The Canadian Securities Administrators (CSA) have received formal submissions (Submissions) on Consultation Paper 52-404 – Approach to Director and Audit Committee Member Independence (Consultation Paper) from 27 commentators, ranging from public companies, large investors, governance commentators, professional bodies and practitioners at law firms, among others, with several Submissions representing the collective views of numerous contributing organizations. The Consultation Paper considers the CSA’s current approach to director independence determinations and board committee membership. (See our November 2017 Blakes Bulletin: Are Directors Independent? It Depends: CSA Revisiting 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. Most notably, executive officers of controlling shareholders of issuers are deemed to be non-independent under the current rules, even if factually they are independent of the issuer’s management.
Generally, the Submissions focused on two related themes: (i) whether to shift the current regime to a “principles-based” approach for independence determinations; and (ii) whether the current approach to determining independence is appropriate for companies that have a controlling shareholder.
DEEMING PROVISIONS VS. PRINCIPLES-BASED
As noted by the CSA in the Consultation Paper, “[t]he definition of independence is a central component of our corporate governance regime” and “the exercise of independent judgment contributes to the effectiveness of boards and board committees”. The Submissions did not take issue with these statements, but rather expressed both support and criticism of the current approach to determining director independence given inherent consequences of such determinations.
Some commentators viewed the current regime as striking the right balance, ensuring consistency and predictability, taking pressure off directors for making determinations, and obviating the need for shareholders to investigate particular situations in order to reach their own conclusions. Others contended that the current deeming provisions are overly restrictive, capture immaterial relationships and result in suitable individuals being precluded from serving as independent members of boards and their committees.
Further Submissions provided for a middle ground by advocating for: (i) maintaining the “bright-line tests” with some updates (e.g., to increase thresholds for non-director compensation paid to directors by the issuer or to align with similar provisions employed in the U.S.); (ii) augmenting a reduced set of “bright-line tests” with a set of best practices or expanded commentary on the types of relationships that often can reasonably be expected to interfere with the director’s exercise of independent judgment; or (iii) expanding the applicable exceptions to better accommodate the particular context of an issuer and the director in question.
Several commentators supported the current regime, but requested that the CSA provide greater focus on the base determination (i.e., a director is considered independent if he or she has no direct or indirect material relationship), fearing that boards may too often curtly conclude that if an individual is not “caught” by the deeming provisions, the individual is necessarily, and appropriately viewed as being an independent director.
Other Submissions noted that the deeming provisions are troublesome in that they can actually result in disclosure that is misleading to investors, by labelling a director as being non-independent despite the board of the issuer having reasonably come to a contradictory conclusion.
In particular, one context that was frequently the core focus of many of the Submissions was the inappropriate application of the current regime to issuers with controlling shareholders. These Submissions propose that the determination of director independence should be factual and contextual, undertaken by the issuer’s board of directors on a case-by-case basis based on actual relationships with an issuer’s management, without reference to any determinative presumptions, including, in particular, relationships with a controlling shareholder.
Certain Submissions argue that the automatic deeming provisions result in a one-size-fits-all regime that is inconsistent with the history of CSA’s principles-based approach to corporate governance (as well as the 1994 Report of the Toronto Stock Exchange Committee on Corporate Governance in Canada (known as the Dey Report)) and outdated given the acceptance of alternative forms of good governance by various governance commentators (for example, see our October 2011 Blakes Bulletin: CCGG Releases Governance Guidelines for Equity Controlled Corporations) and proxy advisory firms (for example, see our January 2018 Blakes Bulletin: 2018 Proxy Advisory Firm Voting Guidelines: Canadian Highlights).
The authors of such Submissions also note their belief that members of key committees (i.e., audit, nominating and compensation committees) of a board should be permitted to have a relationship with the controlling shareholder (i.e., serving as an officer of such shareholder), to provide the knowledge and perspective of the controlling shareholder with respect to the matters under the responsibility of such committees. However, the Submissions point out that such directors would not be “representatives” of the controlling shareholder since corporate law provides that all directors must always act with regard to the best interests of the corporation as a whole, including its shareholders generally, and not any single shareholder or any shareholder group.
Several of the Submissions note that, in most cases, the best interests of a controlled company will be consistent with the interests of a controlling shareholder, which interests will also be aligned with the interests of minority shareholders, such as senior management compensation. The potential governance issues typically associated with controlling shareholders relate to conflicts of interests and self-dealing, which, the Submissions provide, to the extent they arise, should be resolved directly through a process involving only directors who are independent of the controlling shareholder and the controlled company rather than using the broad brush of deemed non-independence.
Submissions also advocated for, among other things:
- Connecting director tenure to determinations of independence
- Enhancing the provisions of Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special Transactions in a targeted manner (as a more appropriate way of addressing transactions involving controlling shareholders rather than deeming directors to be non-independent)
- Using the same independence criteria for the board and committees (i.e., no “enhanced” independence for the audit committee)
- Revising the application of the provisions to employees of professional services firms that are not personally involved in advising an issuer
- Providing further commentary on what it means to be “financially literate” for purposes of sitting on an audit committee.