CCGG POLICY GOVERNANCE DIFFERENCES OF CONTROLLED CORPORATIONS

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1 Draft: April 11, 2011 INTRODUCTION Background DRAFT FOR PUBLIC COMMENTS In 2010 Building High Performance Boards, the Canadian Coalition for Good Governance ( CCGG ) developed a set of guidelines to help ensure that the board of a public company: Is accountable and independent Has experienced, knowledgeable and effective directors committed to the highest level of integrity Has clear roles and responsibilities, and Engages with its shareholders. (See for the complete version of 2010 Building High Performance Boards. All references to CCGG Guidelines are to the guidelines contained in that document). Many large Canadian issuers are controlled by a family, a parent company or a group of shareholders through their holdings of common shares. Effective equity control can come from holding as little as 20% of the common shares of a widely held company. These guidelines relate only to those issuers who are controlled through the holding of common shares, and not to issuers who are controlled by virtue of multiple-voting or dual class share structures. CCGG will prepare guidelines for dual class share companies, which have unique governance issues, in the near future. CCGG recognizes that a controlling shareholder may have a legitimate interest in being actively involved in the board of directors of the corporation. In fact, many institutional investors expect shareholders who control a corporation by their equity holdings to have substantial influence over the strategic direction of the company, the appointment of some of the directors, the financial affairs of the business and executive appointments and compensation. CCGG believes that representation of the controlling shareholder on the board and its influence over the corporation while important and often valuable - should generally be proportionate to its equity holdings, and the board should always have a meaningful number of independent directors who are not related to the controlling shareholder. CCGG BOARD OF DIRECTORS CHAIR David Denison CPP Investment Board VICE CHAIR Dan Chornous RBC Global Asset Management DIRECTORS Bill Chinery BlackRock Emilian Groch Alberta Teachers Retirement Fund Stephen A. Jarislowsky Jarislowsky Fraser Wayne Kozun Ontario Teachers Pension Plan Larry Lunn Connor, Clark and Lunn Brian Murdock TD Asset Management Donald F. Reed Franklin Templeton Investments Corp. Kim Shannon Sionna Investment Managers CONTACT US Stephen Griggs Executive Director sgriggs@ccgg.ca Judy Cotte, General Counsel and Director of Policy Development jcotte@ccgg.ca of 7

2 All public companies should strive to have their governance practices go beyond legal minimums to ensure excellence. CCGG expects that all public companies including controlled corporations - will follow the core governance guidelines set out in 2010 Building High Performance Boards. The purpose of this document is to modify certain of these governance guidelines to ensure that the legitimate ownership interests of a controlling shareholder are not in conflict with a guideline designed for widely held issuers. In addition, some of the guidelines are amended by this document to reflect that a controlling shareholder has the ability to control the assets of the corporation possibly to the detriment of other shareholders and that there may be a need for additional governance protections for minority shareholders beyond those applicable to widely held issuers. Definitions In this document: A corporation controlled by a shareholder or group of shareholders (directly or indirectly) by holding a sufficient number of common equity shares to be able to elect the board of directors (often as little as 20%) is a Controlled Corporation, and the controlling shareholder(s) is referred to as the Controlling Shareholder. A director is independent of the corporation (an Independent Director ) if he or she has no direct or indirect material relationship with the issuer, meaning a relationship which could, in the view of the issuer's board of directors, be reasonably expected to interfere with the exercise of a member's independent judgment 1. This definition deems a director who is related to a shareholder holding 50% or more of the voting shares not to be independent of the corporation even if he or she is in fact independent of management. A director is considered to be related to a Controlling Shareholder (a Related Director ) if he or she is a significant owner of the Controlling Shareholder, directly or indirectly employed by the Controlling Shareholder (or one of its significant shareholders) or is an immediate family member 2 of the ultimate controlling shareholder. A person who is a director of a Controlling Shareholder but is otherwise independent of the family or entity that owns or controls the Controlling Shareholder will not be considered to be a Related Director of the corporation solely because of being a director of the Controlled Corporation. An officer is considered to be related to a Controlling Shareholder if he or she is a significant owner of the Controlling Shareholder, directly or indirectly employed by the Controlling Shareholder (or one of its significant shareholders) or is an immediate family member of the Controlling Shareholder. 1 For these purposes, CCGG adopts the definition of an independent director contained in Section 1.4 of National Instrument Audit Committees of the Canadian Securities Administrators. 2 As defined in Section 1.1 of National Instrument Audit Committees of the Canadian Securities Administrators. 2 of 7

