Harmonizing Code

Report of the Research Study on
Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan
April 2003
PREFACE
The Securities and Exchange Commission of Pakistan (SECP) introduced the Code of Corporate Governance (the Code) in March 2002 for the stated purpose of establishing a framework of good corporate governance whereby a listed company is managed in compliance with best practices. In order to bring about such a change, the Code has been incorporated in the listing regulations of the three stock exchanges and is thus applicable to all listed companies, which - being the repository of shareholder investments - require additional regulation and scrutiny in view of the SECP. This study was commissioned by the SECP to evaluate the substantive value of the Code while comparing it to internationally recognized best practices of good governance. The report endeavours to identify any legal and/or implementation issues, which may arise, keeping in mind the already existing laws and regulations of the country in the area of corporate governance. At the same time, the report also attempts at elucidating as to how the existing laws and regulations in the area of corporate governance may actually facilitate and further the goals of the Code. The laws selected for review include the very important, overarching laws such as the Companies Ordinance, 1984 and the laws empowering the SECP within specific frameworks, for specific purposes. The report highlights that the Code breaks new ground in areas such as the role of non-executive directors, appointment of company secretary, quantity and quality of information to be presented before boards of directors, audit committees and internal auditors. These are essentially areas, which have not been addressed in existing laws and hence there is no question of a conflict. It also identifies that issues, such as the structure and responsibilities of the board of directors, powers and duties of executive directors, role of external auditors and disclosure requirements have been addressed quite adequately by existing laws and are augmented and well-supplemented by the provisions in the Code. The overall picture, which emerges is that of harmony rather than conflict. The report supports efforts towards setting up an Institute for Corporate Governance in Pakistan, which should provide training programs for directors and office bearers of companies and also make available a forum for open debate on topical issues of governance. Other recommendations for effective implementation of the Code, in view of certain dynamics of the Pakistani capital market, follow. The SECP acknowledges the support of the United Nations Development Programme in initiating this research study. We would also like to appreciate the work of the consultant, Mr. Osama Siddique in undertaking the research and preparing this report on the crucial subject of harmonizing the Code with other laws and regulations.
TABLE OF CONTENTS
CHAPTER 1. CHAPTER 2.
EXECUTIVE SUMMARY THE BACKGROUND TO THE EMERGENCE OF THE CODE OF BEST PRACTICES IN THE UK: A COMPARATIVE ANALYSIS BETWEEN THE CORPORATE GOVERNANCE STANDARDS IN THE UK AND THE PAKISTANI CODE ASSESSMENT AND REVIEW OF THE LAWS GOVERNING THE CORPORATE SECTOR IN PAKISTAN. RECOMMENDATIONS, WHERE APPLICABLE, FOR AMENDING THE SAME TO HARMONIZE THEM WITH THE CODE POWERS OF THE REGISTRAR AND THE SECP UNDER THE ORDINANCE FOR THE PROTECTION OF SHAREHOLDERS RIGHTS AND THE ROLE PLAYED BY THE COURTS CONCLUSIONS AND RECOMMENDATIONS
CHAPTER 3.
35
CHAPTER 4.
104 111 119
CHAPTER 5.
LIST OF REFERENCES
CHAPTER 1.
EXECUTIVE SUMMARY
In August 2002, the SECP, the United Nations Development Programme (UNDP) and the Economic Affairs Division (EAD) signed a Memorandum of Understanding under which UNDP agreed to provide technical and financial assistance to the SECP for encouraging good corporate governance practices and establishing a sound regulatory framework for the corporate sector in Pakistan (the Project on Corporate Governance). One of the initiatives taken by the SECP under the Project on Corporate Governance was a decision to fund a Research study on harmonizing the Code of Corporate Governance with other laws/regulations in Pakistan. As mentioned in Chapter 1, SECP had introduced the Code in March 2002 and now felt that since the initial implementation of the Code had taken place, it was an appropriate time to identify and resolve any issues which may be emerging due to any potential conflicts of any provisions of the Code with existing corporate laws. According to the Terms of Reference (the TOR) issued for this Report, it was to focus on the following main objectives:

To review the Code to establish overlap/nexus with other important laws governing the corporate sector. To identify conflicting and overlapping provisions in other laws and regulations with the Code. To propose amendments in the Code as well as in other laws to harmonize regulatory framework for corporate sector. To give policy guidelines for effective implementation of the Code.
