King III: Under The Governance Tree

International In-house Counsel Journal Vol. 4, No. 15, Spring 2011, 1 King III: Under The Governance Tree ALYSON N D'OYLEY Company Secretary, African Rainbow Minerals Limited, South Africa High eminent, blooming Ambrosial Fruit of vegetable Gold Flow rs of all hue the mantling vine Layes forth her purple Grape, and gently creeps Luxuriant John Milton, Paradise Lost Abstract King III [1] came into effect on 1 March 2010 superseding King II. [2] The drafters of King III were convened by the Institute of Directors of Southern Africa to update governance guidelines in response to changing governance trends worldwide and the new Companies Act, 2008 (No. 71 of 2008), which was not in effect when this paper was written, but came into effect on 1 May 2011. Noting global developments, King III takes an integrated approach to sustainability and recommends the integration of social, environmental and economic issues to achieve integrated reporting and integrated performance. In addition to sustainability, King III endorses other emerging trends, including the increasing prominence of alternative dispute resolution as an element of good governance. King III supports a risk-based approach to internal audit, which requires the determination of the effectiveness of the systems of internal controls. King III introduces the requirement for shareholders to pass a non-binding vote advisory vote on a company s remuneration policy, addresses business rescue and provides detail on information technology governance. This paper outlines the principal differences between King II and King III and describes emerging governance areas. Keywords Board of Directors; Corporate Governance; King II; King III; King Report on Governance for South Africa 2009; King Code of Principles for South Africa 2009; South Africa. [1] The King Report on Governance for South Africa (The Institute of Directors in Southern Africa) September 2009 and the King Code of Principles for South Africa (The Institute of Directors in Southern Africa) September 2009 are collectively referred to as King III. [2] The King Report on Corporate Governance for South Africa 2002. International In-house Counsel Journal ISSN 1754-0607 print/issn 1754-0607 online

2 Alyson N D'Oyley 1. Introduction In many societies, the tree is the meeting point for elders to consider matters of importance to the community. As the tree itself obtains sustenance from its roots which it distributes to its leaves and fruit, so decisions made under the tree affect the well-being of the community. The decisions are made within an established governance framework and throughout history models have been developed to improve leadership. The company is no exception. Companies themselves and those who regulate them continually seek improvement in this area. Best practices have emerged across cultures, which are tailored for the communities in which the companies operate. 1 This paper examines the South African corporate governance framework. 1.1. Overview of King III The King Report on Governance for South Africa 2009 (the King Report) and the King Code of Governance Principles 2009 (the King Code) comprise the third report on corporate governance in South Africa (collectively, King III). This report became necessary as a result of the enactment of the new Companies Act, 2008 (No. 71 of 2008) (the 2008 Act) and international developments in governance. 2 King III was compiled by the King Committee and its various sub-committees and on 1 March 2010 replaced the King Report on Corporate Governance for South Africa 2002 (King II). King III is now in effect for listed companies with financial years ending after 1 March 2011. This paper will consider the principles of corporate governance, including ethical leadership, corporate citizenship and legal compliance. The paper then reviews some of the structural elements required to achieve good governance focusing on the board of directors (the board) and the board committees which assist the board with its functions. 1.2. To whom does King III apply? King II applied only to affected companies i.e., those listed on the JSE Limited (the JSE), banks, financial and insurance companies and state-owned companies. 3 It was an aspirational code for other companies. King III applies to all entities in whatever form of incorporation, whether public, private, state-owned or non-profit, regardless of size or structure. This paper focuses on listed companies. 1.3. Compliance standard The King II standard required affected companies to comply with or explain noncompliance with the code. 4 A level of enforcement was implied and there was lack of flexibility regarding the application of its provisions. This requirement was further stated in the JSE Listings Requirements, which codifies the comply or explain standard. 5 1 See e.g. the Financial Reporting Council, Guidance on Board Effectiveness (March 2011). 2 For example, Canada introduced new rules regarding corporate governance disclosure, corporate governance guidelines and rules regarding audit committees with effect from 30 June 2005 and IFRS-related amendments were made with effect from 1 January 2011. Ontario Securities Commission, National Instrument 58-101 - Disclosure of Corporate Governance Practices and Forms 58-101F1 and 58-101F2 (17 June 2005), available at <http://www.osc.gov.on.ca/en/securitieslaw_rule_20050617_58-101_disc-corpgov-pract.jsp> (hereinafter collectively, the Canadian Disclosure Rule); Ontario Securities Commission, National Policy 58-201 - Corporate Governance Guidelines (17 June 2005), available at <http://www.osc.gov.on.ca/en/14206.htm> (hereinafter the Canadian Governance Policy); Ontario Securities Commission, Multilateral Instrument 52-110 - Audit Committees and Forms 52-110F1 and 52-110F2 (10 December 2010); and Ontario Securities Commission, Companion Policy 52-110CP Audit Committees (10 December 2010), available at <http://www.osc.gov.on.ca/en/securitieslaw_rule_20101210_52-110_unofficial-consolidated.htm>. 3 King II, section 1.1. 4 King II, section 3.1.4. 5 JSE Listings Requirements, Rule 8.63(a).

