Are Directors Independent? It Depends: CSA Revisiting Regime
The Canadian Securities Administrators (CSA) have released CSA Consultation Paper 52-404 – Approach to Director and Audit Committee Member Independence (Consultation Paper) and are inviting comments on the current approach to director independence determinations and board committee membership. Although the CSA regime has remained largely unchanged since 2004, the views of various governance commentators have evolved over time, with some diverging from the current standards under Canadian securities laws.
The concept of director independence is central to the corporate governance framework under Canadian securities laws. In National Policy 58-201 – Corporate Governance Guidelines (NP 58-201), the CSA set out recommended corporate governance practices, including that a majority of the directors of a reporting issuer be “independent”, while National Instrument 52-110 – Audit Committees (NI 52-110) provides that an issuer’s audit committee must (subject to limited exceptions) be composed entirely of independent directors.
The current CSA approach to independence and audit committee composition was originally adopted in 2004. In 2008, the CSA published proposed changes to the corporate governance regime, notably including a proposed shift to “principles-based” independence determinations; however, in 2009, the CSA concluded that, within the context of a challenging economic climate, the time was not right for significant changes to the Canadian corporate governance regime.
Currently, a director is considered independent if he or she has no direct or indirect material relationship with the public issuer, any of its subsidiaries or any controlling shareholder of the issuer. For these purposes, a relationship is material if, in the view of the issuer’s board, it could reasonably be expected to interfere with the director’s exercise of independent judgment. However, certain relationships are deemed to be material and automatically result in a director being considered non-independent by the CSA, even if the issuer’s board has factually determined otherwise. Examples of such relationships include an individual who is, or has been within the last three years, an employee or executive officer of the public issuer, any of its subsidiaries or any controlling shareholder of the issuer.
The Consultation Paper highlights the CSA’s view that “consistency and predictability” of the current Canadian approach are among its primary benefits. On the other hand, the CSA note, the current Canadian approach has been criticized for being inflexible and overly restrictive.
The Consultation Paper compares the Canadian system for determining independence with those in the U.S., the U.K., Australia and Sweden. The Canadian and American systems have similar structures, with a definition of independence that is supplemented by deeming rules or “bright line tests” that require directors with certain relationships not to be considered independent.
On the other hand, in the U.K., Australia and Sweden, the definition of independence is supplemented by non-binding guidance. This approach permits boards to consider the totality of a director’s relationships and approach even in the event that the director has a relationship that is considered likely to result in a determination that the director is not independent.
According to the Consultation Paper, there is a substantial degree of overlap between the factors that preclude a director from being considered independent in Canada and the U.S. and those that are referred to in the guidance supplementing the definitions of independence in the U.K., Australia and Sweden.
Certain corporate governance commentators have adopted different views on the definition of independence, in particular as it relates to directors who are also employees or officers of an issuer’s controlling shareholder.
For example, the Canadian Coalition for Good Governance (CCGG) considers directors who have a material relationship with a controlling shareholder “related directors” and acknowledges that such directors may be independent of management. In addition, CCGG and the proxy-advisory firms Institutional Shareholder Services and Glass Lewis provide for different analysis and recommendations regarding board and committee composition of controlled companies, such as supporting presence of a greater proportion of related directors who are independent of management.
During the comment period on the governance changes proposed in 2008, a number of companies and institutional investors also recommended that the provisions of NI 52-110 be revised to permit directors with a relationship with an issuer’s controlling shareholder (but otherwise independent of the issuer’s management) to be considered independent of the issuer.
REQUEST FOR COMMENTS
The Consultation Paper includes a broad request for comment from the CSA and also specifically asks for comment on the following issues, among others:
- Whether the CSA’s approach to determining independence is appropriate for all issuers in the Canadian market
- Whether the CSA should consider any changes to their approach to determining independence and requirements concerning audit committee composition
- The advantages and disadvantages associated with maintaining the CSA’s current approach or replacing it with an alternative.
The CSA will accept comments until January 25, 2018.
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or any other member of our Corporate Governance group.
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