The following is a brief outline of the contents and findings of this Report under the headings of the objectives listed above: (1) To review the Code to establish overlap/nexus with other important laws governing the corporate sector in Pakistan. Apart from reviewing the Code, Chapter 4 of this Report looks at twenty-one important Pakistani laws in detail, which include broad regulatory laws such as the Companies Ordinance, 1984 and the SECP related laws as well as specific statutory regimes for setting up certain banks and other institutions of national significance. What emerges is that there are comparatively very few areas of actual conflict, which require any amendment to the relevant laws. These are in the areas of tenure of office of directors; frequency of meetings of board of directors and appointment of external auditors and these have been highlighted in Chapter 4. Chapter 5 of the Report contains a detailed analysis of the existing corporate regime for the protection of shareholder rights through the special powers of the (a) Registrar; (b) the SECP; and (c) the Courts. This evaluation gives a useful backdrop to the existing corporate laws against which the Code has come into play. On the other hand, the Report finds that the Code breaks new ground in areas such as role of NEDs and officers of the company such as the Company Secretary and the CFO, the quantity and quality of information, which needs to be before boards of directors to take
better decisions, the roles of audit committees and of internal auditors. These are essentially areas, which have not been addressed in existing laws and hence there is no question of a conflict. Then there are areas such as the structure and responsibilities of the board of directors, powers and duties of executive directors, role of external auditors, and disclosure requirements, which have been addressed at times quite adequately by existing laws but which are augmented and well-supplemented by the new provisions in the Code. The overall picture, which emerges is that of harmony rather than conflict. Furthermore, the new amendments, which have been recently introduced to the Companies Ordinance, 1984 further entrench and bolster some of the important provisions of the Code. (2) To identify conflicting and overlapping provisions in other laws and regulations with the Code. As mentioned above, there are various features of the existing law, which supplement and advance the goals of the Code and have been discussed at length in Chapter 4. Then there are other areas where the Code fills some gaps. The areas of conflict are comparatively few and have been identified in detail in Chapter 4. (3) To propose amendments to the Code as well in other laws to harmonize regulatory framework for corporate sector. This Report evaluates the Code at two levels: (a) against the existing Pakistani laws; and (b) against the code of corporate governance in place in the UK. As far as the former is concerned, this Report finds the Code to be introducing some very useful additional measures and does not propose any amendments to the Code itself in view of existing Pakistani corporate laws. On the other hand, in Chapter 4 it does propose some amendments to existing laws where they conflict with the Code. Coming to the second paradigm of analysis, Chapter 3 of the Report conducts an exhaustive analysis of the Corporate Governance debate and the resulting reports and codes in the UK. The Report finds the Code to be quite sophisticated and up to speed with the recent code introduced in the UK. However, it does propose some amendments to the Code itself, the approach towards implementing the Code as well as institutional mechanisms to keep the Code sensitive to the actual and emerging corporate markets realities in Pakistan, in view of the UK experience. These have been discussed at length in Chapter 6 and include, inter alia, the following: (i) the entrenchment of a mechanism in the SECP whereby the Code is being constantly evaluated with the flexibility to amend it in view of persuasive market feedback;
(ii) the courting of institutional and market support by the SECP in order to make the Code more in touch with ground realities as well as more successfully implementable; (iii) the constant emphasis on the nexus of good governance with greater profitability; (iv) extensive market studies to get an accurate picture of the actual profile of listed companies in Pakistan and the Pakistani capital markets to review the contents of the Code for possible amendments; and (v) a focus on creditors rights given the nature of the capital markets in Pakistan.
(4)
To give policy guidelines for effective implementation of the Code. Apart from what has been said above and discussed at length in Chapter 6, the Report, in Chapter 6, further evaluates additional recommendations for effective implementation of the Code. This includes support for the ideas of a permanent Research Cell at the SECP, the proposed setting up of the Institute for Corporate Governance, the proposed introduction of a Compliance Rating System, the proposal for a transparent and detailed set of criteria for granting exemptions from compliance with the Code and opposition to any proposals for giving statutory protection to the Code by amending the Companies Ordinance, 1984 for incorporation in it of all the provisions of the Code.
CHAPTER 2. THE BACKGROUND TO THE EMERGENCE OF THE CODE OF BEST PRACTICES IN THE UK: A COMPARATIVE ANALYSIS BETWEEN THE CORPORATE GOVERNANCE STANDARDS IN THE UK AND THE PAKISTANI CODE
Introduction
Recent years have seen a spate of activity in and tremendous emphasis on the area of Corporate Governance all over the world. This development has been for a variety of reasons, ranging from a downturn in economic performance exposing otherwise undisclosed corporate governance weaknesses to downright corruption in the uppermost echelons of corporate management. The reasons why this area has been comparatively understudied in Pakistan have more to do with the level of development of its corporate sector. The past few years, however, have been very significant in terms of legal developments in the Corporate Governance area and some recently introduced laws and regulations are progressive and up to speed with the latest global trends. There is growing awareness in the legal and corporate circles in Pakistan that Corporate Governance is not just a sophisticated buzzword, but of profound importance to the sound functioning of a corporate system and fundamental to the establishment of investor and creditor confidence.