Corporate Governance 3 King III, however, is a code which sets out a voluntary basis for governance compliance. King III adopts an apply or explain approach. It asks a company to consider how the principles and recommendations of King III are to be applied. A company may apply the King III recommendation or apply another practice that still achieves the overarching principle. If a recommendation is not applied, the reasons must be explained. 6 The underlying principle is that there is more than one approach to governance. Notwithstanding the objectives of the King Committee, the JSE is of the view that enforcement of King III is necessary for listed companies and therefore, JSE-listed companies must comply with certain governance provisions to ensure that high standards are maintained. 7 2. Governance, ethics and corporate citizenship 2.1. Corporate governance Corporate governance embodies principles, strategic imperatives and practices that govern and control any organisation. It provides the framework to achieve a company s business objectives, while focusing on strong values. A strong governance framework provides a regime to foster innovation and entrepreneurial activity. Good corporate governance lays the foundation for sound commercial decision-making that is integral to successful, sustained corporate performance, and optimises stakeholder value and ultimately shareholder protection. In countries, such as South Africa, which have adopted an apply or explain approach, governance principles supersede specific recommended practices (except where the principles and practices have been legislated or where they become so widely accepted that they become the appropriate standard of conduct). 8 There are many forums which examine governance best practices and principles, such as the Institute of Directors, the Deloitte Southern African Centre for Corporate Governance and industry associations. 2.2. Ethics King III identifies the underlying ethical values of good corporate governance as responsibility, accountability, fairness, and transparency. 9 A company can demonstrate these ethical values by promoting clear leadership; inculcating a culture of integrity and work ethics; and by encouraging whistleblowing. Directors must observe their fiduciary duties and responsibilities, avoid conflicts of interest and act in the best interests of the company. Ethical values and principles should be set out in a written code of conduct. 10 Ideally, a company should also establish, monitor and enforce a number of written governance policies, including: policies regarding the declaration of business interests; the declaration of gifts, gratuities and hospitality; dealings in securities and anti-insider trading; anti-bribery and anti-corruption rules; confidentiality; competition law compliance; authority limits for expenditure and contracts; and general operational policies and procedures. The general governance policies, together with established policies on matters such as safety, health and environment; social investment; broad-based black economic empowerment; 11 and employment equity, 12 provide a sound framework for sustainable 6 King III, Introduction, section 3. 7 JSE Listings Requirements, Rule 3.84. 8 King Report, Introduction, section 4. 9 King Report, Principle 1.1, paragraph 14. 10 This recommendation is consistent with international practice. See e.g. the Canadian Governance Policy, section 3.8. 11 In South Africa, the Broad-based Black Economic Empowerment Act, 2003 (No. 53 of 2003) provides for the establishment of a legislative framework for the promotion of black economic empowerment and authorises the issuance of codes of good practice and the publication of transformation charters. Black economic

4 Alyson N D'Oyley corporate governance. To ensure the success of such programmes, the company should conduct training sessions on ethics policies, include ethics and integrity issues on employees key performance indicators, and establish and publicise a whistleblowing hotline. The company must also establish and implement disciplinary procedures for instances of non-compliance with its ethics and integrity standards. Ultimately the directors will set the tone by adhering to high ethical standards when acting on behalf of the company and complying with all relevant laws and regulations. 2.3. Corporate citizenship King II introduced the expectation that a company would be a good corporate citizen, which was interpreted as the requirement for boards to take cognisance of and not to act independently of the societies in which a company operates. 13 King III takes the requirement of corporate citizenship further. It places the board under a duty to ensure that the company acts and is seen to act as a responsible corporate citizen. 14 Ethical leadership and corporate citizenship are detailed in principles 1.1 and 1.2, respectively, and form the tenets of the entire first chapter. The trend away from the individual and towards collaborative responses to sustainability matters is now established. King III describes the African approach to the moral responsibilities of corporate citizenship in the expression of Ubuntu from umuntu ngumuntu ngabantu meaning I am because you are, you are because we are. 15 King III notes that Ubuntu means humaneness and the philosophy of Ubuntu includes moral support and respect, interdependence, unity, collective work and responsibility. 16 The company is expected to act as a responsible corporate citizen in all respects. Ultimately, good corporate governance is about effective leadership. The board is the collective decision-making body that leads a company. 3. Board of Directors 3.1. Directors duties The requirement for a board to act in the best interests of the company is established law. 17 King III acknowledges the departure from the usual interpretation of best interests of the company meaning best interests of shareholders to mandate compliance with South Africa s Bill of Rights 18 as codified in the 2008 Act. The Bill of Rights sets out a company s constitutional responsibilities and denotes the key values of dignity, freedom and equality as the foundation for stakeholder engagement. King III reflects the codification of directors duties in the 2008 Act. The common law duty for directors to exercise the care, skill and diligence of the reasonably diligent person is now enshrined in legislation as is the fiduciary duty for a director to act in good faith and in a manner that the director reasonably believes to be in the best interests of the empowerment codes of good practice in areas such as ownership, and employment equity were first gazetted in 2007. 12 Objectives for human resource development, including employment equity and skills developments, are set out in various binding and non-binding sector and transformation charters, such as the Broad-Based Socio- Economic Empowerment Charter for the Mining Industry (revised September 2010), the South African Financial Sector Charter (2004), the Charter for the South African Petroleum and Liquid Fuels Industry on Empowering Historically Disadvantaged South Africans in the Petroleum and Liquid Fuels Industry (2003), and the Charter of Empowerment and Transformation in the Tourism Industry (2005). 13 King II, section 18.7. 14 King Report, Principle 1.2. 15 King Report, Principle 1.2, paragraph 21. 16 King Report, Principle 1.2, paragraph 21. 17 King Report, Principle 2.14, paragraph 14. 18 Constitution of the Republic of South Africa, 1996, Chapter 2, Bill of Rights.

