I thank Dr. Jesus P. Estanislao, chairman of the Institute of Corporate Directors for inviting me to this morning’s Breakfast Roundtable. Due to the length of our topic, I will immediately cut to the chase and discuss six topics.
Nature of Independent Directorship
FIRST, What is an Independent Director or ID? What kind of beast is this new creation of law? To begin with, an ID like any other member of the board of directors must qualify as a director under the Corporation Code. He must own at least one share of stock and elected in accordance with the provisions of the Code, the Articles of Incorporation and Bylaws of the Corporation concerned.
Usually, he (or she) is screened and nominated by the Nomination Committee, approved by the Board of Directors and elected by stockholders. When allowed by the Bylaws, the Board may also elect him to fill up vacancies but the elected director serves merely the unexpired term of the vacant post.
All directors, whether independent or not, are trustees or fiduciaries of the shareholders. As such, they must always uphold the welfare and interests of the corporation and of the shareholders, above and beyond their own individual or partisan interests.
Members of the Board of Directors, including the Independent Directors, collectively exercise the corporate powers of the corporation, and conduct all corporate business and control all property of the corporation. But apart from his work as member of the Board, the Independent Director as such does not perform any other service for the corporation for which he can receive additional compensation, inasmuch as the Independent Director’s position requires that he precisely remain independent of management.
When it comes to compensation, directors (including Independent Directors) are entitled to reasonable per diems, whereas compensation other than per diems may be granted to directors by the vote of the majority stockholders. While executive directors hold positions in management apart from their directorships, and are therefore entitled to compensation for their work as executives, on top of their compensation as directors, the Independent Director gets no such additional or other income. Precisely because he as an Independent Director must remain independent of management, he therefore may not perform other work for the corporation for which he could receive additional or other compensation.
However, while an Independent Director may not hold executive positions and collect additional incomes, but that does not mean that he has less work. In fact, he is given additional distinct and crucial responsibilities, as I will discuss shortly.
SRC’s Definition of IDs
SECOND, The Securities Regulations Code or SRC institutionalized the “Independent Director.” Section 38 of the SRC “defines” an ID in a rather negative way, as follows:
SEC. 38. Independent Directors. xxx xxx. For this purpose, an “independent director” shall mean a person other than an officer or employee of the corporation, its parent or subsidiaries, or any other individual having a relationship with the corporation, which would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.
On the other hand, the Revised SRC Rules (SRC Rule 38, Item no. 1) utilize the same definition-by-exclusion approach:
Xxx xxx. As used in Section 38 of the Code, Independent Director means a person who, apart from his fees and shareholdings, is independent of management and free from any business or other relationship which could, or could reasonably be perceived to, materially interfere with his exercise of independent judgment in carrying out his responsibilities as a director in any covered company and includes, among others, any person who:
A. Is not a director or officer of the covered company or of its subsidiaries and affiliates except when the same shall be an independent director of any of the foregoing;
B. Does not own more than five percent (5%) of the outstanding shares of the covered company and/or its subsidiaries and affiliates;
C. Is not related to any director, officer or a shareholder owning at least 20% of the outstanding capital stock of the covered company or any of its subsidiaries and affiliates. For this purpose, relatives include spouse, parent, child, brother, sister, and the spouse of such child, brother or sister;
D. Is not acting as a nominee or representative of any director or substantial shareholder of the covered company, and/or any of its subsidiaries and affiliates pursuant to a Deed of Trust or under any contract or arrangement;
E. Has not been employed in any executive capacity by the covered company, any of its related companies and/or by any of its substantial shareholders within the last two (2) years; (SEC MC No.13, Series of 2004)
F. Has not been retained, either personally or through his firm or any similar entity, as professional adviser, by that covered company or any of its subsidiaries and affiliates, within the last two (2) years; (SEC MC No. 13, Series of 2004) or
G. Has not engaged and does not engage in any transaction with the covered company and/or with any of its subsidiaries and affiliates, whether by himself and/or with other persons and/or through a firm of which he is a partner and/or a company of which he is a director or substantial shareholder, other than transactions which are conducted on arms length basis.
In addition, the same Revised SRC Rules (SRC Rule 38 : Requirements on Nomination and Election of Independent Directors) also list the qualifications and disqualifications for Independent Directors:
3. Qualifications and Disqualifications
A. In addition to the qualifications for membership in the Board provided for in the Corporation Code, Securities Regulation Code and other relevant laws, the Board may provide for additional qualifications which include, among others, the following:
(i) College education or equivalent academic degree; (Note, ladies and gentlemen, that under this, the richest man on earth, Bill Gates – a Harvard drop-out – will not qualify as an Independent Director.)