Reason for using the experience of Corporate Governance in the UK as a benchmark for the Pakistani initiative
The overview conducted in this Report of the fast evolving legal regime governing Corporate Governance in Pakistan has been undertaken, keeping in view certain internationally accepted principles and standards of good Corporate Governance as the fundamental benchmark. While there is a wealth of contemporary literature on the subject, these benchmarks for best practices of Corporate Governance have been gleaned primarily from the experience of Corporate Governance in UK. This is primarily due to the following three reasons: (1) UK A Pioneer in the debate on Good Governance: UK is in many ways the forerunner of the debate on Corporate Governance in the world with detailed studies undertaken and proposals given in the early 1990s. The fact that over a decade has passed since the introduction of the first code of best practices in the UK has meant that there has been enough time to observe and evaluate the working of the initial code and that there now exists a wealth of literature, which analyzes several aspects of the debate, including implementation successes and failures. It is this decade long, constant market scrutiny and academic debate, which has resulted in the introduction of additional studies and finally a modified code in 1998. Therefore, much can be learnt from the UK experience in terms of not just the substantive merit of what the experts in that country consider to be best practices but also the practicalities of implementation of such best practices. The UK Code its place in the international context: The evolving code of best practices in the UK has served as a benchmark and reference point for the codes of good governance/ best business practices in many other countries in Europe and elsewhere. Hence,
4
(2)
it would not be an overstatement to say that the final version of the code of best practices in the UK in many ways embodies and is one of the primary contributors to what may be considered an internationally recognized set of principles which contribute to and bring about good governance. (3) The nexus between Pakistani Law and the Common Law tradition: The Pakistani legal approach and system stems primarily from the Common Law tradition of the UK. In other words, the fundamental approach to the law is the same in both countries and Pakistans unique historical experience has resulted in many laws, which tally with their UK counterparts. This includes the primary and overarching corporate law statute in Pakistan i.e. the Companies Ordinance, 1984. Therefore, in spite of the fact that the contemporary UK economy and market realities are quite different in many ways from the Pakistani economy and market realities (and this factor is duly kept in mind in and discussed later in this Report) the commonality of legal approach and jurisprudence cannot be understated or overlooked. Thus, this factor further supports the conducting of a comparative analysis of the codes in the two countries as the legal systems in which these codes operate, have many similarities and overlaps.
Given the above, we now proceed to take a brief look at the evolution of UKs code of best practices and the modern approach to Corporate Governance in the UK.
From Cadbury to the Combined Code: The Evolution of the Code of Best Practices in the UK
The contemporary debate in the UK on Corporate Governance can be traced back to the Report1 (hereinafter referred to as the Cadbury Report) of a Committee set up in the UK to look into the financial aspects of Corporate Governance (hereinafter referred to as the Cadbury Committee), which was submitted under the Chairmanship of Sir Adrian Cadbury on 1st December, 1992. Sir Adrian Cadbury in many ways, one of the pioneers of this debate and widely regarded as one of the leading international experts on the subject has recently come up with a book2 (hereinafter referred to as the The Cadbury Evaluation 2002) which traces and evaluates this debate and its outcome in the UK. The Cadbury Report The Cadbury Report is regarded as one of the most penetrative and exhaustive contemporary studies of the issues of modern Corporate Governance and puts forward detailed findings and recommendations. The output of the Cadbury Report has been widely discussed in recent years and forms the basis of several subsequent reports on Corporate Governance and codes of best practices, including the Code, which has been recently introduced in Pakistan. Financial and Institutional support extended to the Cadbury Committee: It is important to look at the financial and institutional support extended to the Cadbury Committee, which sheds light on why its output found acceptability and recognition in the corporate environment of the UK. The Cadbury Committee was set up in 1991 by the Financial Reporting Council, which is responsible for accounting standards in the UK as well as the London Stock Exchange and the accountancy profession. The fact that these three sponsoring bodies joined forces shows their collective concern
1 2
Report of the Committee on the Financial Aspects of Corporate Governance. 1st December, 1992. Corporate Governance and Chairmanship: A Personal View by Sir Adrian Cadbury. Oxford University Press, 2002.
