1. Corporate Governance Code and the Role of Regulators
Role of the Regulator Best Practices Implementation Process
David A. Brown, C.M., Q.C.
May 5, 2009
Bahrain

2. Overview
Policy makers and thought leaders are turning their attention to corporate governance issues
For three reasons
Good governance works!
Investors expect good governance
Government social agendas

3. Good Governance Works!
Institutional investors recognize that good governance contributes positively to corporate performance
Example – Canadian Coalition for Good Governance – 41 pension funds holding $1.4 trillion assets of Canadian public companies
“good governance practices contribute to a company’s ability to create value for its shareholders”
Corporate activist

4. Investors Expect Good Governance
Confidence in fairness has been shaken by recent events
Corporate failures (Enron, etc)
Global financial crisis
Perception that inadequate governance contributed to the destruction of shareholder values

5. Government Social Agendas
Governments seeking to foster economic development
Create jobs
Create opportunities for wealth creation for their populations
Recognize advantages of a viable capital market
Good corporate governance a cornerstone

6. Particularly Important for Bahrain
Relative infancy of capital markets
Historical and cultural background - survey
Companies owned by families or closely held
Boards reflect ownership structures
More representative than strategic
Boards must evolve to align more with structures in developed markets
Fulfill several functions including oversight of management, strategy setting, risk management
Assist establishment of a viable capital market

7. Why is a Corporate Governance Code Necessary?
To compete for issuers and investors, must have a viable capital market
Issuers and investors must have confidence in the integrity of the market
Fair and efficient access for issuers
Safe environment; level playing field for investors
Market reputation is critical
Must be seen as a fair place for investors to invest

8. A Viable Capital Market
Major determinant of a marketplace’s reputation for fairness will be the principles by which listed companies conduct themselves
Compliance with a robust governance code is essential

9. A Viable Capital Market
Draft Bahrain Code captures the best practices that have been developed since the failures of Enron, Parmalat, etc.
Adapts internationally accepted principles to the environment here in Bahrain

10. A Viable Capital Market
If the new Code is embraced and enforced by all of the principal players, Bahrain will be a viable competitor for investors and listings among competing marketplaces
There will be tangible improvements in the businesses that adopt them
Economic development will be enhanced

11. Role of Regulators
Pressure on regulators to provide marketplaces with a competitive edge
From politicians
Benefits in fostering social change
From market participants
Convenience – burden with complying with foreign regulations

12. Role of Regulators Difficult role for regulators
Very least – ensure regulatory systems not a drag
Probably pressured to go further – create a favourable regulatory climate
Not an impossible job
Effective regulation and competitive markets have common roots
Both require fair treatment of investors

13. Role of Regulators Must have investors who want to invest
Climate in which investors confident of protection against fraud, manipulation, unfairness
Wide choice of listed companies
Must have listed companies
Efficient and fair marketplaces
Will be attracted by presence of investors
Not if rules designed to attract investors place unreasonably high regulatory burdens
Need an environment attractive to both sides
Real challenge is to maintain a proper balance

14. Global Context
Useful to examine your draft Code in the context of global corporate governance developments
Explain why some principles evolved
Discuss objectives sought to be achieved
Underscore the desirability of implementing and enforcing the Code

15. Global Context Global pressures for governance reform
Enron etc. collapses attributed, in part, to failures of corporate governance
Failure by boards of directors to provide independent oversight of management
Failure to ensure that external auditors provided independent, objective review of financial reports
Failure by companies to provide timely and accurate information
Rules and practices evolved to rectify these failures

16. Core Principles of Bahrain Code
Examine the principles of your draft Code against the background of this global evolution
Focus on four key areas
Empowering the board
Role of the audit committee
Protection of minority shareholders
Compensation and incentives

17. Empowering the Board
Enron and other failures exposed serious issues about board effectiveness
Boards had been comprised of competent, experienced people; some with high profiles
Yet, management wasn’t challenged
Necessary stewardship wasn’t provided
No one was protecting the best interests of the corporation and its investors

18. Empowering the Board Global response to board shortcomings
Require some degree of board independence from management
Clearly articulate the board’s accountabilities, duties of loyalty
Many countries have gone further
separate the roles of the chair of the board and the CEO
Require CEO and CFO certification of financial statements

19. Empowering the Board Result
Public companies are recruiting knowledgeable, independent directors
Legitimized conduct by directors
Questioning, probing management
Holding management accountable
Now widely accepted as part of board culture
Draft Bahrain Code incorporates these best practices

