The crisis in the indigenous Financial Sector has been justifiably one of the most passionately debated issues in our recent history. In particular, there has been considerable debate about the costs and causes of financial sector adjustment. Perhaps there has not been enough debate about the benefits or opportunities of adjustment and solutions to the crisis. Today, I will attempt to address both sides of this cost benefit equation.
To date, the estimated gross cost of preserving the values of depositors funds, pension fund investments and life insurance policy benefits is in the order of J$75B. Clearly, some of this cost the portion that cannot be recouped from divestments, loan collection and the like will have to be borne by the taxpayer. FINSACs job is to minimize this cost and, as part of that process, to minimize the possibility of a crisis of this kind ever facing Jamaica again.
It is therefore important to critically analyze the causes of the distress experienced by the several institutions, which have had to be intervened by FINSAC. It is within this context that the role of directors of financial institutions requires careful scrutiny.
Once the analysis is complete and any shortcomings identified, we must outline a new modus operandi, which ensures implementation of corrective measures. As the old saying goes, "Those who do not learn the lessons of history will repeat them."
The duties/responsibilities of a director at common law can be conveniently discussed under two headings:
A directors fiduciary duty of loyalty and good faith can be further broken down into four separate rules.
(a) Directors should act in good faith in what they truly believe to be in the best interest of the company.
(b) Directors should not abuse the powers conferred on them by the office they hold.
(c) Directors should not restrict their discretion in how they act.
(d) Directors should not, without the informed consent of the company, put themselves in a position where their personal interests are likely to conflict with those of the company.
The Australian case of Mills v. Mills (1938) establishes that the court can be quite liberal in determining reasonable expectations of directors actions deemed to be in good faith. In Mills, it was stated that directors are "not required by law to live in an unreal region of detached altruism and to act in a vague mood of ideal abstraction from obvious facts which must be present to the mind of any honest and intelligent man when he exercises his powers as a director."
Even though it is well established by law that the duties of the directors are primarily owed to the company, this does not mean that there can be no circumstances in which the rights of creditors take primacy over those of the company.
Such circumstances would exist where a company has lost all its capital. In this situation shareholders have no financial interests and the directors have a duty to stop trading. As Lord Diplock opined in Lournho Ltd. v. Shell Petroleum Co. Ltd. (1980), the principle that directors must act in the best interests of the company "are not exclusively those of its shareholders but may include those of its creditors." In West Mercia Safetywear Limited v. Dodd (1988), the Court of Appeal held that a director of an insolvent company must have regard to the interests of its creditors.
Looking at the commercial banks and insurance companies benefiting from government intervention, the creditors interests which directors must regard extend to the government, now the primary and largest creditor, and in some cases shareholder, which has protected the interests of depositors and policyholders through its injection of funds.
In an apparent move to strengthen the framework of determining directors responsibilities, provisions in the proposed new Companies Act would codify the common law standard of directors duty of care and skill. Under the proposal, every director and officer of a company in exercising his powers and discharging his duties must act honestly and in good faith with a view to the best interests of the company.
The proposal would also provide that in determining what are the best interests of a company, a director may have regard to the interests of the company's employees in general, its shareholders, and the interests of the community in which the company operates. This provision expressly recognizes a broad scope of stakeholders.
The proposal also would introduce an objective test of care and skill from the Canadian model, stating that every director and officer of a company, in exercising his powers and discharging his duties shall exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
Keeping in mind the legal standard for the responsibilities of directors, I would like to look at the causes of the Financial Sector crisis in Jamaica. A review of the causes of the Financial Sector crisis in Jamaica reveals several contributing factors at the macroeconomic level. These are well detailed in Ministry Paper No. 13 that was submitted to Parliament with the 1998 budget.
First, structural reform of the 1990s created new avenues for profit for these institutions such as trading in foreign exchange and a wide range of securities, and a real estate boom which encouraged institutions to invest heavily in the real estate sector.
Second, the existence of an inflationary environment facilitated rapid growth in profitability and at the same time masked weaknesses in the Financial Sector. These weaknesses emerged once the anti-inflationary policies were put in place.