(ii) Practical understanding of the business of the corporation;
(iii) Membership in good standing in relevant industry, business or professional organizations; and
(iv) Previous business experience.
B. No person enumerated under Article 3(E) of the Revised Code of Corporate Governance shall qualify as an independent director. He shall likewise be disqualified during his tenure under the following instances or causes:
(i) No person, who is disqualified by the Commission under existing and/or future regulations or ruling, shall qualify as an independent director;
(ii) His equity ownership exceeds five percent (5%) of the outstanding capital stock of the company where he is such director; (*Based on leading practices on corporate governance. Explanation shall be provided in case of noncompliance);
(iii) Absence in more than fifty (50) percent of all regular and special meetings of the Board during his incumbency, or any twelve (12) month period during the said incumbency, unless the absence is due to illness, death in the immediate family or serious accident. The disqualification shall apply for purposes of the succeeding election.
Distinctive Duty of IDs
THIRD. From the foregoing negative covenants, which are worded like the Ten Commandments (Thou shall not have strange gods before me; thou shall not kill; thou shall not steal; thou shall not covet thy neighbor’s wife; etc) comes the sterling requirement that the ID must be independent of management, which in turn is installed or elected by the controlling stockholders.
He is expected to fiscalize and counter-check management and even the controlling shareholders who elected him to office. Specifically, he is expected to uphold ever zealously at all times the laws of the land, the articles and bylaws of the corporation, the canons of corporate ethics and the manual of corporate governance.
Indeed, the implicit assumption and unspoken expectation behind the creation of the post of Independent Director is that the person/s elected as such will be sufficiently courageous and independent as to be able to effectively fiscalize and counter-check whatever the other (non-independent) directors and the management are doing, and not hesitate to voice contrary opinions and actively oppose the management (and even the majority of the Board) if and when necessary.
Thus, to harmonize the provisions of the more recent SRC and the earlier Corporation Code, we can say that all directors are required to exercise independent judgment but in addition, the Independent Director is also expected to fiscalize and countercheck the rest of the board and the management.
This additional role and responsibility laid on the shoulders of an Independent Director is no small matter. Recall that he is nominated by the Nomination Committee of the Board of Directors, and elected by the majority shareholders, who also elect the rest of the Board of Directors who in turn appoint and install management. Yet the Independent Director is expected to fiscalize and countercheck the very people in whose hands his fate depends. He is even expected by some official quarters to “guarantee the integrity and accountability of the corporation” on whose board he sits. That is expecting a lot from the individual Independent Directors. And yet all this fiscalizing demanded of them will not allow for the payment of any extra compensation to them. But why not? In fact, precisely because of their added responsibility and the gravity of their role as fiscalizers, they ought to be paid more, not less, than the ordinary directors. In meantime however, let me just plead for equal and fair treatment of Independent Directors.
Safeguarding ID’s Independence
FOURTH. Like the Judicial Department of government where I came from, the SRC demands independence from IDs. Justices and judges, to be accurate, are required to possess four traits: “proven competence, integrity, probity and independence.” However, independence is the lynchpin, the foremost quality demanded of justices and judges; independence specifically from the President who appointed them and from the Congress, which legislates their compensation and other perks.
To assure their independence, justices and judges are granted several protections by the Constitution, including security of tenure and security of compensation. Thus, they serve permanently and cannot be removed from office except for cause until reaching the age of 70; and their compensation cannot be reduced but shall be released automatically during their term.
In contrast, IDs do not enjoy similar guarantees. In order to be elected as such, an ID – to repeat – must first be nominated by the Nomination Committee of the Board of Directors, upon signed recommendation of a nominating stockholder, and then be voted into office by the rest of the shareholders. In actual practice, the Nominating Committee is appointed by the Board of Directors, which in turn is voted into office by (or with the assent of) the controlling shareholder or group of shareholders. Thus, in actual practice, an Independent Director will only become such if he is acceptable to the board majority and the controlling shareholder/s.
By law, directors (including Independent Directors) have a term of one year. Their continuation in office and their eventual reelection as such depends on the controlling shareholders and the management. A director deemed too inquisitive, divisive, or much too inclined to dissent will certainly encounter enormous difficulties getting reelected, assuming of course that he is not earlier booted out (for he as well as any other director can be removed); this is simply normal human nature at work. In brief, there is no “security of tenure” for the Independent Director.
The compensation of directors is fixed by the board or by the by-laws or by the controlling shareholders. There is no escaping the fact that, with respect to the matter of compensation, the fate of an Independent Director is likewise in the hands of the majority bloc. In other words, there is also no “security of compensation” for the Independent Director.
To recap, while enormous expectations are laid at the doorsteps of the Independent Director, many factors serve to hamper if not limit his independence, chief among them the lack of security of tenure and of compensation; and sometimes, ironically by the unreasonable impositions of the Securities and Exchange Commission.