3 The CEO is the Chief Executive Officer or a person holding the most senior executive office in the corporation. Regulatory Definition of an Independent Director CCGG has advocated for a change to the current regulatory definition of an independent director in National Instrument Audit Committees of the Canadian Securities Administrators. CCGG believes that a distinction should be made between a director who is independent of management and a director who is independent of management but is affiliated with a shareholder holding the majority of the common shares or voting rights of the company. The current regulatory definition may deem a director affiliated with a controlling shareholder not to be independent, even if he or she is independent of management of the company in question. CCGG agreed with the Canadian Securities Administrators 2008 proposed definition of an independent director which focused on providing a framework for establishing and maintaining strong, effective and independent audit committees by focusing on independence from management. 3 CCGG encourages the CSA to move forward with these amendments which would allow, for example, a Related Director to be on an Audit Committee. The following refers to certain of the CCGG governance guidelines in 2010 Building High Performance Boards, which are modified or reiterated to reflect the governance differences of Controlled Corporations and the additional minority shareholder protections that may be required. Guideline One - Shareholder Democracy Controlled Corporations should allow shareholders to vote for or against each individual director nominee and adopt the CCGG Majority Voting policy. The nominating committee of a Controlled Corporation should have a process to accept and discuss suggestions from shareholders of individuals to be considered by the nominating committee in its board selection process. CCGG recommends that boards of all companies facilitate the ability of shareholders to effectively vote their shares for or against individual directors by adopting the CCGG Majority Voting policy 4. CCGG believes that minority shareholders should have the ability to express their views on each proposed director even if the Controlling Shareholder holds 50% or more of the voting shares. The CCGG Majority Voting Policy commits a board to (1) holding director by director elections and disclosing the results, and (2) requiring a director who has more votes withheld than are voted for him or her to tender his or 3 See the December 19, 2008 Request for Comment Proposed Repeal and Replacement of NP Corporate Governance Guidelines, NI Disclosure of Corporate Governance Practices, and NI Audit Committees and Companion Policy CP Audit Committees. CCGG s response to this Request for Comments is available at 4 See the 2011 CCGG Majority Voting Policy, available at 3 of 7

4 her resignation to the board. The board would promptly consider the resignation and, other than in exceptional circumstances, accept it. CCGG acknowledges that, where the controlling shareholder has 50% or more of the votes, it is highly unlikely that more votes for an individual director will be withheld than are voted for. However, CCGG believes that it is important for such a board to adopt the full CCGG Majority Voting Policy as an indication of its commitment to the important principle that shareholders have the right the elect the directors and to take into account the views of other shareholders about each nominee director. The board of a Controlled Corporation should also ensure that it has processes in place to allow director nominations from interested minority shareholders with appropriate nominations being formally considered by the nominating committee. For example, shareholders may be encouraged in the annual proxy circular to submit suggested individuals to the chair of the nominating committee. Guideline Two - Board Composition At least two thirds of the directors of a Controlled Corporation should be Independent Directors and/or Related Directors who are independent of management, with Related Directors being no more than two thirds of the board. However, if the CEO is related to the Controlling Shareholder, Related Directors are deemed to not be Independent Directors. In this case, to ensure an appropriate level of board independence from management, the number of Related Directors should not exceed the proportion of equity held by the Controlling Shareholder (but not more than two thirds). CCGG believes that at least two thirds of every board should be independent of management to ensure that the interests of most directors are aligned with the interests of their shareholders and not (potentially) with those of management. It can be valuable to the corporation for Related Directors (such as professional advisors to or owners or executives of the Controlling Shareholder) to sit on the board, but Related Directors should be no more than two thirds of the board regardless of the equity ownership of the Controlling Shareholder. However, if the CEO is related to the Controlling Shareholder, Related Directors are not independent of management and the number of Related Directors should be limited to the proportion of the corporation owned by the Controlling Shareholder to ensure the independence of the board from management. For example, if a Controlling Shareholder holds 50% of the common shares and a family member is the CEO, no more than half of the directors should be Related Directors. Guideline Three - Independent Chair There should be a separation of the roles of Chair of the Board and Chief Executive Officer at all corporations, as these roles have different responsibilities and functions. The Chair should always be independent of management as the Chair has a fiduciary duty to the corporation that is different from the role of senior management, and the Chair must have the objectivity needed to oversee management effectively. The Chair of a Controlled Corporation may be a Related Director, provided that the CEO is not related to the Controlling Shareholder. 4 of 7

