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Corporate Governance: Who Is Liable for “Shadow Directors’” Decisions?

by internationaldirector

Written By: Diana Bailey – Corporate Finance

The Financial Stability Board (FSB) is endorsed by the G20 and Organisation for Economic Co-operation and Development (OECD) to monitor and make recommendations about the global financial system in order to strengthen its international stability. It coordinates national financial authorities and international standard-setting bodies as they work toward developing strong regulatory, supervisory and other financial-sector policies. It checks and encourages coherent implementation of these policies across sectors and jurisdictions.

In a recent report on peer review in corporate governance, the FSB checked how corporate governance has been put in place in G20 jurisdictions and financial institutions. While it mentioned effective practices and areas in which good progress has been made, the FSB also issued 12 recommendations on how corporate governance could be improved.

Financial institutions’ governance and transparency of responsibilities could be improved.

Among the FSB’s recommendations on corporate governance was the need for harmonisation in the different legislations, rules and codes that jurisdictions impose on their financial institutions. It also suggested that in their governance principles, jurisdictions should make sure that they take into account the ownership structure, geographical presence and stage of development of financial institutions. But what may be very interesting is that the FSB report entered quite deeply into financial institutions’ board structures and ways of functioning.

More power to shareholders and protection to whistle-blowers? The FSB considered that disclosures should be improved on governance structures, voting arrangements, shareholder agreements with significant cross-shareholding and cross-guarantees. Shareholders should be provided with board-remuneration-related information. But they should also be given the opportunity to vote at shareholder meetings on the remuneration policies of financial institutions and the total value of compensation arrangements offered to the board and senior management. There also should be succession planning for board members, but also a transparent process of nomination and election, so that shareholders can be transparently informed and possibly involved. Boards should undertake regular assessments of their effectiveness, but the FSB also mentioned that they should receive regular training to be kept aware of relevant new laws and regulations.

The FSB stressed the fact that effective whistle-blower programs also should be enhanced, including policies to protect whistle-blowers. The recent Wells Fargo scandal has definitely alerted public and financial institutions to the necessity to protect those employees who want to sound the alert on illegal or unethical practices.

“Shadow directors” ought to be liable for their influence or decisions.

Going further, the FSB dug into the real responsibilities of boards within group structures, whether regarding disclosure of related parties’ transactions from shareholders or board members, or the importance of having real, independent directors on the board. The FSB stressed that board members have to be able to act according to their full responsibilities and independence.

The term shadow directors refers to the possibility that board members are not totally responsible for board decisions, if they are dependent on the decisions of executives working out of their entities but, for instance, within mother companies. “One key policy issue in board liability relates to who can or should be considered a board member, for the purposes of assigning liability in case should something go wrong,” wrote the FSB.

A shadow director  is someone who is not appointed as a director but who gives directions or instructions upon which the directors of the financial institution are accustomed to act. And, indeed, the situation is real, as in most groups board members of subsidiaries can be employees of the group, and they are generally nominated by the mother company’s executives. Their salaries and promotions depend fully on “someone above them”. Moreover, executives from the group (but not from the subsidiary) are present on many project or investment steering committees, new-product committees, remuneration committees—leading to most of the important decisions, if not all, being taken by shadow directors.

The FSB mentioned that this role should be taken into account by regulators and shareholders. And it should be described in corporate governance how regulators and shareholders could presumably hold parties who influence the board responsible. According to the FSB, it should be defined in the corporate governance how to impose sanctions on the “real” decision-makers. In fact, the FSB noted that only Australia and the United Kingdom have shadow-director frameworks within their corporate laws, in line with the common-law legal tradition. Ten of the remaining FSB jurisdictions do not formally have the concept of shadow director but have extended the concept of director to achieve the same goal.

The United Kingdom, in its new Senior Managers Regime (SMR—introduced in 2016), explicitly includes group managers within the “responsibility regime”. In practice, this means that individuals at the parent or elsewhere within the financial group who exercise significant influence over the financial institution’s activities are now automatically included as shadow directors and thus are held accountable by regulators (but not shareholders). The SMR is thus an example of how to ensure that liability is properly established within company groups.


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