By way of analogy, can Supreme Court justices who are to be appointed yearly by the President and whose compensation is dependent totally on Congress be expected to be independent?
Improper SEC Impositions
FIFTH. I think we can all agree that the system of independent directorship should be strengthened to encourage them to perform their main job of courageously and intelligently checking management and the controlling stockholders. In this connection, let us examine two recent moves of the SEC in relation to this objective:
One, to prohibit ID’s from participating in stock options, even if these options are granted to all other directors evenly, equally, openly and transparently; and even if these are granted only upon approval by 2/3 vote of the total outstanding voting and non voting capital stock, and even if the stock scheme must first be scrutinized and approved by the SEC. I will not discuss this first item in detail because I have filed a petition before the SEC en banc to nullify this restriction imposed by the Corporation Finance Department of the SEC, on the ground that it is unreasonable, unfair, unjust, discriminatory, whimsical and illegal.
Two, to impose the so-called 5-5 plan, that is, that a ID can sit on the board of directors of any given corporation and its subsidiaries and affiliates for only five consecutive years, and only in not more than five publicly listed corporations and their subsidiaries and affiliates simultaneously in any given year.
Like the Ten Commandments and the SRC, the two prohibitions are worded in negative covenants. They areNOT provided in the SRC but are SEC-originated inventions and impositions. Incidentally, the Ten negative Commandments of the Old Testament have been modified by our Lord Jesus Christ by the single positive commandment of LOVE: Love God with all your heart and all your strength; and Love your neighbor as God loves you.
We do not have too much time, but I will ask a few questions which I propose we all concentrate on during this roundtable, but only for academic discussion because, as I will show later, I believe the SEC has no authority to impose this term limitation.
What is the purpose of the 5-5 plan? Will it enhance the independence of IDs? Will it help them carry out their role and responsibility of independence? Is there any empirical evidence that the plan will make them more independent and efficient? Why 5-5, why not 3-3, or 8-8, or 10-10, or even 20-20?
Should not the limits be calibrated according to the IDs’ professional track record as shown by their participation, attendance, knowledge and experience? Not all directors are equally capable and diligent, why limit them equally? Some serve as full time directors, some have full time jobs in other companies. Why are they subjected to the same restrictions? Should not the shareholders whose interests they are supposed to protect be the more reliable judges of their performance? Should shareholders not be given the discretion to evaluate their compensation and reelection? If at all, should these restrictions be applied prospectively and not retroactively?
Is the work of IDs more difficult than chairmen or CEOs? Why then are they limited while the most successful CEOs are not so restricted? In fact, the most successful CEOs run more than 20, sometimes 50 companies, including more than five gigantic publicly listed ones. Yet they are unquestionably successful. For his part, Secretary of Foreign Affairs Albert del Rosario was a director of more than 40 corporations, here and abroad, prior his DFA stint. Yet, can anyone say that he was incapable or inefficient?
The venerable Washington Sycip, a virtual institution by himself, has been, by my reckoning, an independent director for far longer than any other individual in this country. He has been Independent Director of some corporations for more than five years even before the SRC institutionalized the concept. I can’t help asking myself — should the 5/5 rule be made to apply to Mr. Sycip too? What possible good could come out of that? What happens if Mr. Sycip is disqualified on account of the 5/5 rule? Will not the affected corporations be the worse for it? Why punish Mr. Sycip? Is there any evidence that he has not performed his job well? Remember, he had just been awarded the “Order of Lakandula, rank of Bayani” by no less than President Noynoy Aquino, the ultimate boss of the SEC.
SIXTH. What are the remedies of those who disagree sincerely with and are affected unjustly, adversely, unfairly, arbitrarily and illegally by SEC inventions and impositions?
1. Take the route of persuasion which I have done in the case of stock options that the Corporation Finance Department of the SEC denied to IDs. Persuade the SEC via reason and logic to review and reverse these actions and proposals. Instead of emphasizing negative covenants, how about stressing positive actions to strengthen independence and accountability? Show the SEC that the planned impositions will not safeguard and promote the directors’ independence; on the contrary, demonstrate that they are unfair, unreasonable and illogical.
2. Take the administrative route. Ask the help of SEC’s administrative superiors, like the Department of Trade and the Office of the President, to convince the SEC to review and reverse them.
3. Take the judicial course. Appeal to the Court of Appeals and Supreme Court. Show that the SEC abused and exceeded its power and authority; show that the SEC actions and plans are ultra vires, illegal and whimsical.
