The way forward

Simeon Ken Ferrer and Ricardo Jesus Gutierrez of SyCipLaw look at some recent changes in the definition of corporate governance which have helped emphasise the responsibilities of boards of directors

sycip.jpg

www.syciplaw.com

Philippine law recognises the central role of a corporation's board of directors. The Corporation Code of the Philippines provides that

'corporate powers of all corporations formed under [the] Code shall be exercised, all business conducted and all property of such corporations controlled and held by the board of directors'.

The Philippine Securities and Exchange Commission (SEC) promulgated the 2009 Revised Code of Corporate Governance in June 2009. This Code became effective in July 2009 and superseded the 2002 version. The 2009 Code amended the definition of board of directors under the 2002 CG Code by adding the phrase 'elected by the stockholders'. Although the amendment emphasises the traditional view that the board's mandate is to create value for its stockholders, the recent trend in corporate governance is the creation of a working board that serves not only stockholders' needs but those of the other corporate stakeholders as well. This is evidenced by the changing board composition requirements and the re-definition of corporate governance under Philippine law.

In terms of board composition, the Corporation Code only requires stock corporations to have no fewer than five but no more than 15 directors, a majority of which must be residents of the Philippines.

The 2002 Code introduced the independent director requirement for public companies. Public companies refer to corporations 'with a class of equity securities listed in an [e]xchange or with assets in excess of Fifty Million Pesos (P50,000,000.00) and having two hundred (200) or more stockholders each holding at least one hundred (100) shares of a class of its securities'.

The 2002 Code requires public companies to have at least two independent directors or such independent directors which will constitute at least 20% of the members of the board, whichever is less. Thus, under the 2002 Code, if the board is composed of five directors, only one of the directors is required to be an independent director. It also encouraged, but did not require, non-public companies to have independent directors.

Under the 2002 Code, an independent director is

'a person other than an officer or employee of the corporation, its parent or subsidiaries, or any other individual having any relationship with the corporation, which would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. This means that apart from the directors' fees and shareholdings, he should be independent of management and free from any business or other relationship which could materially interfere with the exercise of his independent judgement.'

The 2002 Code also provides that the board may include a balance of executive and non-executive directors (including independent non-executives), having a clear division of responsibilities such that no individual or small group of individuals can dominate the board's decision making. An executive director refers to 'a director who is at the same time appointed to head a department/unit within the corporate organisation'. A non-executive director refers to a 'board member with non-executive functions'.

While not designated to head a corporate unit or department, the non-executive directors should be of sufficient qualifications, stature and number to carry significant weight in the board's decisions. Non-executive directors considered by the board to be independent shall be identified in the corporation's annual report.

The 2009 Code expanded the scope of the corporate governance requirements to include, aside from public companies (as defined under the 2002 Code), corporations (a) that sell equity and/or debt securities to the public that are required to be registered with the SEC, (b) whose equity securities are listed on an exchange, or (c) that are grantees of secondary licences from the SEC.

To emphasise the need for independent directors, the 2009 Code added that independent directors must 'in no case be less than two' to the composition of the board. It now reads that:

'A) Composition of the Board

The Board shall be composed of at least five (5), but not more than fifteen (15), members who are elected by the stockholders.

All companies covered by this Code shall have at least two (2) independent directors or such number of independent directors that constitutes twenty percent (20%) of the members of the Board, whichever is lesser, but in no case less than two (2). All other companies are encouraged to have independent directors in their boards. (Emphasis supplied.)'

All the other prescriptions concerning board composition under the 2002 Code remained unaltered under the 2009 version.

The banking industry, which is vested with public interest, is subject to more stringent corporate governance rules issued by the Bangko Sentral ng Pilipinas (BSP), the Philippine central monetary authority.

The BSP Manual of Regulations for Banks as amended by BSP circular no. 749, series of 2012, requires banks to have at least five to 15 members of the board, except that in the case of a bank merger or consolidation, the number of directors may be increased up to a total number of the members of the board of the merging or consolidating bank as provided for in their respective articles of incorporation, but in no case exceed 21. The board will determine the appropriate number of its members to ensure that the number thereof is commensurate with the size and complexity of the bank's operations.

