to give effect to the Commission’s key proposals.[4]
This article outlines the Recommendation’s most important innovations, with specific regard to independent directors’ role. These proposals are to be implemented in the Member States either through legislation or through best practice rules based on the flexible “comply or explain” principle.[5] In particular, this article focuses on the Italian experience of regulating the role of independent directors so as to ensure that they act in accordance with European guidelines. To this day, corporate governance remains a central issue in Italy, especially in light of the December 18, 2008 judgment issued by a Milan court concerning Calisto Tanzi.[6] The Court sentenced Tanzi, a former chief executive officer of Parmalat-which collapsed five years ago in a massive fraud-to 10 years of imprisonment.[7] The Parmalat case[8] represents one of the most glaring examples of corporate governance abuses. It has contributed to the creation of the Italian corporate governance system ensuring the presence of independent directors in the boards of listed companies.[9] The Parmalat debacle demonstrates that the question is still open on whether the “comply or explain” principle is a valid safeguard for corporate governance and, if so, what measures need be introduced in Italy so as to render it really efficient. This brief article aims at proposing a few preliminary suggestions in what appears to be an open and ongoing debate.
II. THE IMPORTANCE OF INDEPENDENT DIRECTORS
Independent directors play a key role in the corporate governance system that has been developed in Europe, following the Sarbanes-Oxley Act in the United States. The basic idea is that corporate governance should ensure that boards exercise appropriate scrutiny over management and shareholders (in their capacity as owners of the company)[11]. Boards are thought less likely to exercise efficient monitoring if they are composed of individuals who either maintain close ties to the management or lack the appropriate expertise. Independence is particularly crucial in those areas which involve a potential conflict of interests between managers and shareholders: for example, appointment of the management, manager’s pay, and auditing of the company’s performance.[12]
III. THE RECOMMENDATION’S KEY ADVANCES
One of the most important objectives of the Recommendation is to promote the function of independent, non-executive or supervisory directors in major fields of potential conflicts of interests between management and shareholders.[13] To this end, the following key points have been outlined by the Recommendation:
A. Separation of the role of Chief Executive Director and (supervisory) Board [14]
The administrative, managerial, and supervisory bodies should include an appropriate balance of executive/managing and non-executive/supervisory directors so as to avoid allowing any individual or group of individuals coming to dominate the decision-making process.
B. Sufficient number of Independent Directors [15]
“[A] sufficient number of independent non-executive or supervisory directors should be elected to the (supervisory) board of companies to ensure that any material conflict of interests involving directors will be properly dealt with.”[16] Independence means freedom from any business, family, or other relationship with the company, its controlling shareholder, or the management.
C. Creation of Board Committees to solve conflict of interests [17]
Three types of committees should be created within the (supervisory) boards-nomination, remuneration, and audit-whenever these dutiesare not the direct responsibility of shareholders. The presence of independent non-executive directors in such committees is strongly emphasized.
D. Transparency concerning Independent Board Members [18]
The disclosure of individual directors’ competences and of adequate information on the board’s determination of the directors’ independence is strongly advised.
E. High standards for the qualifications and commitment of (supervisory) Board Members [19]
For a (supervisory) board to be efficiently set up, its members should have, taken together, the “required diversity of knowledge, judgment, and experience to complete their tasks properly.” More specifically, directors should devote sufficient time and attention to their work by limiting their other professional commitments (especially in case of directorships in other companies) and/or disclosing their other assignments and significant professional commitments.
IV. THE VIEW FROM ITALY: THE PREDA CODE AND INDEPENDENT DIRECTORS
The European Union and the United States have essentially identified the same issues and goals in corporate governance-that is, the importance of good corporate governance for the benefit of investors and the economy. Yet, unlike the Sarbanes-Oxley Act, which imposes mandatory provisions for U.S. companies (through a one-size-fits-all approach), the corporate governance initiatives proposed in the European Union are not intended to be mandatory.[20] Self-regulation through corporate governance codes, which merely requires public companies to disclose whether or not they are in compliance with the codes, is a typical feature of the European approach to corporate governance.
In Italy, independence standards for directors are provided by the Italian corporate governance code (the “Preda Code”) as well as the Recommendation. Borsa Italiana S.p.A., the Italian stock exchange, implemented the Preda Code in 1999. The Code was later updated in 2002 and 2006 after the major Cirio[24] and Parmalat financial scandals.
