Attributes of a Good Independent Director

Address delivered by retired Chief Justice ARTEMIO V. PANGANIBAN before the Good Governance Advocates & Practitioners of the Philippines on October 19, 2015 at the Dusit Hotel, Makati City.

Let me thank your President Gil L. Gonzales for inviting me to speak before your forum on the general theme of “BOARD INDEPENDENCE: Reality or Myth?” This theme is quite provocative and timely in view of the current effort of the Securities and Exchange Commission to update the Corporate Governance Blueprint.

At the outset, let me stress that I favor the upgrading of corporate governance, even if I have objections to some proposed regulations, which in my humble view are illegal and/or unreasonable.

I was asked to speak specifically on the topic, “The Attributes and Challenges of a Great Independent Director.” This topic is quite provocative too because it assumes that yours truly is a “Great Independent Director,” an honor I would like to humbly decline. The word “great” intimidates me for it implies “fantastic” or “extraordinary” expertise.

Expertise is easily demonstrated in the science of medicine. During my parents’ time, physicians used to call on patients’ homes and cured all kinds of diseases. Then, specialization came and doctors became experts only of the brain, or of the heart, or of the kidney, and so on.

This reminds me of my high school friend who studied medicine at the best university in Diliman, Quezon City and who specialized abroad on the diseases of the eyes. Due to difficulties with my right eye, I visited him at his private eye center. After his assistants preliminarily examined me with microscopes and gadgets and applied drops and ointments in and around my right eye, I was finally ushered into his private room.

“Art, I am sorry I cannot help you,” he solemnly began. “Why not? You are a great eye expert, why can’t you help me?” I protested. “Well,” he smiled sheepishly, “it’s because the problem is in your right eye. I am a great expert only of the left eye.”

Yes, an expert is one who knows more and more about less and less. So the ultimate expert is one who knows everything about nothing!

I hope my doctor-friends will forgive me for that joke. Nonetheless, please permit me to avoid using the word “great.” I would rather just speak of a “good” independent director, a more modest and achievable ambition. So, may I respectfully plead that my topic be changed to “The Attributes of a Good Independent Director.”

Let me divide my address into three general subjects culled from the very words of the topic assigned to me: Good Independent Director or GID. Permit me, however, to reverse the sequence; the first topic would be about being a director, the second, about being independent, and the third, about being good.

About Being a Director
To begin with, a GID must own at least one share of stock and elected to the Board of Directors in accordance with the Corporation Code, as well as the Articles of Incorporation and Bylaws of the corporation concerned.

All directors, whether executive, non-executive or independent, are trustees or fiduciaries of the corporation. Their prime duty is to promote and uphold the welfare of the corporation which has a legal personality, attributes, goals, and undertakings that are distinct and separate from its shareholders. As such, directors are expected to promote and defend such separate and distinct corporate characteristics above and beyond their own individual or private interests. Their major duty is to help the corporation grow and profit legally, honestly, reasonably and ethically.

Because of their unique background, special training, wide experience and vast contacts, GIDs have – to use a common computer terminology – “killer apps.” Thus, aside from their special duty of being enforcers of good corporate governance, GIDs dispense balanced advice in special fields like advance technologies, economics, law, finance, acquisitions and mergers, government relations, and the like.

GIDs normally have high moral ascendancy in the business community. They are chosen not only for their intellectual expertise but also for their trustworthiness, objectivity and fairness. They may be former Cabinet members, esteemed business executives, outstanding professionals, or retired members of the judiciary. They can become good referees and mediators to cool the competitive tension not only among shareholders and directors within the same company but also between the major shareholders and directors of one conglomerate locked in bruising battle with their counter-parts in competing conglomerates.

About Being Independent
Let me now go to the second major topic: about being “independent.” What differentiates IDs from executive and non-executive directors is the very name they carry, and that is: they are “independent.” But what does “independent” mean? The Securities Regulation Code or SRC does not really “define” what IDs are; it merely states what they are not, as follows:

“SEC. 38. Independent Directors. – … 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.”