Corporate Governance 5 company. 19 The 2008 Act also unequivocally provides that failure to perform these duties may result in the personal liability of a director. 20 Other duties of directors are similar across legal regimes. For example, directors are required to comply with a company s policy on directors dealing in securities prior to the announcement of its financial results or during another market sensitive period. 21 King III recommends that non-executive directors act independently of management. 22 Independence is emphasised throughout the King Report, including recommendations for the board and the audit, remuneration and nominations committees to comprise a majority of independent non-executive directors. 23 Above all, conflicts of interests are to be managed and, if fundamental, avoided. 24 3.2. The board s role Regarding the board s role, King III sets out comprehensive recommendations. 25 For example, the board should provide effective leadership based on an ethical foundation and be the focal point for and custodian of corporate governance. The board should play a prominent role in the strategy-development process and appreciate the relationship between strategy, risk, performance and sustainability. King III also highlights the board s new statutory governance obligations which have come into effect with the 2008 Act, including the requirement for the board to act in the best interests of the company and to monitor on a continuous basis whether the company is liquid and solvent. The role and functions of the board should be set out in a written board charter, the terms of which are disclosed to stakeholders. 26 To fulfil its duties, the board should have unfettered access to the company s information and the right to seek independent professional advice in connection with its duties, at the company s expense. 27 3.3. Board composition A board should annually appoint an independent non-executive chairman to provide direction. 28 Consistent with global practice, King III recommends that where a chairman is not independent or free from conflicts the board should appoint a lead independent non-executive director for the duration that the situation exists. 29 The boards of listed companies must make such an appointment. 30 King III encourages a company to weigh factors affecting the independence of the chairman against the positive factor of continuity of the chairman. This review is important for companies founded by chairmen who are significant shareholders and continue to play an active role in the business. The reasons for the appointment of a chairman who is not independent must be stated in the integrated report (which, with King III, replaces the annual report ). King III outlines the functions of a chairman with a view to sustainability of the entity, including the requirement to set the ethical tone of a company, provide leadership and 19 Companies Act, 2008 (No. 71 of 2008) (hereinafter the 2008 Act), section 76. 20 2008 Act, sections 20(6), 77 and 218(2). 21 JSE Listings Requirements, section 3. 22 King Report, Principle 2.14, paragraph 18. 23 King Report, Principle 2.23, paragraph 131. 24 2008 Act, section 75; King Report, Principle 2.14, paragraphs 23, 24 and 25. 25 King Report, Principles 2.1 to 2.14. 26 King Report, Principle 2.1, paragraph 1. In Canada, the requirements for a board mandate are set out in the Canadian Governance Policy, section 3.4. 27 King Report, Principle 2.14, paragraphs 19 and 22. 28 King Report, Principle 2.16. 29 King Report, Principle 2.16, paragraph 38 and Annexure 2.1; King III Practice Notes: Lead Independent Director Charter (February 2011). See e.g. the Canadian Governance Policy, section 3.2. 30 JSE Listings Requirements, Rule 3.84(c).