Despite the fact that the Preda Code’s provisions are generally not mandatory, they require all Italian listed companies to present a yearly corporate governance report declaring whether and to what extent they conform to the Code. This reporting system stems from the “comply-or-explain”principle, which allows companies to apply corporate governance principles with an eye to their own specificities. In this context, the Recommendation works as a proxy for international best practice. Article 3 of the Preda Code requires independence of judgment for all directors.[25] Nonetheless, only non-executive directors may provide an “independent and unbiased judgment on proposed resolutions, they are not directly involved in the running of the company.”[26] For this reason, the Preda Code refers to a non-executive director as an “independent director.”[27]
Furthermore, the Preda Code addresses the most common symptoms of lack of independence. However, these provisions are purely explanatory and not binding, as the board of directors may adopt additional or different criteria by giving “adequate information” about the effectiveness of any different evaluation in terms of independence.[28] The Preda Code favors a case by case approach to the extent that each board needs to evaluate the fulfillment of the independence requirements.[29] The evaluation of non-executives’ independence should be made on a substantial rather than formal basis.
In particular, as to the “commercial, financial, and professional relations directly or indirectly entertained by the director with the issuer,”[30] the corporate governance committee (the “Committee”)[31] has not set out specific criteria to assess independence. The board is in charge of evaluating the materiality of such relationships, “both in objective terms and in relation to the economic-financial situation of the party concerned.”[32] According to the commentary accompanying the Preda Code, the key to determining whether a relationship is “material” is whether the director is benefiting in a way “not aligned with the market.”[33] The Committee is careful to note, however, that there is no relationship that can be considered de facto independent, that is, all relationships must be put to the test.[34]
It should also be noted that the customary structure of Italian administrative bodies includes the possibility that certain directors are independent even though they are members of the executive committee of the issuer, in part because the executive committee does not necessarily confer individual powers to its members. The Committee focuses on the objectivity of the independence requirements, irrespective of whether the shareholders have appointed the directors.[35] As a result, independent directors’ appointments may be proposed alternatively by the majority or minority shareholders since, in any case, the independence requirement shall be verified based on actual practice, following the Preda Code and the Recommendation’s guidelines.[36]
V. THE “COMPLY OR EXPLAIN” PRINCIPLE
The Report concludes that “a majority of Member States [have] compl[ied] at least to a large extent with the recommendations,” and, as the preceding discussion demonstrates, Italy is no exception.[37] Nonetheless, with an eye to all Member States, the Commission is concerned with the practical efficiency of the “comply or explain” principle, which has inspired, among others, the Italian corporate governance scheme. In the Commission’s opinion, the success of such a principle “will depend largely on the quality of the information provided in the corporate governance statement.”[38] In addition, even the “[t]ransparency requirements may be insufficient if shareholders do not take a pro-active and critical attitude toward the decisions of the management and do not seek changes in corporate governance policies and structures . . . .”[39] Taking into account all these concerns, the Commission expressed its intention to continue monitoring the implementation of the Recommendation across Member States.[40]
VI. RECENT DEVELOPMENT IN THE ONGOING ITALIAN DEBATE OVER CORPORATE GOVERNANCE
The debate over the efficiency of corporate governance systems is alive and well in Italy, and Italian legislators still appear willing to test the actual efficacy of the “comply or explain” principle.[41] For example, to respond to the Commission’s concern about the efficiency of the “comply or explain” principle, Italy implemented Directive 2006/46/EC in November 2008.[43] More specifically, since the amendment of Article 123-bis by Legislative Decree 58/1998 (the so-called “Consolidated Financial Act”)[44], it is now mandatory for EU listed companies to publish management reports including information on the adoption of a corporate governance code. Because even the best corporate governance codes may remain powerless so long as they do not impose a real requirement to comply or explain, Directive 2006/46/EC contributes to enhancing transparency and to monitoring compliance progresses.
Furthermore, potential conflicts of interest in related party transactions and executive contracts remain a significant concern in Italy. Consequently, in September 2008 the Commissione Nazionale Società e Borsa (“CONSOB”), the Italian securities market regulator, has launched a consultation process concerning the need to enhance independent directors’ role with regard to related parties transaction.[45] CONSOB focuses on the central function of independent directors in approving related parties transactions so as to ensure efficient and transparent management procedures. In addition to the various disclosure duties still applicable to listed companies, CONSOB is of the opinion that a deep involvement of independent directors in executing relatedparties transactions would help reduce risks of conflicts of interest.[46]
The measures highlighted above reflect the continuing and compelling need for an actual and efficient implementation of corporate governance rules in Italy which would align agency costs and asymmetry of information between management and ownership of companies.[47] Will such measures succeed in pursuing this goal? Will they allow investors to consider explanations and to dialogue with companies where issues arise? Will the enforcement mechanism of the “comply or explain” rule be powerful? These questions have yet to be answered in Italy where an efficient system of corporate governance is even more needed after the Parmalat collapse.
