Safe direction

Irish legislation is forcing executive and non-executive directors to keep a tighter rein on corporate governance. Feargal Brennan reports on how the new regime is working

The responsibility of private equity board nominees and the need for them to push the corporate governance agenda in the boardroom has again been highlighted.

It is hard to believe that two years have passed since one of the largest corporate scandals of the modern era rocked the US. As we now all know, the Enron scandal was to cause serious aftershocks worldwide and it is fair to say it has caused regulators to increase their focus on ensuring that similar scandals do not happen again.

Irish legislators have been quick to appreciate the long-term benefits that accrue from fostering a strong regulatory regime to underpin economic growth. A number of recent legislative and administrative changes have heightened awareness of the importance of putting in place good corporate governance procedures and generally increasing levels of responsibility in the boardroom.

Given that the legislative framework does not, in the main, differentiate between executive and non-executive directors, these changes have also increased the need for non-executive directors appointed as venture capital nominees to fully appreciate the onerous responsibilities assumed by them.

Companies (Auditing and Accounting) Act 2003
Legislation’s most recent effort to increase compliance and raise standards comes in the guise of the Companies (Auditing and Accounting) Act 2003. The background to the legislation goes back to 1999, when the Dail Committee of Public Accounts found widespread non-compliance with company law in Ireland. Arising from this, the Tanaiste established the Review Group on Auditing, comprising business, professional and independent persons.

While much of the act deals with the establishment of a new supervisory body – the Irish Auditing and Accounting Supervisory Authority – it also sets out the requirement that, subject to minimum thresholds, directors of certain companies must prepare directors’ compliance policy statements and annual directors’ compliance statements, with a related obligation on auditors to review these and determine whether or not the statement is both fair and reasonable.

A compliance policy statement will require directors to set out the company’s policies regarding compliance with those aspects of tax and company law and other legislation that affect the company. An annual compliance statement will require directors to acknowledge responsibility for securing compliance with these obligations and further state that they are of the opinion that they have used ‘all reasonable endeavours’ to secure compliance with relevant obligations or, if this is not the case, why not.

Importantly, and consistently with Irish company law generally, the legislation makes no distinction between executive directors and non-executive directors, who will share responsibility equally in relation to compliance statements. Venture capital (VC) directors will need to consider carefully the terms of both the compliance policy statement and the annual compliance statement. The level of verification that a VC director will need to carry out in relation to these statements is likely to be the subject of much debate during the coming months.

Increased enforcement
The successes of the Office of the Director of Corporate Enforcement (ODCE) and its director Paul Appleby have also been noteworthy and serve to highlight further the need for VC directors to pay increased attention to the obligations assumed by them as officeholders of a company.

In 2003 alone, the ODCE handled more than 3,000 regulatory issues, up from 1,000 only a year before. 2003 also saw a fourfold increase in the number of reports made to the ODCE by auditors suggesting the possible commission of indictable company law offences by companies and directors, and a threefold increase in the number of convictions secured against companies and individuals.

Separately, under the restriction procedures of Section 150 of the Companies Act 1990 (as amended), directors, whether executive or otherwise, of insolvent companies are required to demonstrate that they have acted “honestly and responsibly” in the conduct of the affairs of the companies. The legislation provides for the implementing of regulations granting an exemption from the requirement for directors appointed as nominees of a VC company, but so far no such regulations have been introduced and VC directors will need to be aware that in the future they are more likely to be called upon to justify their actions towards any failing companies in their portfolios.

In Tralee Beef & Lamb Limited, involving an application under Section 150, a well-known and highly respected Dublin investor was made the subject of a restriction order on the basis that, although he had discharged the burden of demonstrating that he had acted honestly, he was unable to show that he had acted responsibly.

In her judgment, Ms Justice Finlay Geoghegan emphasised the common law duties of all directors to inform themselves about the affairs of their company and join with their co-directors in supervising and controlling them. A non-executive director needs to take reasonable steps to place themselves in a position to guide and monitor the management of the company.

The case has put into sharp focus the need for a VC director to appreciate that they are not relieved from the obligations of being a director merely because they may have no day-to-day involvement with a company.

The burden on VC directors is obvious; being a director on numerous boards, all perhaps at various stages of development, and some perhaps in difficulties, makes the ability to devote sufficient time to each one difficult, to say the least. The obvious conflicts of interest that often arise where a nominee is required to serve the best interests of the company, while at the same time representing the economic interests of the VC firm that appointed them, make the role of VC nominee director fraught with complexity. Particularly in follow-on rounds, a VC director will often conduct negotiations for the venture capitalist in situations where they participate in the board decision to proceed with a funding round, the very terms of which they may well have negotiated for the VC themselves. In such circumstances, VC directors would be well advised to consider excusing themselves from participating in board meetings convened to discuss investment terms.

There is no doubt that the compliance message is being driven home. There is now widespread realisation among non-executive directors that proper procedures are vital for all companies, regardless of size, as well as an appreciation that instances of company law non-compliance, even in relation to relatively minor breaches, will no longer be overlooked.

If anything, levels of corporate compliance are likely to increase further as the Director of Corporate Enforcement steps up the pressure on non-compliant companies and this will increase VC directors’ levels of vigilance in ensuring good corporate governance.

In his report for the last year, the Director of Corporate Enforcement signalled his determination not only to increase enforcement activity, but also to prosecute a number of company law offences for which convictions have never been secured in the past. The driving force behind this level of activity is Appleby’s acknowledgement that “fraud, non-compliance and other unlawful or irresponsible activity all distort business markets by conferring unfair and unwarranted advantages on some companies and their stakeholders to the detriment of other stakeholders, including other companies operating in the sector and the general public.”

Overall, these changes are to be warmly welcomed. The changes might, however, require VCs to reassess the ways in which they actively manage portfolio companies and, in particular, whether they will install directors on the boards of every company in their stable.
It is to be hoped that VC directors, rather than fearing the heightened scrutiny, will embrace the new regime as an opportunity to push the corporate governance agenda in the boardroom to the betterment of all.

Feargal Brennan is a partner in the corporate commercial department of BCM Hanby Wallace