Recently, the Securities and Exchange Authority of Pakistan (SEAP) has issued directives to the Stock Exchanges of the country to appoint their respective Chairman for their Board from the directors nominated by SEAP.
The contents of this directive are being currently discussed and debated through the electronic and print media within the county. The reaction of the members of Stock Exchanges seems to be critical and aggressive. Its legal and practical implications are being analysed.
It is being strongly advocated that the directive's implementation by the end of next week indicates that the Regulator have somewhat different motives behind this move. It also violates the compliance of some of the requirements laid down by the Companies Ordinance.
Thus making this directive difficult to implement within the given time frame. SEAP's view is different and it maintains that the directive is quite lawful and thus should be implemented as directed. However, having said that, it is becoming a general impression among the stakeholders that the SEAP being regulator in this area is acting in a dictatorial manner without any regard to the wishes of the stakeholders.
It has become a routine practice to issue directives that are not even discussed with the stakeholders but may prove damaging for all the players in this field.
There is absolutely no second opinion regarding the Regulators authority to propose desired changes in the working of the stock exchanges of the country to improve investment climate. This is essential for the transparency and trustworthiness of these institutions.
It was generally being felt that the composition of the board of directors of all the three stock exchanges lacked effectiveness and independence due to the simple reason that its composition was based upon the two groups having substantial interest in the affairs of the stock exchanges.
One group represented the stockbrokers and the Regulator nominated the other group. If the composition of the board is on this pattern, then it is obvious that there is a conflict of interest. It is difficult to be effective director and maintain independence at the same time. It was this weakness that needed correction.
Therefore, there was an urgent need to rectify this situation and it was being demanded that the Chairman of the board should be an independent person that has no conflict of interest. This objective could only be achieved if the board appoints a neutral independent director on this position.
Under the present composition of the board, this objective remains difficult to achieve unless some fundamental changes are brought in, to change the composition and structure of the board. Under the present situation, a Chairman representing the stockbrokers is as objectionable as if it were representing the Regulator.
No one can deny this fact that there should be independent Chairmen of the Board of Directors of these Stock Exchanges, but it seems surprising to observe that the directive has put all the emphasis on the appointment of Chairman from amongst the directors nominated by SEAP.
This makes this directive questionable and raises an important issue of independence of these nominated directors as defined in the rules of corporate governance that are generally acceptable in most countries. It was this element that annoyed the other stakeholders and created doubts among this community about the Regulators motives.
Under this acceptable code of corporate governance, let us examine, if the directors nominated by SEAP for the board of directors of these Stock Exchanges fall under the category of truly independent directors.
In 2003, the Higgs recommendations were made public that recommended that further measures were needed to strengthen corporate governance and suggested that at least 50% of board members should be non-executive and independent members.
To remove any ambiguity regarding the concept of independence, several important area were defined that needed attention before a director was classified as an independent director. All these areas may not be relevant here for our discussion except the few important requirements: that he holds no cross directorships or has significant links with other directors.
He does not represent a significant shareholder or has served on the board for more than ten years. It was further made clear that it was the boards responsibility to determine if a director is independent or not and should state reasons of doing so.
This Code is applicable in Britain from November 2003 and is being considered as an important step towards improving corporate governance.
As seen in this definition, it is a very broad definition and excludes all those having any relationship that may create conflict of interest between the company and its directors.
The most important aspect of these appointments is to ensure that there is no conflict of interest by appointing individuals as directors. Very little attention has been given to this aspect that has resulted in poor governance and ineffective board.
It seems surprising that individuals have been nominated on boards having substantial conflict of interest from both sides. These all nominations are contrary to the concept of independence and create a conflict of interest.
There are instances where these appointments led to access of the confidential information that benefited the individual persons. This desires that SECP should come out very clearly how the directors are nominated on behalf of the Regulators.
They should not only be professional in their related fields but should also perform a fiduciary role to protect the organisation itself for which they act as directors.
Once a person is appointed as a director of the board of any stock exchange by SEAP, he should not be under the influence of SEAP; otherwise, he would not pass the test of being independent director.
This will result in a serious allegation of conflict of interest and that may be disastrous for the investment community.
Therefore, the appointment of Chairman from the nominated directors of the regulator may be questionable on the ground that the individual selected by the board would not be a truly independent director to hold this position.
He may not bring in harmony and co-ordination that is desired to conduct the affairs of the Board. It is the responsibility of the board alone to appoint a Chairman.
Therefore, it is of utmost importance that the entire board should select an independent candidate for the position of Chairman from within or outside the stakeholders representation. This is a matter that should be allowed to be resolved by the board itself and should not be dictated by the Regulator.
It is being argued that if the Managing Director is representing the Regulator because, he is being appointed through the approval of the Regulator along with other four nominated directors, the appointment of the Chairman amongst the nominated director would further strengthen the operational control of the Regulator over these stock exchanges effectively.
So in these circumstances how these individuals may act independently and effectively remains to be resolved. Therefore, the Board would be under the complete command of the Regulator. This situation may be harmful for the investment climate as the functioning of the stock exchanges and the role of the Regulator should be separate.
The Securities and Exchange Commission of Pakistan, being an autonomous regulator needs to perform a very important role in making non-executive directors an effective body. The rules drafted, proposed and enacted by this body should also be respected and implemented by the Commission itself.
The Rule of Law demands that all irrespective of rank and file must follow rules once enacted. It would have been more transparent, if Securities and Exchange Commission of Pakistan had issued comprehensive instructions for the selection and appointment of non-executive independent directors and how they should perform their effective role in the boards they sit.
The Commission should treat the private and nominated directors alike to ensure that the government appoints non-executive directors in a transparent manner and the government appointees must meet the test of independence laid in the Code of Best Practices so that the private sector follows the same procedure.
It has been established clearly through case law that the full liability of non-executive directors is no less than any other executive director. Having said this, it seems surprising that how the nominations of non-executive directors are being made, not realising by these appointees that this task carries an unlimited liability.
If nominated directors act on the advice of the regulators, then the nominees are accepting an unlimited liability due to their conflict of interest in carrying out their fiduciary role.
This concept was emphasised after the decision in a recent case of City Equitable Life Assurance v Bowley [2003] BCC where former non-executive directors sought summary judgement for excusing them from all liability for negligence and breach of fiduciary duty under section 727 of the British Companies Act 1985 on the basis that they acted honestly and reasonably. Their petition was turned down on the ground that there was real prospect of success and the case should go on trial.
This directive was issued at a time when the performance of Stock Exchanges has been satisfactory after the events of March 2005 and there is clear evidence that the foreign investors are gradually increasing their stakes in the Pakistani capital markets.
This assertion is proved by the recent statistics released by the State Bank of Pakistan that there was an inflow of foreign direct investment in the equities to the extent of over $250 million during the first quarter of this fiscal year.
Taking into account all these factors, it is the need that the Regulator should co-ordinate their activities with the other stakeholders to ensure smooth implementation of any directives that are aimed to improve the investment climate by making the systems and procedures more transparent.