6 Alyson N D'Oyley build and maintain stakeholder relations as well as to evaluate the performance of individual directors and to mentor the development of directors skill and confidence. 31 These functions should be written in the board charter. 32 The board should annually evaluate the chairman s performance against these duties. 33 The chairman, together with the board, should regularly take into consideration the number of outside chairmanships that the chairman holds. 34 The board should appoint a chairman and a chief executive officer in separate roles. The boards of listed companies must do so. 35 With effect from 1 September 2008, listed companies were required to appoint a financial director who is an executive of the Company. 36 King III recommends that the board should also provide input on other senior executive appointments. Unlike King II, King III specifically deals with the role of the chief executive officer and defines responsibilities regarding the achievement of the company s strategy, ensuring compliance with laws and governance principles and providing ethical leadership. 37 The chief executive officer bears ultimate responsibility for all management functions. 38 The board establishes the levels of materiality taking into consideration strategic and operational effectiveness and efficiencies 39 while the chief executive officer establishes a delegation of authority framework, which permits the company to achieve its financial, operating, social and environmental goals. 40 All public companies and state-owned companies must appoint a company secretary, who plays a central role in the corporate governance of the company. 41 The company secretary is appointed by the board. 42 If a company does not employ a company secretary, this role may be outsourced to an appropriate person. 43 King III recognises the importance of the company secretary s role in the corporate governance of a company and makes specific recommendations, including the provision that the company secretary should have a direct channel of communication to the chairman and be available to provide practical support and guidance to directors and the board as a whole. 44 The composition of the board is important because it provides the framework within which the board is able to achieve efficiency. In terms of King II the board should comprise a balance of executive and non-executive directors preferably with a majority of non-executive directors of whom sufficient should be independent. 45 King III is more categorical in its recommendation that the board consist of a majority of non-executive directors and that the majority of non-executive directors should be independent. 46 King III also provides that both the chief executive officer and the financial director should be 31 King Report, Principle 2.16, paragraph 40. 32 In Canada, the board is required to develop position descriptions for the chairman of the board, the chairmen of each committee and the chief executive officer. The Canadian Governance Policy, section 3.5. 33 King Report, Principle 2.16, paragraph 41. 34 King Report, Principle 2.16, paragraph 43. 35 JSE Listings Requirements, Rule 3.83(c). 36 JSE Listings Requirements, Rule 3.84(h). 37 King Report, Principle 2.17, paragraph 60. 38 King Report, Principle 2.17, paragraph 48. 39 King Report, Principle 2.17, paragraph 50. 40 King Report, Principle 2.17, paragraph 52. 41 2008 Act, section 86. 42 King Report, Principle 2.21, paragraph 96. 43 2008 Act, section 87; King Report, Principle 2.21, paragraph 95. 44 2008 Act, section 88; King Report, Principle 2.21, paragraph 103. 45 King II, section 2.2.1. 46 This requirement is consistent with international best practice. See e.g. the Canadian Governance Policy, section 3.1, which requires the board to consist of a majority of independent directors.

Corporate Governance 7 appointed to the board. The memorandum of incorporation (the constitutional instrument of the company which, must replace the articles of association during the transition period provided for by the 2008 Act) should provide that the board may remove directors without having to seek shareholder approval. 47 King II introduced some criteria to assist boards in the determination of whether directors are executive, non-executive or independent. 48 An independent non-executive director should be independent in character and judgment and, among other things, should not: (i) be a representative of a shareholder; (ii) have an interest which exceeds 5% of the company s total number of shares in issue; and (iii) have been employed in an executive capacity within the preceding three financial years. 49 King III identifies additional criteria to be considered in the determination of independence, which were heavily debated when the draft of King III was circulated for comment. The most critical of these, which is also set out in the JSE Listings Requirements, is that a director whose remuneration is contingent upon the share price or the performance of the company is not considered independent. 50 Directors who have served for a consecutive period of nine years may only be nominated for reappointment following an independence analysis. Independence of directors should be assessed annually and the findings disclosed in the integrated report. 51 3.4. Board committees Board committees constitute an important element of the governance process and should be established with clear terms of reference. 52 King II recommended that companies have a minimum of audit and remuneration committees. King III adds a risk committee and a nomination committee to the list. 53 For JSE-listed companies, the appointment of an audit committee and a remuneration committee is mandatory. 54 Where a company chooses not to establish a separate risk committee, the board may delegate the consideration of risk issues to the audit committee. In terms of the 2008 Act, a social and ethics committee may be required for some companies. 55 Companies may also consider establishing governance, information technology and sustainability committees, or in small companies, ensure that these matters are covered by the board. 56 King III recommends that non-executive directors meet regularly without management present. These meetings are typically held before or after board meetings and provide non-executive directors with the opportunity to discuss in camera matters of importance to the company, often with a focus on governance and ethics. Such meetings are required in other jurisdictions, such as Canada. 57 They are prescribed for in certain sectors, such as the banking sector where legislation requires the board to establish a directors affairs 47 King Report, Principle 2.18, paragraph 79. 48 King II, section 2.4.3. 49 King II, section 2.4.3; King Report, Principle 2.18, paragraphs 67.1, 67.3 and 67.4. 50 King Report, Principle 2.18, paragraph 67.8; JSE Listings Requirements, Rule 3.84(f)(iii). 51 King Report, Principle 2.18, paragraphs 77 and 78. 52 King Report, Principle 2.23, paragraphs 125-127. 53 King Report, Principle 2.23, paragraph 130. 54 JSE Listings Requirements, Rule 3.84(d). 55 2008 Act, section 72(4). 56 King III Practice Notes: Improving board functioning through the performance of the sustainability, risk and audit committees (February 2011). 57 Canadian Governance Policy, section 3.3.