over the reliability of the reports and accounts produced by the UK companies in the early 1990s. The output of the Cadbury Committee not only stimulated debate in the UK but helped fuel similar approaches world wide and different countries as well as organizations such as the OECD, the World Bank, the IMF and the Commonwealth Association for Corporate Governance followed suit by bringing out their own codes of best practice. Later on, major institutional investors also warmed up to the task and produced their own codes of best practice, which set out the standards that they expect from the boards of the companies in which they invest.3 The reasons for growth of interest in Corporate Governance: Sir Adrian Cadbury attributes this overwhelming interest in the subject to the following factors: (a) rapid growth in the international capital markets and the wish on part of countries to attract investment and the consequent need to convince potential investors that reliable governance structures are in place; (2) the growth in size and internationalization of companies thus raising new questions over their accountability; and (3) growing societal concerns over corporate activities and the media attention on the same.4 The thrust of the Cadbury Report: The Cadbury Report includes recommendations to investors, accountants and auditors and its core is encapsulated in its Code of Best Practices, designed to achieve the necessary high standards of corporate behaviour. The Cadbury Committee adopted a definition of Corporate Governance, which described Corporate Governance as being the system by which companies are directed and controlled. The Cadbury Report operates upon the basic premise that company boards must be free to drive their companies forward, but exercise that freedom within a framework of effective accountability. In other words, companies and their boards work within certain boundaries. This, according to the Cadbury Report, is the essence of any system of good Corporate Governance. The Cadbury Reports recommendations are focused on the control and reporting functions of boards of companies as a whole and the various important components of the corporate structure such as the chief executive, chairman of the board, executive and non-executive directors, company secretary, other executives and internal and external auditors. This reflects the Cadbury Committees purpose, which, according to it, was to review those aspects of Corporate Governance, which are specifically related to financial reporting and accountability. The Cadbury Reports proposals do, however, seek to contribute positively to the promotion of good Corporate Governance as a whole. The Greenbury Report Other committees subsequently took up the process started by the Cadbury Committee. These looked in even greater detail at different aspects of Corporate Governance, which caught public attention in the UK in the mid 1990s, and came up with their own recommendations. The Study Group on Directors Remuneration, usually referred to after its Chairman as the Greenbury Committee (hereinafter referred to as the Greenbury Committee), was set up in January 1995 in response to public and shareholder concerns over executive pay. Importantly, the Greenbury Committee was constituted primarily of heads of major businesses, whose lead on executive remuneration was likely to be followed by their fellow chairmen. The Greenbury Committee published its report in July 1995 (hereinafter the Greenbury Report). For purposes of this Report, we do not look in any great detail at the Greenbury Report or for that matter the component in other such reports which deals with the area of executive remuneration because: (a) executive remuneration is not an area addressed in any detail by the Code in Pakistan, and (ii) for reasons to be
3 4
Ibid. Ibid.
discussed later, it can be argued that it is a topic which is premature and not immediately relevant for attention in the Pakistani corporate environment, and that other areas of more immediate attention require our focus. The Hampel Committee Report The afore-mentioned reports received great public attention and in view of contributions and criticisms from various quarters, the need was felt in the UK to revisit the area. In November 1995, the Committee on Corporate Governance was established by the Chairman of the Financial Reporting Council under the Chairmanship of Sir Ronald Hampel (hereinafter referred to as the Hampel Committee). Once again there was tremendous market and institutional support as the Committee was sponsored by the London Stock Exchange, the Confederation of British Industry, the Consultative Committee of Accountancy Bodies, the National Association of Pension Funds, and the Association of British Insurers and thus had a broader basis of support than any of its predecessors. The Hampel Committee was entrusted with the task of reviewing previous governance recommendations, identifying new issues and pulling together existing recommendations, plus those of its own into a single Combined Code. The final report of the Hampel Committee was published in January 1998 (hereinafter referred to as the Hampel Report, the Cadbury Report, the Greenbury Report and the Hampel Report are hereinafter collectively referred to as the UK Corporate Governance Reports). It is important to look at the Hampel Report as it brings about certain changes to the recommendations made by the Cadbury Report and the Greenbury Report, although by and large it agrees with and proposes the same recommendations as propounded in the earlier two reports. The changes, however, give an insight into how the outlook towards Corporate Governance underwent change in the UK in view of changing market realities and concerns, the criticisms and recommendations made by various components of the UK corporate bodies and the practical difficulties faced in implementing the earlier codes. A review of this process of change is thus educative from the Pakistani perspective as it looks at both substantive and process dimensions and may help us in determining not just the substantive credentials of the Code in Pakistan but also in evaluating the process through which it came about. The Combined Code The Hampel Committee followed up with a Combined Code, which came out in June 1998 (hereinafter referred to as the Combined Code). At this point, the London Stock Exchange also published its new listing rules together with the related Principles of Good Governance and the Combined Code. The Combined Code is highly significant as it supersedes all previous codes and thus it is the one code, which ultimately determines the effect of various Corporate Governance initiatives on the boards of the UK listed companies. This Report, therefore, includes a detailed comparison of the Code introduced in Pakistan with the Combined Code to determine the similarities and differences and possible reasons for the same as well as a determination of whether anything needs to be done, if at all, to achieve greater parity between the two. The Most Recent Review of the Combined Code in the UK The prevailing institutional and market sentiment in the UK remains that the Combined Code can and should regularly evolve to stipulate the best practices in the boardroom and to raise the bar for performance. The most recent initiative to focus on the Non-Executive Directors component of Corporate Governance and to improve and clarify the role of Non-Executive Directors in the Combined Code is the Review of the Role and Effectiveness of Non-Executive Directors that was presented to the Chancellor of the Exchequer and the Secretary of State for Trade and Industry on January 20, 2003 by Derek Higgs (the Higgs Review).
