Is Legislation in Malaysia sufficient post Enron & Worldcomm?
Directors being pillars of corporate governance (Cowan, 2004) should at all times act honestly and use reasonable diligence in the discharge of their duties. This is more so in light of recent major corporate issues like ENRON & Worldcomm in the United States and the Transmile case in Malaysia. In essence directors are agents of the company and as agents, they owe a duty of trust to the company and shall do their utmost to put the interest of the company first before personal ones.
Cowen (2004) wrote that since directors are agents of the company, they are accountable to shareholders and to stakeholders in various guises. It is also clear that as a custodian of something that does not belong them, directors owe a fiduciary duty of care to safeguard the company’s assets and maximize returns for shareholders and to ensure that the other stakeholders needs are met as well. The principle that a company is a legal entity by itself and separate from its shareholders, directors and managers also lent to the need for directors to act honestly and diligently in the position that they are entrusted to.
The statement in Section 132(1A) of the Companies Act 1965 in Malaysia states that a director of a company shall exercise reasonable care skill and diligence. Section 132(1) of the same act further states that a director of a company shall at all times exercise his power for a proper purpose and in good faith in the best interest of the company. The statement is more obvious when seen in the context that a company is a legal entity and it exists independently from both shareholders and staff. Playing the role of the middleman, directors are the link between the providers of capital and the company together its operational management team.
However, it must be noted that a director can also be a shareholder because although physically one person, the director plays the role of two distinct legal identities. This principle of separate and legal entity between the company and shareholders was first established in the landmark case of Salomon vs Salomon & Co. Ltd.(1985) where the term “Veil of incorporation” was established.
Fok (1996) , mentioned that a director is a person elected by the shareholders or appointed by the board to participate in management of the company. It goes without saying then that directors should safeguard the shareholders’ investment in the company and at all times act honestly and use reasonable diligence in the discharge of his duties to shareholders. Cowen (2004) wrote that since directors are agents of the company, they are accountable to shareholders and to stakeholders in various guises. It is also clear that as a custodian of something that does not belong them, directors owe a fiduciary duty of care to safeguard the company’s assets and maximize returns for shareholders and to ensure that the other stakeholders needs are met as well.
2. NEED FOR DIRECTORS
Directors are stewards of the company and who provide the company with leadership, guidance and directions. Directors of a company would include the following positions or designations;
• Managing Director
• Executive Director
• Independent non-executive Director
• Non-independent no-executive Director
All companies in Malaysia are required to have a board of directors and the minimum number is two. In essence the two originating directors of a company would most likely also be the shareholders as well. It is also common for shareholders to continue to hold office as directors and the board to be filled with trusted associates and relatives. Therefore we tend to take the issue of due diligence and honesty on the part of directors as a non-issue. Why would someone cheat themselves or their relatives?
However, when a company grow and it attracts capital apart from the original shareholders, the responsibilities of directors to act honestly and with proper diligence cannot be taken for granted any longer. They are now working for others rather than just themselves or family members and the need for them to act honestly and diligently is quite real. In most countries, specific laws relating to companies are enacted to govern the administration of such companies and the role of company directors is usually part of the enactment. In public listed companies this becomes even more pronounced as public’s funds are involved.
3. FRAMEWORK GOVERNING DUTIES OF DIRECTORS
3.1 Legislation and Corporate Governance code.
The Finance committee on Corporate Governance in Malaysia wrote that every listed company should be headed by an effective board which should lead and control the company. Directors have a dual role of both leadership and control. Some of the duties of the directors include strategic planning, managing risk, ensuring internal control compliance, reporting to shareholders on the affairs of the company and guiding the company in achieving the objectives of the company. In smaller companies the directions and actions of the company usually mirrors that of the owner or major shareholders. In larger companies and public listed companies there are often no correlation between the values and personality of shareholders and the action that the company takes.
Shareholders are often passive investors and have little or no understanding at all about the operations of the company. In order for the company to get the public to invest in the company, the board of directors must act honestly and diligently as the shareholders rely on them run the company properly and provide shareholders with adequate returns on their investment. Directors must ensure that all shareholders are treated fairly and not just the significant or majority owner(s). Directors also do not need to report on a daily basis to shareholders so it is important that directors act professionally, with proper diligence and honesty.
To safeguard shareholders various provisions were made in laws related to duties and responsibilities of directors and in particular of listed companies. For example; Companies Act 1965 of Malaysia including sections to prevent bankrupts from acting as directors (Sect (125(1), restraining certain persons from managing companies as directors (Sect 130(1) ) and the disqualifications of directors of insolvent companies (130A(1)). Similar provisions exist in company enactments in most countries. There are also adequate provisions in the Penal code to prosecute director for not acting honestly and such provision related to the agency relationship between the directors and the company. For example, Section 409 of the Penal code in Malaysia deals if criminal breach of trust which applies to directors as well as agents in general.