8 Alyson N D'Oyley committee consisting only of non-executive directors to handle certain governance matters. 58 King III emphasises that the board and its directors do not abdicate their duties and responsibilities when they delegate to committees and to management. 3.5. Group boards King II only touched lightly upon the relationship between the boards of holding companies and their subsidiaries. King III provides that a holding company which nominates directors to a subsidiary must acknowledge that those directors owe their fiduciary duties to the subsidiary and not to the holding company. 59 The possibility of conflicts of interest must be recognised. 4. Nomination committees The nomination committee must consist of a majority of non-executive directors, the majority of whom are independent. 60 It assists the board with four key functions, which are described below: (i) appointment of directors; (ii) director training; (iii) performance evaluations; and (iv) succession planning. 4.1. Appointment of directors King III recommends that the board establishes formal processes for the nomination and appointment of directors. These processes should take into account the skill and representivity of the board. 61 Given the importance of this requirement, for JSE-listed companies, the development of a formal appointment policy is mandatory. 62 Assisting the board with appointments is one of the core functions of the nomination committee. Training In line with international practice, there should also be an induction programme for new directors and formal processes for director training and continuing education. 63 This is designed to familiarise directors with their duties and other matters such as the company s operations, the business environment, including risks, sustainability issues and changes in laws. The programmes may be used to improve and develop skills in areas identified by the succession planning or performance appraisal processes. Web-based training and e-learning are becoming more popular tools, especially to measure comprehension. 4.2. Performance Evaluations To improve the effectiveness of the board, King III recommends the evaluation of the board and its committees on a regular basis, as well as the evaluation of individual directors, including the chairman, the committee chairmen, the chief executive officer and other directors. 64 Subjective measures should be considered. In addition to the four 58 Banks Act, 1990 (No. 94 of 1990), section 64B. 59 King Report, Principle 2.24, paragraph 142. 60 King Report, Principle 2.23, paragraph 131; JSE Listings Requirements, Rule 3.84(a). In Canada, the nominating committee should be composed entirely of independent directors. The Canadian Governance Policy, section 3.10. 61 King Report, Principle 2.19. A similar requirement is found in the Canadian Governance Policy, sections 3.12 and 3.14. 62 JSE Listings Requirements, Rule 3.84(a). 63 King Report, Principle 2.20. See e.g. the Canadian Governance Policy, sections 3.6 and 3.7. 64 King Report, Principle 2.22. In Canada, see e.g. the Canadian Governance Policy, section 3.18.

Corporate Governance 9 ethical duties noted earlier, for example, King III states that directors should discharge their duties with conscience, inclusivity, competence, commitment and courage. 65 Independent service providers may be used in the process to assist with the development and administration of the questionnaires and to interview directors. In addition to King III standards, governance measures are often benchmarked globally. Other performance criteria are based upon the role and duties of the board, its committees and the directors. For example, directors are expected to attend board and committee meetings and acquire and maintain a broad knowledge of the economic environment, industry and business of the company. Attendance at meetings should be disclosed in the integrated report. King II recommended that the performance of the board, board committees and individual directors be evaluated annually. 66 In terms of King III, the board is required to disclose the results of the evaluation of the board and its committees together with the corrective action taken. 67 There is no requirement to disclose the results of the evaluations of individual directors; however, King III recommends that the reasons for the resignation of a director be reported in the integrated report. The evaluation of executive directors in their role as directors is distinct from the evaluation of such directors in their role as executives. The former is typically handled by the nomination committee whereas the latter is usually the responsibility of the remuneration committee. It takes courage for a board to conduct meaningful performance evaluations and the scope often depends on the maturity of the board. The results can help strengthen the board and the leadership of the company. For example, an opportunity may be revealed to provide additional mentoring and education to committee members on emerging trends applicable to each committee. 4.3. Succession planning The board should ensure that a succession plan has been established for the chairman of the board, committee chairmen, the chief executive officer and senior management. 68 This is one of the most important functions of the board because it provides for the sustainability of the business and the nomination committee together with other committees should assist the board with this function. To create a comprehensive director and senior management succession plan that strengthens leadership, a company should adopt an integrated approach to succession planning. For example, the sustainable development or human resources committee should regularly review reports on leadership and employment equity programmes and standards and report on developments in these areas to the board. The remuneration committee should develop a remuneration framework which includes incentives to attract and retain non-executive directors and senior management. The nomination committee should oversee the recruitment and development of directors and ensure that the company makes on-going efforts to create short- and long-term management depth. The nomination committee should also lead any succession processes, including appointing recruiting agencies, identifying performance criteria, setting benchmarks, coordinating interviews and contract negotiations, and liaising with board members. The lead independent nonexecutive director may be involved in the process where a chairman has conflicts. 5. Remuneration committees 65 King Report, Principle 1.1, paragraph 15. 66 King II, section 2.8. 67 King Report, Principle 2.22, paragraph 114. 68 King Report, Principle 2.15, paragraph 46 and Principle 2.17, paragraph 61.