Endnotes
[3] See, e.g., Claudio Storelli, Corporate Governance Failure-Is Parmalat Europe’s Enron?, COLUM. BUS. L. REV. 765, 767-70 (2005) (discussing the importance of the Parmalat case, which highlighted the inherent danger of concentrating the functions of chief executive and of chairman of the board in the hands of the same person).
[4] Commission Report, supra note 1, at 3.
[5] Recommendation 2005/162/EC, supra note 2, recitals 4, 5 & ¶¶ 1.1, 1.2, 1.3.2.
[6] Mara Monti, Tanzi, Dieci Anni per Aggiotaggio, IL SOLE 24 ORE, Dec. 19, 2008.
[7] Vincent Boland, Parmalat Ex-Chief Sentenced to 10 Years, FINANCIAL TIMES, Dec. 18, 2008.
[8] For a general introduction to the issues related to the Parmalat case and its implications for the development of Italian corporate governance, see Guido Alessandro Ferrarini & Paolo Giudici, Financial Scandals and the Role of Private Enforcement: The Parmalat Case (Eur. Corp. Gov. Inst., Law Working Paper No. 40, 2005).
[9] Commission Communication, Modernizing Company Law and Enhancing Corporate Governance in the European Union-A Plan to Move Forward, COM (2003) 284 final (May 21, 2003).
[11] Florence Shu-Acquaye, Corporate Governance Issues: United States and the European Union, 29 HOUS. J. INT’L L. 583, 593 (2007).
[12] Recommendation 2005/162/EC, supra note 2, recital 9; see also id. annex I.
[13] Id.
[14] Id. ¶ 3.2
[15] Recommendation 2005/162/EC, supra note 2, ¶ 13.
[16] Commission Report, supra note 1.
[17] Recommendation 2005/162/EC, supra note 2, ¶ 7.
[18] Id. ¶ 9.
[19] Id. ¶ 11.1; Commission Report, supra note 1, at 5.
[20] Elias Mossos, Sarbanes-Oxley Goes to Europe: A Comparative Analysis of United States and European Union Corporate Governance Reform after Enron, CURRENTS: INT’L TRADE L.J., Summer 2004, at 9
[24] Analytical discussion of the Parmalat and Cirio cases, always associated in terms of representative Italian financial scandals, and their effects on financial markets can be found in Cirio, Parmalat e Dintorni: Finanza, Industria, Regole, BORSA 2004: RAPPORTO REF SUL MERCATO AZIONARIO 105 (2004).
[25] Codice di autodisciplina, supra note 23, art. 3 cmt. at 23.
[26] Id.
[27] Id. The comment states that the label “does not express a judgment of value, but it rather indicates an actually existing [sic] situation: the absence . . . of any relation with the issuer . . . .”
[28] Id. at 11.
[29] Id.
[30] Id. art. 3 cmt. at 24-25.
[31] The corporate governance committee is the committee in charge of drafting the Preda Code.
[32] Codice di autodisciplina, supra note 23, art. 3 cmt. at 25.
[33] Id.
[34] Id. The comments undertake a non-exhaustive list of possibly material relationships, including those that are governed by market conditions, non-economically significant, or are indirectly traceable to corporate representatives, as well as relationships created by political activity or familial relationships of directors. Id.
[35] Id.
[36] Id.
[37] Commission Report, supra note 1, at 9.
[38] Id.
[39] Id. at 10.
[40] Id. at 9-10.
[41] Id. at 9.
[42] Parliament & Council Directive 2006/46/EC, 2006 O.J. (L 224) 1.
[43] Directive 2006/46/EC has been implemented in Italy in November 2008 through Legislative Decree 173/2008, Gazz. Uff. No. 260, Nov. 2, 2008, amending Article 123-bis of the Consolidated Financial Act, which deals specifically with reporting requirements on corporate governance and ownership structure.
[44] Gazz. Uff. No. 71, Mar. 26, 2008.
[45]vCommissione Nazionale Società e Borsa (CONSOB), Disciplina Regolamentare di attuazione dell’art. 2391-bis del Codice Civile in materia di operazioni con parti correlate.
[46] Id. at 4.
[47] Guido Ferrarini, Ruolo degli amministratori indipendenti e Lead Independent Director, in LA CORPORATE GOVERNANCE E IL RISPARMIO GESTITO 35 (2006).