The manual adds that

'to the extent practicable, the members of the board of directors shall be selected from a broad pool of qualified candidates. A sufficient number of qualified non-executive members shall be elected to promote the independence of the board from the views of senior management. For this purpose, non-executive members of the board of directors shall refer to those who are not part of the executive committee or day to day management of banking operations and shall include the independent directors.'

In terms of the number of independent directors, the manual also requires a minimum of two:

'c. Minimum number of independent directors. At least twenty percent (20%) but not less than two (2) members of the board of directors shall be independent directors: Provided, That any fractional result from applying the required minimum proportion, i.e., 20 percent (20%), shall be rounded-up to the nearest whole number. (Emphasis supplied.)'

The manual also provides for a nationality restriction on the board's composition. Non-Filipino citizens may become members of the board of directors of a bank to the extent of the foreign participation in the equity of said bank. However, pursuant to the Corporation Code, a majority of the directors must be residents of the Philippines.

For insurance companies, the Philippine Insurance Commission (IC) issued the Corporate Governance Principles and Leading Practices (CGPLP).

Since the insurance business, like the banking business, is imbued with public interest, the board composition requirements under the CGPLP are similar to that under the manual. Below are the essential standards for board composition under the CGPLP:

1. The board shall be composed of at least five but no more than 15 members elected by shareholders.

2. The corporation shall ensure that there are at least two independent directors in the board.

3. The board shall endeavour to include a balance of executives and non-executive directors, such that, no individual or small group of individuals can dominate the board's decision making.

4. Non-Filipino citizens may become members of the board of an insurance company to the extent of the foreign participation in the equity of said insurance company; provided, that pursuant to the Corporate Code, a majority of the directors must be residents of the Philippines.

Recently, the SEC issued the Code of Corporate Governance for Publicly-Listed Companies (PLCs) which took effect on January 2017.

Based on the latest G20/OECD Principles of Corporate Governance and the Association of Southeast Asian Nations Corporate Governance Scorecard, the PLC Code provides for the following recommendations for board composition:

1. The board should be composed of directors with a collective working knowledge, experience or expertise that is relevant to the company's industry/sector.

2. The board should be composed of a majority of non-executive directors who possess the necessary qualifications to effectively participate and help secure objective, independent judgment on corporate affairs and to substantiate proper checks and balances.

3. The board should have a policy on board diversity.

4. The board should ensure that it is assisted in its duties by a corporate secretary, who should be a separate individual from the compliance officer. The corporate secretary should not be a member of the board of directors and should annually attend a training on corporate governance.

5. The board should ensure that it is assisted in its duties by a compliance officer, who should have a rank of senior vice president or an equivalent position with adequate stature and authority in the corporation. The compliance officer should not be a member of the board of directors and should annually attend a training on corporate governance.

The PLC Code shows that prescriptions and rules on board composition should go beyond the number of directors and independent directors, and should also include other requirements that are meant to meet the changing definition of corporate governance (as discussed in the next section). Hence, the requirements of collective working knowledge, experience or expertise, and a policy on board diversity.

Corporate governance is traditionally viewed as being stockholder-centered, and the focus of corporate governance should be the maximisation of shareholder value. The Corporation Code is based on this view. The Philippine Supreme Court affirmed this by holding that the director of a corporation has a duty of loyalty to his corporation, and, by extension, to the stockholders of the same.

Recently, the trend has been for corporate governance to also address the interests of other stakeholders. Now, the purpose of corporate governance is the balancing of all the interests involved in the management of a corporation.

In the Philippines, the BSP adopted a more stakeholder-oriented approach within the banking industry. In subsection X141.3 of the manual, which was first introduced by BSP circular no. 283, series of 2001, the BSP decreed as the general responsibility of the board of directors that:

'The position of a bank/quasi-bank/trust entity director is a position of trust. A director assumes certain responsibilities to different constituencies or stakeholders (e.g., The bank/quasi-bank/trust entity itself, its stockholders, its depositors and other creditors, its management and employees, and the public at large). These constituencies or stakeholders have the right to expect that the institution is being run in a prudent and sound manner. (Emphasis supplied.)'