10 Alyson N D'Oyley 5.1. Purpose and function The underlying principle in King III is that companies should remunerate directors and executives fairly and responsibly. 69 Remuneration committees do this by considering the company s remuneration policy and issues such as the mix of variable and fixed pay and the optimal methods to balance risk and reward in bonus schemes. 70 Benchmarking provides guidance on the level of guaranteed pay and incentives. 71 Knowledge of the business is required to establish performance conditions and targets and to effectively align the interests of executives and other senior executives with those of shareholders. The board should set out these and other functions in the remuneration committee s terms of reference. 72 Remuneration committees should annually review their approach to remuneration to reflect regulatory changes. This may result in annual amendments to the remuneration strategy and policy. Companies in certain sectors, such as financial services, may be subject to additional regulatory requirements. King III shifts the landscape to require particular attention to the following four emerging developments: (i) preparation of a comprehensive remuneration report; (ii) disclosure of remuneration to executives who are not directors; (iii) submission of the remuneration policy to the shareholders for a non-binding advisory vote; and (iv) prior approval of the non-executive directors fees by shareholders in a general meeting. 73 5.2. Performance, pay and incentives Performance targets that align pay and performance should be established. These might include links to business strategy, performance management and remuneration strategy. During the annual review of performance and executive remuneration, the remuneration committee should consider the economic climate, market pressures, and shareholder and public perceptions. In determining incentive awards, the remuneration committee should analyse the appropriateness of performance conditions and targets for short- and longterm incentive plans as well as the importance of motivating executives to perform, especially in challenging times. 5.3. Remuneration report Consistent with trends in the United Kingdom, 74 Canada, 75 and the European Union, increasingly comprehensive remuneration disclosure is being required. In South Africa, the remuneration report must include a detailed description of the following: (i) base salary, short-term and long-term incentives; (ii) the connection between the elements of 69 King Report, Principle 2.25. 70 King Report, Principle 2.25, paragraphs 151, 157, 158 and 160. 71 King Report, Principle 2.25, paragraph 174. 72 King III Practice Notes: Remuneration Committee Terms of Reference (September 2009). In comparison see e.g. the Canadian Governance Policy, sections 3.16 and 3.17. 73 2008 Act, section 66(9); King Report, Principle 2.25, paragraph 155. 74 Financial Reporting Council, The Combined Code on Corporate Governance (June 2006); Financial Reporting Council. June 2008 Changes to the Combined Code (May 2008); and Financial Reporting Council, UK Corporate Governance Code (May 2010) (hereinafter the UK Corporate Governance Code). 75 Ontario Securities Commission, National Instrument 51-102 - Continuous Disclosure (10 December 2010), available at <http://www.osc.gov.on.ca/documents/en/securities-category5/rule_20101210_51-102_unofficial-consolidated-post-ifrs.pdf> (hereinafter the Canadian Continuous Disclosure Rules); and Ontario Securities Commission, Form 51-102F6: Statement of Executive Compensation (in respect of financial years ending on or after 31 December 2008), Canadian Continuous Disclosure Rules, page 168ff (hereinafter Canadian Executive Compensation). See also Canadian Coalition of Good Governance, Best Practices in Director Compensation (2011), available at <http://www.ccgg.ca>and Canadian Coalition of Good Governance, 2009 Executive Compensation Principles, available at <http://www.ccgg.ca/site/ccgg/assets/pdf/2009_executive_compensation_principles.pdf>.

Corporate Governance 11 the remuneration package and the business strategy; (iii) a description of how the policies have been implemented to support the business strategy; and (iv) details of executive employment contracts, including duration, notice provisions, restraint of trade provisions and termination or change of control payments. 76 5.4. Disclosure of remuneration paid to executives who are not directors In Australia, the remuneration of the five executives with the greatest authority for strategic decision-making is disclosed. 77 In the United Kingdom, disclosure below board level is on a banded basis. 78 King III now requires the disclosure of remuneration paid to the three most highly-paid executives who are not directors. 79 There are three approaches to disclosing such remuneration information. A company may choose to report the remuneration of such executives: (i) individually, but anonymously; (ii) individually and naming the executive (similar to the disclosure of director s remuneration); or (iii) in aggregate. The King III Practice Notes recommend that disclosure should be made by name, but if not, reasons should be provided. 80 5.5. Non-binding advisory vote. King III requires shareholders to vote on a company s remuneration strategy and application. 81 Similar requirements exist, for example, in the United Kingdom, 82 Canada 83 and Australia. 84 Although the shareholder vote on the remuneration policy is non-binding, it is uncertain what the consequences would be if the vote was not passed by the requisite majority. In the UK, for example, the Walker Review recommends that the chairman of the remuneration committee be directly accountable and stand for re-election if the remuneration report is not passed by the requisite number of votes. 85 Remuneration committees should give consideration to addressing a negative vote on the remuneration policy. 6. Audit committees, risk management and internal audit 6.1. Audit committees King II required the boards of affected companies to appoint audit committees mirroring the provisions in the Companies Act, 1973 (No. 61 of 1973), as amended. 86 The 2008 Act provides that the company s shareholders in general meeting must elect an audit committee. 87 King III echoes this provision as well as the provisions in the 2008 Act 76 King Report, Principle 2.25, paragraph 177 and Principle 2.26, paragraphs 183 and 184. 77 Australian Government Productivity Commission, Executive Remuneration in Australia Inquiry Report No. 49 (Melbourne: 4 January 2010), available at <http://www.pc.gov.au/projects/inquiry/executiveremuneration/report>. 78 See e.g. the UK Corporate Governance Code. 79 King Report, Principle 2.26. 80 King III Practice Notes: Remuneration Guidelines (July 2010), PN 180.3. 81 King Report, Principle 2.27; King III Practice Notes: Remuneration Guidelines (July 2010). 82 UK Corporate Governance Code. 83 Canadian Continuous Disclosure Rules and Canadian Executive Compensation. See also Canadian Coalition of Good Governance, Model Say on Pay Policy for Boards of Directors (September 2010), available at <http://www.ccgg.ca>. 84 Australia Securities Exchange Corporate Governance Council, Corporate Governance Principles and Recommendations with 2010 Amendments (2 nd edn, 30 June 2010) available, at <http://www.asx.com.au/documents/about/cg_principles_recommendations_with_2010_amendments.pdf>. 85 Sir David Walker, A Review of Corporate Governance in UK Banks and Other Financial Industry Entities Final Recommendations (26 November 2009) available, at <http://webarchive.nationalarchives.gov.uk/+/ http://www.hm-treasury.gov.uk/walker_review_information.htm>. 86 King II, section 6.3.1. 87 2008 Act, section 94(2).