Some companies also have provisions in their memorandum or articles of association which provides for the appointment of directors who are required to hold a specified numbers of shares as prequalification for board membership. In Malaysia, Section 124 of the Companies Act 1965 states that if the articles of association of the company requires that a directors must hold a specific number of shares to ‘qualify” as director. This is to ensure that the value of other shareholders are looked after since the director, as a shareholder himself, will have every reason to discharge of their fiduciary duties and maximize shareholders funds.
However, not all issues can rely on legislation to ensure that directors act in the best interest of shareholders. Some issues are caused by director’s lack of dedication or capability and this brings us to the issue of accountability.
3.2 Sense of Accountability
Sometimes directors fail to achieve shareholders or company’s object for reasons which may not come under any legal purview. Sometimes directors fail just because of attitude or ineptitude or both. Cowan (2004) commented that given that directors are acting on behalf of the company’s owners and it is clear that the first level of accountability is to the shareholders. Just as other employees can be terminated by the company due to poor performance and directors too can be terminated by shareholders at shareholders meetings. . Removal of directors can be touchy affairs but the one can rely on provisions in various company laws and acts to do so. In Malaysia, removal of directors can be done under section 128(1) with the use of an ordinary resolution at the annual general meeting (AGM), Extraordinary General meetings (EGM) or any properly constituted shareholders meeting
However, it must be noted that it since reports to shareholders are not very frequent and not in full details, it might be sometimes too late for shareholders to take appropriate actions . It is therefore incumbent on directors to act diligently to ensure that they lead the company well thus achieving the company’s objectives and ensuring a reasonable rate of return for the shareholders. Directors must dedicate themselves fully to the company’s cause and to ensure disclosure and transparency to all shareholders.Cowan (2004) states that shareholders have contributed their funds to the company and, in return, have the right to expect reasonable treatment and protection in exchange for the risk exposure of their funds.
One of the remedy for wayward directors is to have independent non-executive directors providing alternative views and oversight capacity. In addition they might bring in additional skills and expertise to complement the executive directors in improving the board’s performance and in doing so spurring the company to greater heights.
Paragraph 1.01 of the Listing requirements of Bursa Malaysia Securities Berhad and Practice note No 13/2002 noted that an independent director is one who is independent of management and free from any business or other relationship, which could interfere with the exercise of independent judgement or the ability to act in the best interest of a listed company .
However, we must also bear in mind that many independent non-executive directors have other positions in industry as well and may not be in position to understand the business let alone improve performance of the company. However, it must be noted that listing requirements nowadays requires the appointments of independent non-executive directors. Furthermore they are expected to form the majority of members in audit committees and other oversight board level committees.
In summary, it is clear that directors should act honestly and diligently in discharging their duties especially in listed company or in instances where directors are not shareholders. Not doing so would mean that they are not fulfilling the professional and legal responsibilities that they are paid for. Various legislation and acts have been formulated in many countries to ensure that directors act honestly and diligently although in some cases it is just as simple as to terminate the directors or hope that they change their ways. Recent cases like the ENRON affairs and Worldcom’s collapse illustrates to us how important it is for directors to act honestly and diligently in their duties towards shareholders. It can also be seen that there are many safeguards available to ensure that directors carry out their duties honestly and diligently and these measures carry both legal and moral bearing on the errand director.
1.Cowan, Neil 2004, Corporate Governance that Works!, Prentice Hall, Jurong, Singapore
2.Lee, Mei Pheng 2005, General Principles of Malaysian Law 5th Ed., Oxford Fajar, Selangor, Malaysia.
3.The Institute of Internal Auditors Malaysia, 2006, The Professional Practices Framework, The Institute of Internal Auditors, Kuala Lumpur Malaysia.
4.Fok, William, 1996, A Practical handbook on Company Secretarial Practice, Leeds Publications, Kuala Lumpur, Malaysia.
5.Legal Review Board, 2008, Penal Code (Act 574) as at 15th January 2008, International Law Book Services, Petaling Jaya, Malaysia.
6.Finance Committee on Corporate Governance, 2000, Malaysian Code of Corporate Governance, Malaysian Institute of Corporate Governance, Kuala Lumpur, Malaysia.
7.Ministry of Finance Malaysia, 2007, Companies Act and Regulations- Amendments up to September 2007 26th Edition, MDC Publishers Sdn. Bhd., Kuala Lumpur Malaysia
This article also appears in the Year End 2010 Journal of the Institute of Commercial and Industrial Accountant, Malaysia.
About the Author:
DOMINIC SHUM FIPA, MCCS, CCIA, BBA(Spore), MBA (Aust)
Dominic Shum is a freelance management consultant and is involved in non-profit organizations as well. He is a director of Eventmastery Asia Pacific Sdn. Bhd. , a council member of the Institute of Public Accountants, Australia, Accreditation and Disciplinary Committee member of the Malaysian Association of Company Secretaries and an EXCO member of the Malaysian Economic Association. He has a Business Administration Degree from the National University of Singapore and an MBA in Entrepreneurial Management from the Australian Institute of Business.