Subsequently, the SEC, in the 2002 Code, also adopted a similar approach to corporate governance and defined the same as

'a system whereby shareholders, creditors and other stakeholders of a corporation ensure that management enhances the value of the corporation as it competes in an increasingly global market place (Emphasis supplied.)'

In 2005, the Insurance Commissioner formally adopted the CGPLP, which provides that:

'[d]irectors and independent directors shall…[a]ct honestly, in good faith, and with loyalty to the best interest of the institution, its stockholders (regardless of the amount of their stockholdings) and other stakeholders such as its policyholders, investors, borrowers, other clients and the general public. (Emphasis supplied.)'

However, the 2009 Code removed all references to stakeholders and appears to have reverted to the traditional stockholder-centered view by limiting the definition of corporate governance to the board's and management's duties and responsibilities to stockholders, thus:

'a) Corporate Governance – the framework of rules, systems and process in the corporation that governs the performance by the Board of Directors and Management of their respective duties and responsibilities to the stockholders (Emphasis supplied.)'

During that period, there were doubts as to whether the Philippines, in regulating corporations, adhered to the stakeholder-oriented approach first introduced in the 2002 Code.

In May 2014, however, the SEC issued SEC memorandum circular 09-14, series of 2014, amending the 2009 Code. Under this circular, the SEC redefined corporate governance to include the board's and management's duties and responsibilities to stakeholders, thus:

'a) Corporate Governance – the framework of rules, systems and processes in the corporation that governs the performance of the Board of Directors and Management of their respective duties and responsibilities to stockholders and other stakeholders which include, among others, customers, employees, suppliers, financiers, government and community in which it operates. (Emphasis supplied.)'

Further, on November 2016, the SEC promulgated the PLC Code which, consistent with the revised 2009 Code, defined corporate governance to include the board's and management's duties to stakeholders, the society and the nation, thus:

'Corporate Governance – the system of stewardship and control to guide organization in fulfilling their long-term economic, moral, legal and social obligations towards their stakeholders.

Corporate governance is a system of direction, feedback and control using regulations, performance standards and ethical guidelines to hold the Board and senior management accountable for ensuring ethical behavior – reconciling long-term customer satisfaction with shareholder value – to the benefit of all stakeholders and society.

Its purpose is to maximize the organization's long-term success, creating sustainable value for its shareholders, stakeholders and the nation. (Emphases supplied.)'

In view of these recent developments, it can be said that the Philippines has formally adopted the more inclusive stakeholder-oriented corporate governance framework.

About the author
		Simeon Ken Ferrer Partner, head of corporate services, SyCipLaw T: +632 982-3500 F: +632 817-3896 E: skrferrer@syciplaw.com W: www.syciplaw.com Simeon Ken Ferrer heads the firm's Corporate Services Department. His practice areas include banking, finance and securities, foreign investments, M&A and corporations. He has assisted Philippine and foreign banks and other financial institutions in connection with equity, debt and derivative securities issues, as well as securitisation transactions by Philippine corporations and by the Republic of the Philippines. Mr. Ferrer also assists foreign investors in structuring their direct investments in the Philippines. He acts as director, corporate secretary or assistant corporate secretary of various Philippine and multinational corporations engaged in diverse economic activities, such as power distribution, car assembly, mineral processing, manufacturing, pharmaceuticals, semiconductors, and property holding and development.

About the author
		Ricardo Jesus Gutierrez Associate, SyCipLaw T: +632 982-3500 F: +632 817-3896 E: rjegutierrez@syciplaw.com W: www.syciplaw.com Ricardo Jesus Gutierrez is a member of the firm's banking, finance and securities, special projects and intellectual property practice groups. His practice areas include banking and finance regulations, structured finance, mergers and acquisitions, investments, technology, franchising and distribution, and arbitration. He regularly advises banks and financial institutions, including insurance companies, for regulatory compliance. He also helped established a branch of a foreign bank when the country allowed full entry of foreign banks. Mr. Gutierrez has also been involved in complex multi-jurisdictional structured financing transactions. He has participated in a number of global acquisitions and advised clients in connection with the Philippine aspect of the transactions. He has also helped clients forge joint venture agreements. Mr. Gutierrez also regularly advises clients on Philippine Economic Zone Authority-related matters, internet regulations and data privacy.