20. Role of the Audit Committee
External auditors had become too aligned with management
Audit not a reliable independent, professional review of management’s financial statements
Auditors looked to management as their client
Required a knowledgeable body, independent of management, to direct external auditors

21. Role of the Audit Committee
Global response was to mandate and empower an audit committee of the board
Independent of management
Members financially literate
Audit committee rather than management would become the external auditor’s “client”

22. Role of the Audit Committee
Result
Audit committees are part of virtually every public company
External and internal auditors report to the audit committee
Boards are now allocating additional responsibilities to the audit committee
Danger that they will become over burdened
Draft Companies Law and Code mandate and empower an audit committee

23. Protection of Minority Shareholders
Regulators recognize the importance to markets and economies of the entrepreneurial drive of family groups and other controlling shareholders
For the most part, interests of controlling shareholders are aligned with the minority
Corporate scandals exposed areas where controlling shareholders can use their position to advantage
Need to find a proper balance

24. Protection of Minority Shareholders
Responses to these issues vary depending on local environment
Universal requirement – all directors owe their duties to the corporation and all of its shareholders
All shareholders are equal
In many countries there are further protections
Nominees of controlling shareholders are not classified as independent directors
Dealings with controlling shareholders must be approved by independent directors
Draft Companies Law and Code adopt these provisions

25. Compensation and Incentives
Following Enron and other failures – recognized that form of management compensation could create perverse incentives
Stock options seen as fostering short term outlooks
Interests not aligned with shareholders
Particularly when awarded to directors
Share ownership better aligns interests with shareholders
Many companies require directors to own shares

26. Compensation and Incentives
Still, properly designed compensation plans can be an effective tool for motivating management
Some forms of incentive plans are here to stay

27. Compensation and Incentives
Global response in the post-Enron period
Governments generally reluctant to legislate the form or amount of compensation
Instead required compensation committees of the boards
All or a majority independent of management
Required extensive public disclosure of management compensation
Amounts and components
Factors considered in designing compensation
Draft Bahrain Code adopts these approaches

28. Compensation and Incentives
Recent economic crisis has exposed instances of compensation excesses
Particularly in some financial institutions
Incentivizing excessive risk-taking

29. Compensation and Incentives
Responses are still being formulated
In the U.S., caps are put on executive pay in corporations receiving government monetary support
“Say on pay” votes by shareholders
Bahrain draft Company Law and Code require shareholder approval of executive compensation

30. Comply or Explain Approach
Rationale
Alternative to US-based “rules” approach
Principles based, flexible
Allows companies to phase in, adapt to specific circumstances
Canada adopted a code and a comply or explain approach in response to Sarbanes Oxley

31. Comply or Explain Approach
Properly administered, comply or explain can be very effective
Theory is that market forces will determine whether a company is following appropriate governance practices
In Canada – market and peer pressure have prompted uniformity of adoption of all aspects of the code

32. Comply or Explain Approach
Success depends on effective, constant oversight by regulators
Failure to address disclosure items
“Boilerplate” disclosure
Guidance; assistance to help issuers make appropriate disclosure
available precedent
After initial start up phase
Regulators can issue public report highlighting deficient areas of disclosure

33. Comply or Explain Approach
Targeted reviews of problem areas of disclosure
Enforcement
Require delinquent companies to republish correct disclosure
Fines, sanctions of directors and/or officers
Delisting last resort
punishes shareholders, not those responsible for the failure

34. Comply or Explain Approach
Challenges
Be wary of relying on the stock exchange to police disclosure
Possible confusion of responsibilities under the Code
Ministry of Industry and Commerce (MOIC)
Central Bank of Bahrain (CBB)
Bahrain Stock Exchange (BSE)
Should be a single authoritative voice

35. Summary
Compliance with a robust governance code is essential to a financial market’s reputation for fairness
Draft Bahrain Code captures best practices that have been accepted by investors, listed companies and regulators around the world

36. Summary
As regulators you play an important part in ensuring that the Code is complied with
If listed companies embrace the Code and you enforce it
Bahrain will be a viable competitor for investors and listings among competing financial markets
There will be tangible improvements in the businesses that adopt them
Economic development will be enhanced
Thank you

37. Dialogue, Questions
Dialogue
Discussion
Questions?

38. Implementation Process
Discussion of some of the provisions of the Code
Some issues to watch for
Review and discussion of precedent materials
Dialogue and discussion