Pursuant to the terms of reference for this study, the UK Government commissioned Derek Higgs (a senior independent figure from the business world) to lead a short independent review of the role and effectiveness of Non-Executive Directors, specifically in the UK. Realizing the central role in the UK Corporate Governance of Non-Executive Directors, the Company Law Review5 noted a growing body of evidence from the US suggesting that companies with a strong contingent of nonexecutives produce superior performance. Thus, the Higgs Review aims principally to advance and reflect best practices in this area through proposed revisions to the Combined Code. It includes a focus on the existing behaviours of and relationships with companies of Non-Executive Directors in the UK, and underlines the continuing need for the best people, for Non-Executive Director positions, a set of executives, which the Higgs Review considers to be essential for an effective board. The Higgs Review further develops the UK framework of Corporate Governance, which commenced with the publication of the Cadbury Report and was taken forward by the Greenbury and Hampel Reports. It forms part of a systematic re-appraisal, across leading market economies, of the adequacy of Corporate Governance arrangements in the wake of recent corporate failures. The Higgs Review identifies the Non-Executive Directors as the custodians of the governance process. It notes that over the years, expectations from Non-Executive Directors have risen as increased business complexity has made it more difficult for individual shareholders to effectively hold managements to account. Consequently, the Higgs Review focuses on the requisite quality of Non-Executive Directors and the boardroom climate and behaviours necessary for their success. It finds that raising the quality of appointees is critical to improving the effectiveness of NonExecutive Directors. The evidence collected in connection with the Higgs Review shows that the current population of Non-Executive Directors in the UK is narrowly drawn. What is thus proposed is an open, fair and rigorous appointment process regarded as essential to a successful board. The Higgs Report builds on the comply or explain approach established by Sir Adrian Cadbury a decade ago and sets out an agenda for change that builds on the existing Combined Code best practices. It attempts to clarify the role of the Non-Executive Directors, fosters a relentless meritocracy in appointments, and seeks to create conditions that will maximize their effectiveness. Since the recommendations of the Higgs Report are still under discussion and have not formally altered the current substantive nature of the Combined Code by the time this Report was submitted, it remains to be seen what changes will eventually come about. Therefore, for purposes of this Report, the Combined Code remains the applicable set of best practices in the UK and the provisions of the Higgs Report have not been used as benchmark for the Code nor have they been discussed any further elsewhere in the Report. Creditors Rights One significant area of Corporate Governance, which was not within the ambit of the UK Corporate Governance Reports, is creditors' rights. Partially to fill this gap and partially to supplement the UK Corporate Governance Reports with another more recent study in the area, additional standards and principles, especially for the creditors rights area, have been obtained
5
The Company Law Review is the UK Governments initiative for a fundamental revision of British Company Law. In this connection, a three-year review was launched in 1998 to develop a simple, modern, efficient and cost-effective company law framework. The Reviews final report was presented to the Secretary of State for Trade and Industry in July 2001. In July 2002, the Government published a White Paper titled Modernising Company Law which makes proposals for company law reform. This also includes a codification of the general duties of directors.
from a Paper by La Porta, Lopez-de-Silanes, Shleifer and Vishny6 (the La Porta Report, the UK Corporate Governance Reports and the La Porta Report are hereinafter collectively referred to as the International Corporate Governance Reports). The La Porta Report conducts an analysis of the Corporate Governance rules pertaining to the protection of the rights of shareholder and creditors in 49 countries, the origin of these rules and the quality and effectiveness of their enforcement. The La Porta Report thus offers additional standards with a very international appeal and applicability. Having briefly outlined the reports and studies, which form a background and reference point for the analysis to be conducted in this Chapter, the following are the basic themes of analysis for the remaining Chapter. o Hampel Committee on Corporate Governance: Tracing the changes in a fast evolving market and suggesting changes to the UK approach to Corporate Governance. o The UK Code and the Pakistani Code: A Comparative Analysis.