The macroeconomic environment and the rapid expansion in the Financial Sector placed severe strain on the management of Financial Institutions. Poor management practices compounded the problems arising from the state of the macroeconomic environment. Among the serious management weaknesses noted in the Ministry Paper were:
When these issues are critically examined against the responsibilities of directors as I have previously outlined, it seems quite clear to me that several directors of distressed companies were found wanting in the execution of their responsibilities. I would suggest, however, based on my own experience and dialogue with some directors that many did not properly understand their role.
Consequently, I would suggest that there is a need for companies, in general, and those in the Financial Sector in particular, to make affirmative efforts to select directors with the requisite knowledge and qualifications to actively and meaningfully contribute to the decision-making process. Further, an on-going programme of education must exist to allow directors to continually develop their knowledge base on issues related to the companys business. Moreover, beyond the exercise of good judgement in selection of directors, it is imperative that companies, and especially those in the Financial Sector, develop a culture of strong corporate governance.
The simple model of corporate structure in which shareholders provide the capital, the directors and the managers organize and run the business, and the employees do the work forms the basis of the system of corporate governance in countries, like ours, following the common law tradition.
By corporate governance we refer to the set of rules, regulations and institutions which control and govern the relationships between the company's shareholders, the board of directors and the board's controlling bodies, both internal and external to the company. Corporate governance is designed to govern the relationship between directors, shareholders, and the public based on the notion that the directors are accountable to the shareholders in their overriding duty to maximize profits. In addition to providing checks and balances between the interests of shareholders and the powers of the directors and professional managers, corporate governance should provide for banks and other companies to serve the interests of wider constituencies of stakeholders such as employees, consumers, depositors, and the public.
Reference to our foreign counterparts is instructive. In Canada, the Toronto and Montreal Stock Exchanges have adopted guidelines for effective corporate governance. The Toronto and Montreal Stock Exchanges require that each listed corporation incorporated in Canada or in a province of Canada discloses its approach to corporate governance with reference to these guidelines in annual reports and offering circulars. In the United Kingdom, corporate governance is the subject of principled discussion in documents such as the Cadbury and Greenbury Codes. In the United States, corporate governance is widely discussed by scholars and academics. With regard to the United States financial sector, the Office of Comptroller of the Currency, the supervisor of national banks, Directors Book sets forth principles of corporate governance that national banks should follow.
Here, in Jamaica, there is already some evidence of an attempt on the part of authorities to institutionalize this type of governance through proposed provisions in the new Companies Act. In addition to the proposals in the new Companies Act mentioned earlier are the proposed conflict of interest provisions, such as required approval of material contracts in which directors are interested by the Board of Directors and notification of the shareholders. The proposed new Act also would require that such contracts involving directors be kept at the companys registered office and be open to public inspection.
Further, substantial property transactions (defined as transactions which deal with assets, the value of which exceeds J$500,000 or 10% of the companys net assets) involving directors would be disclosed and approved by the shareholders. The proposed Bill would also prohibit public companies from directly or indirectly giving financial assistance for any purpose by means of a loan, guarantee or otherwise to a shareholder, director or officer of the company or an associate of the foregoing.
Also on point are the recent amendments to the Financial Institutions and Banking Acts which have modified the licensing provision in section 4 to incorporate an expanded definition of the "fit and proper" concept.
Under this expanded definition, regard will be had to a person's ability to exercise the level of competence, diligence, soundness of judgement and probity required of directors, major shareholders or officers of a bank. The amendment gives clear authority to the Minister to exclude from bank ownership or management persons whose relationship with the bank would pose a threat to the interests of the depositors. Individuals deemed to pose a threat to the interests of the depositors are those known to have been engaged in business practices that are deceitful or oppressive, or have previously caused financial loss to depositors, insurance policy holders or investors, by reason of their incompetence, dishonesty or malpractice.
The foregoing are illustrations of regulatory governance in the form of rules being legislated to govern the conduct of regulated entities. However, corporate governance is not the responsibility of regulators alone, but also the companies.
There is a need for companies within the Financial Sector to take a proactive role in facilitating improved governance on the part of their directors. The voluntary formulation of corporate governance as compared to that enacted by regulators will engender a deeper sense of commitment on the part of corporate management. In a dynamic, competitive environment it is imperative that directors and managers of corporations constantly review, evaluate and as necessary modify governance practices to ensure the effectiveness of their corporate governance, to guard against moral hazard, and to favourably compete in the marketplace. The continuous development and evolution of a high standard of corporate governance should be a priority for Financial Institutions.