The Revised SRC Rules use this same negative definition-by-exclusion approach, reminiscent of the Ten Commandments, by listing down what an ID is not, like (1) he/she is not an owner of more than two percent (2%) of the capital stock, (2) not related to a shareholder owning at least 10% of the capital stock, (3) not acting as a representative of any substantial shareholder, (4) not employed in any executive capacity within the last two years, (5) has not been a professional adviser of the company also within the last two years, and (6) has not and does not engage in transactions with the corporation, other than arms length and immaterial ones.

In short, essentially, IDs are corporate fiduciaries or directors who do not have – directly by themselves, or indirectly through their privies (like professional firms, business entities or relatives) – any relationship with the corporation, or its subsidiaries and affiliates, or its major shareholders or their privies, that may affect their objectivity in performing their duties as such fiduciaries or directors.

Aside from the laws passed by Congress, the role and work of IDs is also covered by regulations of various executive agencies, mainly of the Securities and Exchange Commission, as well as of specialized agencies for special types of businesses, like the Bangko Sentral ng Pilipinas for banks, the Land Transportation Franchising and Regulatory Board for busses and taxis, Civil Aeronautics Board for airlines, etc.

One thing is clear however. These regulatory agencies exercise merely delegated powers from Congress and cannot expand their authority beyond what is given them by law. Hence, they cannot restrict or limit rights and powers given by law to corporations and shareholders. In our system of government, the private sector is the engine of economic growth. The role of the government is to inspire and facilitate private entrepreneurship, intervening only to check avarice and to level the playing field.

This is why I have consistently resisted attempts to limit, through administrative fiat, the terms of office of directors, or their number of seats, or their age qualifications. The Corporation Code has granted shareholders the right to vote and be voted into office as directors without any such limitations. Investors buy more expensive voting shares precisely to enjoy these prerogatives to freely elect and be freely elected directors.

The right to vote and be voted directors, just like the right to suffrage in a democracy, is a basic right in a corporate polity that cannot be restricted or limited by mere administrative regulation. Only Congress has the power to legislate on them. Basic is the admonition in several Supreme Court decisions that administrative regulation merely implements legislations and cannot extend, limit or amend them in any wise, even with the best of intentions. A usurpation of legislative power by an administrative agency or official is criminally, civilly and administratively sanctioned by law.

One of the strictest proponents of good corporate governance is the United States where, because of lessons learned from actual corporate debacles, the Sarbanes-Oxley Law (SOX) was enacted. Yet, PLDT – the only Philippine company listed in the New York Stock Exchange – and its directors are not required to observe term, seat or age limits.

What then can our administrative agencies do to regulate the work of IDs? Answer: They may regulate pursuant to the standard of delegation given by Congress to the SEC in the Securities Regulation Code, namely, that an ID is without a relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. Accordingly, the SEC may, as it had already, require IDs to take periodic seminars on corporate governance, make them compulsory chairs of certain board committees, compel stricter disclosures of private interests, etc. It can also require IDs to render annual reports of their work, especially in regard to related party transactions and disclosure rules.

The negative covenants imposed by law on independent directors are meant to free them from the baggage of self-interest so they could effectively check the excesses or over indulgence of executives who wield corporate powers and control corporate funds. Normally, these executives are nominees of the majority shareholders, and many times, they are the majority shareholders themselves.

On the other hand, IDs are expected to uphold zealously the laws of the land, the articles and bylaws of the corporation, the canons of corporate ethics and the manual of corporate governance. All in all, I believe IDs were created by law to be the guardians of good corporate governance.

About Being Good
Now, let me move on to the third topic which is about being “Good.” What are the attributes or qualities of a GID? In my humble opinion, there are at least five major attributes.

