Welcome to the October 2008 edition of The Director’s Dilemma newsletter. I hope you find it informative, interesting and most of all inspiring.
I advise Boards and Directors on complex and challenging issues which can be resolved in a variety of ways. Each option has different pros and cons for the individuals and companies concerned. Every month this newsletter considers three experts’ responses to a real issue. Which response would you choose?
Jane is an independent non-executive director of a listed industrial chemicals company which was originally family owned and is still managed by family members. The CEO of the company has purchased luxury assets such as a yacht, a corporate jet and more, ostensibly for entertaining company guests, customers and opinion makers, as well as a staff welfare measure. Jane believes these assets will be used by the CEO for his personal use, including his family, but is sure that records will be created to reflect that the assets will mostly be used for the purported purpose and only a minimal time will be booked as personal use. The auditors of the Company have sought a resolution from the Board that the assets are in fact for the purpose of the business of the Company.
How should Jane proceed?
While not versed in the legal nuances of Australian governance (if Australian law is similar to UK Companies Act, little distinction is made between responsibilities of executive vs. non-executive directors so care must be taken), I can address several issues within the question that I believe any director should be concerned with, no matter the venue.
The company is a listed entity. Directors, then, are responsible to the shareholders for both the security of, and return on, corporate assets. Does the purchase of the “luxury assets” seem reasonable [a good use of corporate assets] for similar companies in the field? Will personal use of these assets be considered compensation to the CEO? How does the tax code view such family use and how will the company comply? If company records are to be “created” that will distort true usage of the assets and a director is aware of this, or even suspects it, does this not trigger a fiduciary response? If the auditors have sought a Board resolution supporting proper use, does not an affirmative vote place any director so voting in the position of supporting a fraud against the company?
Jane can, if she hasn't already voiced her concerns, assume all will be made to look legal and go along with the resolution. If she does this, though, she violates her covenants with the shareholders and may, in fact, breach her “duty of care” [again, this notion is not well defined in UK law and may not be favored in Australia]. She can ask the CEO to warrant that the “luxury assets” will be used properly and that any personal use will be reimbursed to the Company, intending to reference that document in her vote in support of the resolution. I suspect the CEO will refuse such an initiative and that if she raises it, her tenure as a non-executive director will be short lived.
She can also vote (and go on record) against the resolution. If the resolution passes and she is in a majority, there might be few repercussions. If she is in the minority, her tenure, again, will likely be short. Finally, she can resign her board seat. As my Board mentor, Myles Mace, once said, “ there are sometimes penalties for doing the right thing.”
John Reddish is Principal at Secure Transfer Technologies, LLC, and President of Advent Management International, Ltd. He is the former chairman of Mum Puppet Theatre. He recommends readers of this newsletter read the CAMAC Report.
Okay Jane; why do you believe the assets will be used for personal use but records will show otherwise? If this is the latest instalment in a saga of increasing management abuse of shareholder funds you need to stand firmer now than you ever stood before. The key questions:
- Can management buy assets without prior board approval: Implement proper delegations of authority; expenditure levels should be different for core business assets and for “staff amenity” items. Any expenditure over (say) $5,000 on staff amenity should be either in the business plan (which provides a defensible reason for signing the resolution that the assets are for business use) or the subject of a special board resolution.
- Should these assets be owned by the company, are they going to be used much? Even mining companies with remote sites use charter services rather than buying their own planes. What options did the board assess when (if?) they discussed the need for these assets? Or did the board find out only after the purchase? Either way Jane should develop processes for future ‘rent or buy’ decisions.
- How will management pay for personal use of these assets: What is the going rate, will salary sacrifice be used, who else (apart from the CEO) is entitled to use the assets and how, when there is no over-riding business need, will the asset use be allocated fairly? More process and policy will be needed.
- Why does Jane believe false records will be created? If she can’t trust management’s reports then, as a director, she should get off this board (go straight to the relevant regulator). This is a serious issue. Jane needs to trust the CFO to account correctly for all expenditure and income; she should verify that trust on a regular basis. A new CFO is probably needed and also a good code of conduct with clear sanctions for breaches (such as knowingly creating false records).
If Jane isn’t confident these issues will be addressed she should resign (fast). She needs to consider the legal implications of disclosing her reasons for leaving. Staying quiet allows the CEO to continue to abuse shareholder trust. She needs to understand her sources of support on the board and among the shareholders. Will they back her if she tries to remove the CEO?
There is a lot more work to be done here than just dealing with the resolution requested by the auditors.
Jane’s options? She can condone the behaviour, not sign and leave the board, or not sign and fix the mess. Either way, Jane needs to act now, and she needs a trusted legal advisor.
In my personal opinion this is a serious ethical issue and it sounds like an abuse of management power.
If there is some legitimate company use of these assets, then that should be clearly demonstrated, with logged of numbers of hours and the related expense. To the extent that there is private use, that should similarly be logged, and should be classed as a taxable benefit to the recipients.
If the personal use is greater than, say 20%, then I would say that there is a real issue here as to whether the company even needs these assets. In that case, why should the public shareholders be paying for them?
If such is the case, the Audit Committee and the Board of Directors should request that the assets be sold to the highest bidder, which may include the family members who wished to acquire them.
Obviously, decisions about the foregoing would depend on the regulations governing publicly listed companies in the jurisdiction concerned, accounting treatments for such assets, as well as for their personal use.
Frank Feather is President & Chief Trend Tracker at Future-Trends.com and also Board Member at Claxson Interactive.
The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances have been changed to ensure anonymity.
Trainwreck – I was asked back to the Audit Trail to rebut suggestions that corporate governance is just a myth.
The Lehman Board – Given the spectacular failure of Lehman Bros. there has been a lot of speculation about corporate governance and whether it works to prevent failures. Here are some of my comments on the topic.
Book review – Directors do a lot of reading. I keep a note of my thoughts on each book I read. Here is my review of The Humm Handbook.
Be an expert – I will post next month’s Dilemma on LinkedIn. If you would like to have a go at advising just log on to my Q&A and type in your advice. I will pick the best answer to be published in the November newsletter.
This newsletter – I will issue The Director’s Dilemma monthly in 2008 then evaluate how it performed. If you have any ideas for improving the newsletter please let me know. It is currently read all around the world and I hope to reach 20,000 subscribers soon. Please feel free to forward it to your board colleagues.
Suggestions for dilemmas – Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.
Farewell until next month. Enjoy governing your corporations; we are privileged to do what we do!
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