2.1 Hampel Committee on Corporate Governance: Tracing the Changes In A Fast Evolving Market and Suggesting Modifications to the UK Approach to Corporate Governance
As mentioned earlier, the entrusted task of the Hampel Committee was that of reviewing previous governance recommendations, picking up any new issues which had arisen and pulling together all the existing recommendations, plus those of its own, into a single Combined Code. The following is a list of the basic differences between the approach to Corporate Governance adopted by the Hampel Committee vis--vis the recommendations in the earlier reports. As regards the actual changes in terms of the recommendations made by the Hampel Committee, which will be discussed at a later stage, it has to be emphasized that the changes are comparatively few and are essentially an elaboration upon and further tightening of the principles already enumerated in the earlier reports. The Combined Code, like its predecessors, is recommendatory rather than prescriptive. The essential approach to the issues has not changed and the Combined Code, like its predecessors, remains persuasive rather than prescriptive or mandatory. The fundamental principles on which it is based are that of disclosure and transparency leading to board effectiveness and corporate accountability. Recommendations based on actual experiences of the listed companies in the UK. It is also significant to note that the recommendations are not based on abstract theory but are rooted in actions and experiences of the leading companies in the UK and are applicable to all listed companies in the UK, regardless of size. Many of the provisions in the Hampel Report clarify or refine existing recommendations. The additions are mainly in the fields of remuneration and the role of institutional shareholders.7 Corporate Governance is not just about regulation but a contributor to business prosperity. An important and specially emphasized ingredient of the Hampel Report is that it highlights the role of Corporate Governance as a contributor to business prosperity in addition to its previous focus on financial reporting. It thus puts the contribution of governance to performance into context. A poignant quotation from the Hampel Report demonstrates this: Business prosperity cannot be commanded. People, teamwork, leadership, enterprise, experience, and skills are what really produce prosperity.
6 Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer -- Harvard University. Robert W. Vishny -- University of Chicago. The Journal of Political Economy, Volume 106, Issue 6 (Dec, 1998), 1113-1155. 7
Corporate Governance and Chairmanship: A Personal View- by Sir Adrian Cadbury. Oxford University Press 2002.
There is no single formula to weld these together, and it is dangerous to encourage the belief that rules and regulations about structure will deliver success. Hampel Report -- the result of an exercise to determine all relevant perspectives on Corporate Governance. The Hampel Committee consulted widely. Before producing its preliminary report, the Hampel Committee issued a questionnaire in answer to which over 140 submissions were received, and members of the Hampel Committee took part in over 200 individual and group discussions. It received a further 167 written submissions on the preliminary report and had a substantial number of further discussions. In total 252 organizations or individuals responded in writing to one or both these consultations. The breakdown of these respondents by category was: Public companies Institutional investors Professional partnerships Representative bodies Other organizations Individuals 114 14 12 24 29 59
Summary of the Main Principles and Broad Findings propounded by the Hampel Report The following is a summarized overview of the most significant principles enumerated in the Hampel Report as well as departures from the approach adopted in the past reports as well as a reemphasis of certain principles which were already there in the past reports but lost sight of in view of the Hampel Committee. The Hampel Committee not only endorses the substance and outcome of the previous codes in many ways but also states where it differs with their approach, explaining its resultant modified approach. This summary is useful towards understanding the overall contemporary philosophy and approach towards Corporate Governance in UK, thus providing a benchmark for evaluating the corresponding approach and philosophy in Pakistan. 1. The importance of Corporate Governance lies in its contribution both to business prosperity and to accountability. Emphasis on accountability should not cause one to lose sight of this. Public companies are now among the most accountable organizations in society. They publish trading results and audited accounts; and they are required to disclose much information about their operations, relationships, remuneration, and governance arrangements. The Hampel Committee strongly endorses this accountability and recognizes the contribution made to it by the Cadbury and Greenbury Committees. But, it suggests that the emphasis on accountability has tended to obscure a boards first responsibility to enhance the prosperity of the business over time. 2. Business prosperity cannot be commanded. Rules and regulations about structure dont deliver success but success comes from other facts. Unlike its predecessors, the Hampel Committee is very concerned with the prosperity dimension of Corporate Governance and says that people, teamwork, leadership, enterprise, experience and skills are what really produce prosperity. There is no single formula to weld these together, and it is dangerous to encourage the belief that rules and regulations about structure will deliver success. Accountability by contrast does require appropriate rules and regulations, in which disclosure is the most important element.