5 In some Controlled Corporations, the Chair is a Related Director and is also actively involved in management of the business (sometimes called an Executive Chair ), or the Chair is a Related Director and the CEO is also related to the Controlling Shareholder. Until the board can transition to appoint an Independent Director as Chair, there should be a lead director who is an Independent Director and not a Related Director. The board Chair and CEO have different responsibilities and functions and should be held by different individuals, and the Chair should always be independent of management. The Chair should not participate in management or have a relationship with management or the corporation that would lead a reasonable person to believe that he or she is not truly independent of management 5. The Chair of a Controlled Corporation may be a Related Director, provided that the Chair and those related to the Controlling Shareholder do not participate in the day to day management of the Corporation. While the Chair of most public companies is often more active than other directors (and is generally paid a higher directors fee to reflect this added time commitment), the Chair should not be involved in the day to day business of the Corporation. One indication of the Chair participating in management is a compensation package that is disproportionate to that of other directors, is based on criteria similar to that used to compensate senior management or contains perquisites generally provided to senior management. Where the Chair is also the CEO, the directors who are both Independent and not Related Directors should appoint a lead director and the board should develop a plan to separate the roles of Chair and CEO over a reasonable period of time. The lead director should set board agendas with the Chair and CEO, be responsible for the quality of information sent to the directors, chair in camera meetings when needed, be the liaison between the Controlling Shareholder and the Independent Directors and engage with minority shareholders on behalf of the board. Similarly, if the Chair and CEO are separate individuals, but both are related to the Controlling Shareholder, the board should appoint an Independent Director as lead director and develop a plan to appoint an Independent Director as Chair within a reasonable period of time. Guideline Six - Related Directors on Board Committees Under current securities laws, no member of the audit committee of a corporation may be a Related Director. CCGG believes that a majority of the members of all board committees should be Independent Directors or Related Directors who are independent of management, provided that at least one member of each committee is an Independent Director. If the CEO is related to the Controlling Shareholder, CCGG believes that only one member of the compensation committee should be a Related Director. This will bring to the committee s work the perspective of the Controlling Shareholder while ensuring that CEO appointment and compensation decisions are made by Independent Directors. 5 For example, see Section 1.5 of National Instrument Audit Committees of the Canadian Securities Administrators which considers a person to have a material relationship with the company if he or she accepts any consulting, advisory, investment banking, legal or other fees from the company, other than directors fees, or if his or her the spouse or other family member living in his or her home accepts such fees. 5 of 7

6 Under current securities laws, no member of the audit committee may be a Related Director even though there may be value to the corporation in having the perspective of the largest equity holder brought to the issues discussed by the committee. Boards of widely held issuers usually have compensation committees comprised entirely of Independent Directors. CCGG believes that Related Directors may sit on the compensation committee to bring the knowledge and perspective of the largest equity owner to executive compensation and appointments as recommendations to the full board are being formulated. However, if the CEO is related to the Controlling Shareholder, the compensation committee should include only one Related Director, and he or she would not participate in discussions about the CEO. This will ensure that the compensation of the related CEO is determined by directors who are independent of management and of the Controlling Shareholder. Boards of widely held companies usually have nominating committees comprised entirely of Independent Directors. CCGG believes that it is acceptable for Related Directors to comprise the majority of the nominating committee to bring the knowledge and perspective of the largest equity owner to the work of the committee, even if the CEO is related to the Controlling Shareholder. Boards should consider the quorum requirements for committees where Related Directors are frequently required to leave meetings due to conflicts between the Corporation and the Controlling Shareholder in order to ensure that there is never a single director being asked to approve a conflict of interest transaction. If conflicts arise frequently (as they may in large, complex corporate groups or where members of senior management are related to the Controlling Shareholder), the board should consider creating a conflict of interest committee made up entirely of Independent Directors to address conflicts on behalf of the board. Guideline Ten Assess the CEO and Plan for Succession If the CEO is related to the Controlling Shareholder, the board s process to evaluate the performance, leadership, compensation and succession of the CEO should be led by Independent Directors. Where the CEO is related to the Controlling Shareholder, the board should put in place an objective and independent process for executive appointments, performance evaluation, compensation and succession planning. This will ensure that executive appointments and performance and compensation decisions are not made solely or unduly influenced by the Controlling Shareholder and reflect the views of the entire board. 6 of 7

7 Guideline Thirteen - Shareholder Engagement Shareholder Engagement CCGG believes that the board of a Controlled Corporation should engage with the shareholders of the corporation by having interested shareholders meet with the appropriate Independent Directors and Related Directors to discuss relevant governance issues. In addition, shareholders may in some circumstances wish to meet separately with appropriate Independent Directors or Related Directors. CCGG s Board Engagement Policy 6 was prepared for widely held corporations to allow shareholders to meet with directors who are independent of management to ensure that every board is aware of the views of shareholders on governance matters. In the case of a Controlled Corporation, minority shareholders should be able to engage both with the Independent Directors as well as the Related Directors, either together or separately if appropriate. Say on Pay While a Say on Pay advisory vote can often be passed by the Controlling Shareholder alone, CCGG believes that every public corporation should hold an annual shareholder advisory vote on compensation even if all senior executives are independent of the Controlling Shareholder. The approach taken by the board of every public company to executive compensation is an important indication of the board s governance of the company. As a result, CCGG believes that every public company board should hold an annual advisory vote on its approach to executive compensation to formally obtain the views of minority shareholders. FINAL APPROVED BY THE BOARD OF CCGG:, 2011 DISCLAIMER: The information and comments contained in this document are for the general information of the reader and are not intended as advice or opinions to be relied upon, nor do they necessarily represent the views the views of individual CCGG members. Although we endeavor to ensure that this document is accurate and complete, we do not guarantee it. For particular applications of the law to specific situations, the reader should seek professional advice. No part of this document may be reproduced without CCGG s prior written permission. 6 Available at 7 of 7