12 Alyson N D'Oyley setting out the composition and the increased statutory duties of audit committees. 88 King III requires the audit committee to consist solely of independent non-executive directors 89 and also recommends additional responsibilities for the audit committee including the requirement to oversee the company s integrated reporting, including summarised integrated reporting. 90 King III reiterates many of the statutory duties of the audit committee, such as the requirement to recommend to the board for recommendation to shareholder the appointment, re-appointment or removal of the external auditor firm and designated auditor. 91 For listed companies, both the external audit firm and the individual auditor must be approved by the JSE. The audit committee oversees the entire external audit process and assesses the qualifications and independence of the external auditor, approves the external auditor s terms of engagement and remuneration, monitors the relationship between the external auditors and management, reviews the quality and effectiveness of the external audit process, and ensures the rotation of the external auditor every five years. 92 The audit committee must ensure that the finance, external audit and internal audit functions have been properly resourced and that the company has a policy regarding the performance of non-audit services by the external auditor. 93 The audit committee must also consider annually and satisfy itself regarding the expertise and experience of the financial director. 94 The company should hire the right people, provide enough resources and ensure that these are employed effectively. In a new development, King III requires the effective, independent audit committee 95 to ensure that a combined assurance model is applied to provide a coordinated approach to all assurance activities and to reduce audit fatigue. 96 Thought leadership in this area is developing around the interaction of three levels of assurance: management assurance, typically led by operations management with the assistance of a risk management team; internal audit; and external assurance provider by external auditors and other external assurance providers, such as sustainability assurance providers or legal advisers. 97 While the need for an external sustainability assurance provider will be considered below, the role of external auditors will not be discussed further here; this area is heavily prescribed and covered elsewhere. 6.2. Risk management Combined assurance starts with risk management and internal audit. Under King II, the board exercised its duty of care regarding risk management by identifying key risk areas and the key performance indicators for the business. In terms of King III, the board is responsible for risk governance and the efficacy of risk management. The board through the audit committee or risk committee determines levels of risk tolerance. 98 The audit 88 2008 Act, section 94(7). 89 King Report, Principle 3.2. 90 King Report, Principle 3.4 and Principle 9.3, paragraphs 22 and 23. 91 2008 Act, section 90; King Report, Principle 3.9, paragraph 75. 92 2008 Act, sections 90, 92 and 94; King Report, Principle 3.9. 93 2008 Act, section 94(7); King Report, Principle 3.6, Principle 3.7, paragraph 53 and Principle 3.9, paragraphs 76, 78 and 79. 94 King Report, Principle 3.6, paragraph 52; JSE Listings Requirements, Rule 3.84(i). 95 King Report, Principle 3.1. 96 King Report, Principle 3.5 and Principle 7.4, paragraph 21. 97 King Report, Principle 7.4, paragraph 20. 98 King Report, Principle 4.2.