10
3.
The purpose of Good Governance. Good Governance ensures that constituencies (stakeholders) with a relevant interest in the companys business are fully taken into account. In addition, good governance can make a significant contribution to the prevention of malpractice and fraud, although it cannot prevent them absolutely.
4.
No single recipe of success for every jurisdiction. Corporate structures and governance arrangements vary widely from country to country. They are a product of the local economic and social environment. The Hampel Committee also looked at expert advice on how Corporate Governance works in practice in the United States and in Germany. It found no support for the import into the UK of a whole system developed elsewhere. But it concedes that the underlying issues of management accountability are the same everywhere.
5.
The need to restrict regulatory burden. The Hampel Committee made it clear at the outset that it would keep in mind the need to restrict the regulatory burden on companies, and to substitute principles for detail wherever possible. This is in view of the market feedback about the earlier codes and some of the problems being faced by companies in implementation, which regarded those codes as strict and prescriptive rather than recommendatory.
6.
Much is right in the Cadbury and Greenbury Reports. The Hampel Committee endorses the overwhelming majority of the findings of the two earlier committees. In the Hampel Report, the Hampel Committee comments on matters where it takes a different view, or which Cadbury and Greenbury did not deal with at all. However, according to it, it does not attempt to record every point of agreement. But the Hampel Committee does approach Corporate Governance from a somewhat different perspective. It finds that both the Cadbury and Greenbury reports were responses to things which were perceived to have gone wrong corporate failures in the first case, unjustified compensation packages in the privatized utilities in the second. Understandably, both concentrated largely on the prevention of abuse. The Hampel Committee is equally concerned with the positive contribution, which good Corporate Governance can make.
7.
Hampel Reports verdict on the market acceptance and implementation of the earlier Codes. A great success! The Hampel Report says that it is generally accepted that implementation of the Cadbury Codes provisions has led to higher standards of governance and greater awareness of their importance. It says that despite the belief in some quarters to the contrary, the Greenbury Code was not about controlling board remuneration, nor can that ever be done in a free market economy. But it is already clear that Greenbury Codes primary aim full disclosure is being achieved. Indeed, the new Corporate Governance requirements for the full disclosure of directors emoluments and for a remuneration committee report have led to a disproportionate part of annual reports being devoted to these subjects. For the most part, the larger listed companies have fully implemented both the Cadbury and Greenbury Codes. Smaller companies have also implemented most provisions, but there are some aspects with which they find it harder to comply.
11
8.
One Code should apply to all sizes. The Hampel Committee considered carefully whether it should distinguish between the governance standards expected of larger and smaller companies. The Hampel Committee concluded that this would be a mistake. Any distinction by size would be arbitrary; more importantly, it considers that high standards of governance are as important for smaller listed companies as for larger ones. But the Hampel Committee urges those considering the governance arrangements of smaller listed companies to do so with flexibility and a proper regard to individual circumstances.
9.
Good Corporate Governance all about Broad Principles. The Hampel Report finds that good Corporate Governance is not just a matter of prescribing particular corporate structures and complying with a number of hard and fast rules. There is a need for broad principles. All concerned should then apply these flexibly and with common sense to the varying circumstances of individual companies. It says that this is how the Cadbury and Greenbury Committees intended their recommendations to be implemented. It implies on the one hand that companies should be prepared to review and explain their governance policies including any special circumstances which in their view justify departure from generally accepted best practices and on the other hand that shareholders and others should show flexibility in the interpretation of the code and should listen to directors explanations and judge them on their merits.
10.
Important to remove the misconception that the Codes are prescriptive. The Codes are just guidelines. The Hampel Committee finds that the experiences of various companies in the UK suggests that too often they believe that the earlier codes should be treated as sets of prescriptive rules. That the shareholders or their advisors would be interested only in whether the letter of the rule had been complied with yes or no. A yes would receive a tick, hence the expression box ticking for this approach. The Hampel Committee however, concludes that box ticking takes no account of the diversity of circumstances and experience among companies, and within the same company over time. It assumes, for example, that the roles of chairman and chief executive officer should never be combined; and that there is an ideal minimum number of Non-Executive Directors, and an ideal maximum notice period for an Executive Director. The Hampel Committee does not think that there are universally valid answers on such points. It believes, as did the Cadbury Committee, that there can be guidelines, which will be appropriate in most cases; but that there will be valid reasons for exceptions. Where practices are approved by the board after due consideration, it is not conducive to good Corporate Governance for the companys explanations to be rejected out of hand and for its reputation to suffer as a result.