To assist companies in developing these standards, I would suggest the following:
(a) Financial Institutions should seek to obtain information on corporate governance practices of similar and successful institutions in Jamaica and the Caribbean as well as other commonwealth countries such as the United Kingdom and Canada. I have suggested other commonwealth countries because they have similar legal structures to ours.
(b) Financial Institutions should critically review their current corporate governance practices against those of the counterparts suggested above to identify weaknesses and opportunities for improvement. This review should be conducted where possible with the assistance of external consultants to ensure that it is as objective as possible.
(c) Financial Institutions should ensure that persons appointed to boards are of the requisite skill, knowledge, temperament and character necessary to ensure proper conduct and a meaningful contribution to the company's affairs.
(d) Financial Institutions should hold regular training and review sessions for directors, especially new directors, to ensure that they understand their role, the purpose and objectives of the company, and are keeping abreast of new standards in corporate governance. Directors should understand both the Financial Institution's business environment and the legal and regulatory framework within which the Financial Institution's activities operate.
(e) Financial Institutions can assist in keeping directors informed about industry trends and other matters by including them in management presentations on business activities and industry developments, bank counsel briefings or reports on legislative and regulatory changes, pending litigation, and emerging compliance or legal issues, and bank auditor briefings on major accounting or tax developments.
(f) Financial Institutions should develop a comprehensive formal program of individual director performance assessment and feedback. This should include the chairman of the board. Under this program, each director should receive detailed feedback on the quality of their contribution.
(g) Financial Institutions should develop and adopt a charter of expectations for directors which enunciates the specific responsibilities to be discharged by the bank directors and the individual roles expected of them. This charter should stipulate the personal and professional characteristics expected of all directors and provide benchmarks against which a director will be evaluated. These criteria could also provide a recruitment model for use in selecting new directors. Among the relevant criteria would be the institution's record in complying with laws and regulations, criticisms contained in audit and inspection reports and their resolution, management's responsiveness to board directives and policies, the timeliness, quality, and accuracy of management's recommendations and reports, and management's presentations to the board.
In conclusion, directors of Financial Sector companies may be deemed to have a higher duty of care than other company directors. Their standard powers, duties, and responsibilities are established by law. The lessons of the crisis in the Financial Sector are clear. High standards of corporate governance are necessary to avoid the mistakes of the past. With the introduction of deposit insurance limited to $200,000, the burden will have shifted to depositors and other investors to inform themselves of the business practices and financial condition of the institutions in which they place their savings. A more stringent regulatory regime (which imposes new duties on external auditors to report material transactions or conditions giving rise to significant risks or exposures, demonstrating a weakness in internal controls, or which could have a significant impact on the banks financial viability) will assist in safeguarding against the weaknesses, shortcomings, and abuses which contributed to problems in the Financial Sector.
However, for Financial Institutions to survive, effectively compete, and be profitable in the new regulatory environment and the restructured Financial Sector, they must take responsibility for their own corporate governance. Information on their corporate governance must be readily available to consumers even if regulatory bodies have not required such disclosure along the lines of the Toronto and Montreal Stock Exchanges.
Participation in such disclosure will assure transparency and accountability as well as provide a vehicle for the board of directors to continually reassess its corporate governance structure and procedures to assure for effective, efficient and prudent business operations. The commitment to good corporate governance must go beyond having in place the appropriate structures, processes, and policies, however.
Good corporate governance requires the active responsibility and commitment of the board of directors directly and through its committees to the management of the Financial Institutions business and affairs. Good corporate governance also requires sound ethics, integrity, judgement and values at the level of the board of directors and throughout the Financial Institution.
At FINSAC, we have identified good corporate governance as a priority for Financial Sector reform. We see it as a critical factor for a strengthened Financial Sector. Herein lies the opportunity for Jamaica. As FINSAC seeks to strengthen the corporate governance of its holdings and companies in which it has an ownership interest, I would ask for your support by making corporate governance a priority in your respective companies. Together, our effort to improve corporate governance will inure to the benefit of depositors and shareholders, and ultimately the taxpayer.
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