Corporate Governance 13 committee oversees the development and implementation of a policy and plan to improve the effectiveness of risk management, control and governance processes. 99 Management is responsible for risk management in accordance with the approved risk governance strategy practically speaking through the audit, or risk committee. 100 Management should (i) design, implement and monitor a risk management plan; 101 (ii) implement appropriate risk responses; 102 (iii) continually monitor risk; 103 (iv) identify emerging risks; 104 (v) take measures to increase the probability of anticipating unpredictable risks and managing the impact of unpredictable events, or Black Swans; 105 and (vi) adopt a combined assurance model. 106 Additionally, processes must be established for risk disclosure to stakeholders, including the disclosure of unexpected risks and the risks of material losses. 107 6.3. Internal audit In terms of King II, internal audit was compliance based with a focus on risk management, internal controls and governance. 108 King II introduced the requirement for the board to enquire into and if satisfied confirm in the annual report the adequacy of the company s internal controls. 109 To ensure an effective internal audit function, King III moves beyond a King II compliance-based approach and takes a forward-looking riskbased approach. 110 The focus of internal audit has been augmented to include business processes, internal controls, governance and ethics. The head of internal audit (referred to as the chief audit executive, or CAE) reports to the audit committee and should attend and report on the internal audit function at every audit committee meeting. 111 Annually the CAE should provide the audit committee, prior to submission to the board, with a written assessment of the effectiveness of the company s system of internal controls and risk management processes. 112 The audit committee should also review the CAE s written assessment of the effectiveness of the company s internal financial controls, which forms the basis for the audit committee s statement on such controls in the integrated report. 113 In setting the scope for these written assessments, the audit committee will have to determine whether the CAE will provide a positive or negative level of assurance. Company size and resources will play a role in this determination. King III recommends that companies adopt an internal audit charter covering the role of the CAE and outlining the internal audit function. 114 6.4. Oversight of the audit committees of group companies The 2008 Act provides that an audit company may perform the functions required in the 2008 Act on behalf of the audit committee of a group company. 115 Given the 99 2008 Act, section 94(7)(i). 100 King Report, Principle 4.3. 101 King Report, Principle 4.4. 102 King Report, Principle 4.7. 103 King Report, Principles 4.5 and 4.8. 104 King Report, Principle 4.8, paragraph 46.8. 105 King Report, Principle 4.6; Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable (Penguin Books, 2008). 106 King Report, Principle 3.5. 107 King Report, Principle 4.10. 108 King II, section 4.2.1. 109 King II, section 4.1.1. 110 King Report, Principle 7.4, paragraph 18. 111 King Report, Principle 7.4, paragraphs 24, 28 and 29. 112 King Report, Principle 7.3, paragraph 16. 113 King Report, Principle 3.8, paragraphs 66, 67 and 69; Principle 7.3, paragraph 16 and Principle 7.4, paragraph 29. 114 King Report, Principle 7.1, paragraph 5; King III Practice Notes: Internal Audit Charter (September 2009).

14 Alyson N D'Oyley responsibility of the audit committee regarding the financial statements, holding companies must give consideration to the audit committee s oversight of subsidiaries and associates. 116 The audit committee should have the authority to investigate all matters that may impact on the accuracy or reliability of the financial reporting or the adequacy of the internal controls within the group. One mechanism to ensure the effective functioning of the audit committees of subsidiaries and associates is to provide that the audit committee of the holding company receives regular reports regarding the activities of the company s subsidiaries and associates including, for example, reports and minutes of the audit committee meetings of the subsidiaries and associates together with copies of subsidiary or divisional internal audit reports. To be effective, the combined assurance model for a company with subsidiaries and associates should also take the group structure into account. 6.5. Business rescue South Africa has been one of the few jurisdictions without business rescue provisions. With business failures following on the heels of the National Credit Act, 2005 (No. 34 of 2005) coming into full effect on 1 June 2007 and the global economic downturn in 2008, the legislators have introduced prescripts in the 2008 Act 117 for companies to monitor (i) whether the company is able to pay all of its debts as they fall due and payable, and is solvent and (ii) whether the company is financially distressed. 118 King III devotes an entire principle to the board s responsibilities to consider business rescue and other turnaround mechanisms. 119 Typically, the audit committee of the board monitors solvency taking the advice of the company s external auditors and makes recommendations to the board. The audit committee reports on the results of this enquiry and the directors must make a statement on solvency in the company s integrated report. 120 The 2008 Act also requires the board to consider solvency and liquidity regarding any distribution approved by the board, intragroup loan, or other financial assistance, which loan or other financial assistance must be authorised in the company s memorandum of incorporation and approved in advance by a special resolution of shareholders. 121 7. Information Technology King II included the governance of information technology (IT) as one of the factors to be addressed as part of a company s overall risk management. In terms of King III, IT governance assumes a more prominent role with an entire chapter highlighting the subject. 122 The elevation of the subject to a board responsibility acknowledges the importance of IT to the sustainability of a business and the likelihood that without such emphasis a company may take a fragmented approach to the governance of IT risks. 123 Ensuring that a company maintains the integrity of its IT systems is one way in which directors exercise their duty of care. 115 2008 Act, section 94(2). 116 Associates are entities in which a company directly or indirectly holds or beneficially owns less than 50% but more than 20% of the issued share capital or ownership rights or interests, as the case may be, and over which the company directly or indirectly exercises significant influence but which it does not control. 117 2008 Act, Chapter 6. 118 2008 Act, section 4 and Chapter 6; King Report, Principle 2.15, paragraph 27. 119 King Report, Principle 2.15; King III Practice Notes: Guidance on Business Rescue, September 2009. 120 2008 Act, sections 4 and 29. 121 2008 Act, sections 4, 22, 45 and 46 122 King Report, Chapter 5. 123 King Report, Principles 5.1 and 5.2.