The power of the SEC to formulate rules and regulations is sourced from the SRC itself, specifically, Sec. 5.1 (g) and Sec. 72 thereof. Under Sec. 5.1 (g) of the SRC, the Commission is possessed of the power to “[p]repare, approve, amend or repeal rules, regulations and orders and issue opinions and provide guidance on and supervise compliance with such rules, regulations and orders.” This is buttressed in Sec. 72 of the Code:
“SEC. 72. Rules and Regulations; Effectivity. -This Code shall be self-executory. To effect the provisions and purposes of this Code, the Commission may issue, amend, and rescind such rules and regulations and orders necessary or appropriate, including rules and regulations defining accounting, technical, and trade terms used in this Code, and prescribing the form or forms in which information required in registration statements, applications, and reports to the Commission shall be set forth. For purposes of its rules or regulations, the Commission may classify persons, securities, and other matters within its jurisdiction, prescribe different requirements for different classes of persons, securities, or matters, and by rule or order, conditionally or unconditionally exempt any person, security, or transaction, or class or classes of persons, securities or transactions, from any or all provisions of this Code.
Failure on the part of the Commission to issue rules and regulations shall not in any manner affect the self-executory nature of this Code.”
Xxx xxx xxx (underscoring supplied)
This rule-making power is also known in Administrative Law as “quasi-legislative power,” and the result of the exercise of such power is referred to as “subsidiary legislation.” While, generally speaking, subsidiary legislation has the force and effect of law, still, the key principle in our legal system is that the exercise of quasi-legislative power of any administrative agency cannot amount to “law-making,” but can only cover “law-execution.”
Therefore, the SEC’s power to promulgate rules and regulations is subject to the well-known limitation that such rules and regulations cannot exceed or modify the statute in question. In other words, “xxx administrative regulations are intended only to implement the law and to carry out the legislative policy, but that ‘[t]he discretion to determine what the law shall be is exclusively legislative and cannot be delegated.’” Thus, “[t]o be valid, an administrative rule or regulation must conform, not contradict, the provisions of the enabling law. An implementing rule or regulation cannot modify, expand, or subtract from the law it is intended to implement. Any rule that is not consistent with the statute itself is null and void.”
An example of an ultra vires act is a provision in the Rules of the Judicial and Bar Council disqualifying applicants for nomination in the Supreme Court coming from the non-career service who are more than 65 years old and who, therefore, if nominated and appointed, would serve for less than five years. This old rule of more than 20 years was challenged recently by a private lawyer-applicant.
Instead of risking a reversal by the Supreme Court, the JBC backed off and rescinded the rule. It realized that it cannot – on its own as an administrative agency – add a requirement for nomination that is not found in the Constitution or the law. However noble the intention of the rule may have been, the JBC – which is headed by the Chief Justice – thought it prudent to remove this rule which legislated a requirement not found in the Constitution or the law.
In the present case, the SEC is imposing a requirement that violates and removes a substantial right granted by law to a shareholder to elect and to be elected an independent director, not to mention the right of the said director to proper and equal compensation granted by a corporation to all its directors equally, openly and transparently and approved by 2/3 vote of all shareholders and by the SEC itself.
4. Finally, take the ultimate route. Sue the SEC officials in the Office of the Ombudsman. Let me quote in this connection Article XI of the Constitution:
“Section 13. The Office of the Ombudsman shall have the following powers, functions, and duties:
(1) Investigate on its own, or on complaint by any person, any act or omission of any public official, employee, office or agency, when such act or omission appears to be illegal, unjust, improper, or inefficient.
xx xx xx xx xx”
Under Section 19 of the Ombudsman Law of 1989 (RA 6770):
“Sec. 19. Administrative Complaints. – The Ombudsman shall act on all complaints relating, but not limited to acts or omissions which:
(1) Are contrary to law or regulation;
(2) Are unreasonable, unfair, oppressive or discriminatory;
(3) Are inconsistent with the general course of an agency’s functions, though in accordance with law; Proceed from a mistake of law or an arbitrary ascertainment of facts; Are in the exercise of discretionary powers but for an improper purpose; or Are otherwise irregular, immoral or devoid of justification.”
Is there any crime committed when an official usurps the legislative power of Congress? Yes, Article 239 of the Revised Penal Code provides:
Art. 239. Usurpation of legislative powers. – The penalties of prision correccional in its minimum period, temporary special disqualification and a fine not exceeding 1,000 pesos, shall be imposed upon any public officer who shall encroach upon the powers of the legislative branch of the Government, either by making general rules or regulation beyond the scope of his authority, or by attempting to repeal a law or suspending the execution thereof.
May I conclude this address with the famous saying that the end never justifies the means. However laudable its motives, the SEC must not impose unreasonable, whimsical and illegal inventions beyond its legal mandate to do.
Thank you. I am now ready for your reactions and questions.