The first is a thirst for knowledge. This includes a thirst for:

(1) a basic knowledge of the nature, duties, responsibilities and functions of an ID; this means a working idea of the Corporation Code, the Securities Regulation Code and the basic issuances of the SEC and of the specialized agencies that oversee the special business of the companies concerned, like the BSP, LTFRB and CAB, as earlier mentioned.

(2) a basic knowledge of financial statements and generally accepted accounting and audit principles and internal controls. One need not be a certified public accountant, like one need not be a lawyer, but an ID needs to be able to read and understand a balance sheet, an income statement and a cash flow report, at the minimum.

(3) a basic knowledge of the corporation they serve – – its vision, mission, core values, people, corporate culture, specific business directions, and management.

Of course, GIDs are not expected to memorize these laws, financial data and corporate facts. But they must have a general understanding thereof, and an eye for details such that they can easily spot, compare and challenge items, ratios, variances, etc in management reports.

The second attribute of a GID is an ample dose of courage. As I earlier discussed, the implicit assumption and unspoken expectation behind the creation of the post of independent director is the duty to fiscalize and counter-check what the other directors and the management are doing, to voice contrary opinions, and cast negative votes when necessary. They should at all times be advocates of transparency and timely disclosures. They should scrutinize related party transactions and insist on a faithful observance of good corporate governance.

This fiscalizing role and responsibility of IDs is no small matter. Remember that they are nominated by the Nomination Committee of the Board of Directors, and elected by the majority shareholders, who also elect all the other directors who in turn appoint and install the management. Yet, IDs are expected to countercheck the very people in whose hands their nomination and election to office depend.

As a comparison, if judges were to be appointed by the President yearly and their compensation determined by Congress also yearly, can we expect them to be truly independent? By the same token, can we truly expect full independence from IDs who depend on the votes of the majority to be elected yearly, and on the board of directors (in which they are a minority) to fix their compensation periodically? Surely, instead of restricting the terms of office and prerogatives of IDs, the first order of the day should be to strengthen their independence and integrity so they can perform their lonely work more effectively.

Instead of arbitrarily limiting their terms or their seat count, or ages, good IDs should be encouraged to stay on. Surely, the reappointment of the present BSP Governor to another term of six years (for a total of 12 years) did not diminish his independence and integrity. Quite the contrary, I think his longevity in office has magnified his value. So, too, who can say that the incumbent Chief Justice has less independence and integrity just because she would have a record term of 20 years in the Supreme Court, two years as associate justice and 18 years as Chief Justice? Who can say that the respected senior Justice Antonio T. Carpio has compromised his independence for having served 14 years in the Court and counting? And who can say he cannot discharge multiple undertakings beyond his many judicial responsibilities when he is the most vocal advocate of the Philippine claim in the West Philippine Sea?

Closer to our corporate world, who can say that former Prime Minister Cesar Virata, former BSP Governor Jose Cuisia, former Secretary of Finance and incumbent PSE Chair Jose Pardo, former Finance Secretary Roberto de Ocampo, veteran banker Xavier Loinaz, and of course, the venerable Washington SyCip have lost their independence and integrity just because their terms, seats and ages as IDs have not been limited? True, they are very busy persons. But equally true is the adage that if you want something done well and on time, you should give it to a busy person.

Yes, who among our public officials, from whom independence is required, and who among our iconic IDs, have lost or diminished their objectivity due to their longevity in office, or multiple directorships, or old age? Instead of indulging in vague speculations or alleged foreign practices with no demonstrated local relevance, critics – with due respect – should prove their claimed need for government-imposed limitations by pointing to flesh and blood malevolent Filipino officials and corporate directors who have dimmed their independence and integrity due to their longevity in office, multiple seats or old age.

In the event IDs misbehave and lose their independence and integrity regardless of their term, seats or ages, who can take them out? Answer: In our system of free enterprise, the shareholders. They can provide restrictions or limitations, if they want to, in their companies’ Articles of Incorporation, or use their ballot during corporate elections, or their numerical strength during board meetings, or other ways now practised by some corporations and shareholders.

One final word on this point. Because of their lack of security of tenure and compensation, IDs need a lot of emotional intelligence to know when to intervene and how to intervene so the other directors will not be unnerved unnecessarily by their objections. Indeed, IDs should always find the right way to do the right thing at the right time and for the right reasons.

The third attribute of GIDs is the ability to ask searching questions and the corresponding passion to pursue the correct and timely answer. The business of publicly-listed corporations is often complicated, and many times, even the most assiduous IDs cannot have enough knowledge to guide them in making intelligent decisions or in fiscalizing management. Only by asking searching questions can they really be guided in their work.

Sometimes, the inability to get sufficient information is borne out of a need for confidentiality in protecting the secrets of the corporation. If an ID is not trusted enough to hold company secrets, then he or she has no place in the corporation. Resignation is the only respectable option in such a situation.

In my case, before accepting an independent directorship, I make sure I am able to work with the management and the controlling shareholders. If I cannot, then I do not accept the directorship. This is particularly true of subsidiaries of foreign companies. When asked to be an ID of these entities, I would first want to meet the ultimate decision maker abroad to find out whether I can work with him or her.

The fourth attribute of a GID is integrity. This flows necessarily from the earlier attribute of courage. When I was still in the Supreme Court, I was asked what I understood by the word integrity, which is required by the Constitution of all members of the judiciary. This was my answer: “Integrity encompasses not mere honesty; it includes intellectual decency and a deep sense of personal honor. Persons of true integrity judge themselves not only by their outward acts but by their intentions which are known only to them and to God. To have integrity implies moral courage, which means not only theoretical bravery in battle but, a priori, a purity of spirit and clarity of conscience.” I believe this definition is applicable to IDs too. Integrity includes the voluntary refusal to serve or to be re-elected due to one’s inadequacy or inability or unwillingness to discharge the responsibilities of a good independent director.

The fifth attribute is a passion for hard work, and for organizing thoughts and communicating them well – verbally and in writing. While the IDs’ main work is attendance and active participation in board and committee meetings, the back-breaking job is in the preparation.

For instance, as an ID of a large bank, I am sent a packet of background information on credit and loan applications amounting to several billions of pesos. They are several inches thick and include footnotes written in minute font sizes. I normally reserve an evening to pour over these tomes for several hours to be ready for the board meeting. These evening sessions, free from the hustle and bustle of the day, provide me the solitude to concentrate and read fast, picking on the essentials and skipping the routinary and non-essentials. Fortunately, even at my advance age, I still have 20/20 vision thanks to the laser cornea replacement surgery I underwent in 2008.

Another example: Upon being elected ID of the largest petroleum company in our country, I used a helicopter to view the nearly $3-billion refinery modernization program of the company and to meet with the engineers, contractors and in-plant managers so I would have a good idea of the project.

Before I end, let me summarize the challenges that confront good independent directors. One, GIDs must first and foremost be good fiduciaries who owe complete fidelity to the corporation they serve, above and beyond their private and personal interest. Their main duty as such fiduciaries is to help the corporation grow and profit legally, honestly, reasonably and ethically. Because they do not contribute money or resources to the company, they need to make up for this inadequacy by providing a “killer app,” a special skill or quality that make them valuable corporate trustees.

Two, GIDs must live up to their mandate of independence; that is, they must be free of the prohibited relationships that may diminish their objectivity in performing their duties. Their main responsibility as IDs is to be guardians of good corporate governance, and to ferret out, when necessary, illegal, dishonest, unreasonable and unethical practices that violate the law, or the trust of the shareholders and of the public in general. This includes resisting illegal and unreasonable government regulations.

Third, they must have at least five attributes: an unquenchable thirst for knowledge, an ample amount of courage, an uncanny ability to ask searching questions, an unassailable integrity, and a consuming passion for hard work.
Maraming salamat po.

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