11.
Corporate Governance is not just mere box ticking but a diligent pursuit of some Principles. The Hampel Committee points out another problem with box ticking. It can be seized on as an easier option than the diligent pursuit of Corporate Governance objectives. It would then not be difficult for lazy or unscrupulous directors or shareholders to arrange matters so that the letter of every governance rule was complied with but not the substance. It might
12
even be possible for the next disaster to emerge in a company with, on paper, a 100% record of compliance. The true safeguard for good Corporate Governance lies in the application of informed and independent judgment by experienced and qualified individuals Executive and Non-Executive Directors, shareholders and auditors. 12. Need to expand the definition of Corporate Governance. The Hampel Committee says that its conclusions have caused it to start from the beginning and consider what is meant by Corporate Governance. One can accept the Cadbury Committees definition of Corporate Governance as the system by which companies are directed and controlled. The Hampel Committee, however, feels that this definition puts the directors of a company at the centre of any discussion on Corporate Governance, linked to the role of the shareholders, since they appoint the directors. The Hampel Committee finds this definition to be a restrictive one as it excludes many activities involved in managing a company, which may nevertheless be vital to the success of the business. 13. Preservation and enhancement of shareholder investment is the ultimate aim. The single overriding objective shared by all listed companies, whatever their size or type of business, is the preservation and the greatest practicable enhancement over time of their shareholders investment. All boards have this responsibility and their policies, structure, composition and governing processes should reflect this. A company must develop relationships relevant to its success. These will depend on the nature of the companys business; but they will include those with employees, customers, suppliers, credit providers, local communities and governments. It is managements responsibility to develop policies, which address these matters; in doing so they must have regard to the overriding objective of preserving and enhancing the shareholders investment over time. The boards task is to approve appropriate policies and to monitor the performance of management in implementing them. 14. Directors vis--vis shareholders and creditors Different Relationships. The Hampel Committee recognizes that the directors relationship with the shareholders is different in kind from their relationship with the other stakeholder interests. The shareholders elect the directors. The directors as a board are responsible for relations with stakeholders but they are accountable to the shareholders. This is not simply a technical point. From a practical point of view, to redefine the directors responsibilities in terms of the stakeholders would mean identifying all the various stakeholder groups and deciding the nature and extent of the directors responsibility to each. The result would be that the directors were not effectively accountable to anyone since there would be no clear yardstick for judging their performance. This is a recipe neither for good governance nor for corporate success. 15. Directors duty is towards Shareholders both present and future to the sustained prosperity of the Company. The Hampel Committee carries on to say that it is obvious that directors must not run the company exclusively in the short-term interests of todays shareholders. The directors duty is to shareholders both present and future. The shareholders, many of whose holdings remain largely stable over time, are interested in a companys sustained prosperity. As regards stakeholders, different types of company will have different relationships, and directors can meet their legal duties to shareholders, and can pursue the objective of long
13
term shareholder value successfully only by developing and sustaining these stakeholder relationships. Shareholders recognize that it is in their interests for companies to do this and increasingly to have regard to the broader public acceptability of their conduct. 16. Important to recognize limitations on shareholder actions as well. The Hampel Committee says that it is also important to recognize the limitations on shareholder action. Firstly, shareholders themselves are subject to constraints they range from the smallest individual shareholders who act on their own behalf, to the largest institutional shareholder who invests third party funds, frequently under instruction, and always in a competitive environment. Secondly, shareholders cannot be denied their rights; they must be free to buy or sell as they see fit. Thirdly, shareholders by and large are not experienced business managers and cannot substitute for them. Shareholders however can and should test strategy, performance over time and governance practice, and can and should hold the board accountable provided they do this with integrity. 17. Broad conclusions followed by a small number of broad principles. Having reached broad conclusions on the nature and purpose of Corporate Governance, the Hampel Committee identifies a small number of broad principles some already identified in the Cadbury and Greenbury Reports, which the Hampel Committee hopes will command general agreement. In doing this, the Hampel Committee has been mindful that a business must have proper regard to its responsibilities and to disclosure; but it is equally important to have structures and principles, which allow businesses to flourish and grow. These principles are directed largely at the process of Corporate Governance, which is the Hampel Committees remit. 18. Process is only the means and not an end. The Hampel Committee believes, however, that it is worth repeating that process can only ever be a means, not an end in itself; it will be far less important for corporate success and for the avoidance of disaster than having properly informed directors of the right calibre, bringing openness, thoroughness and objectivity to bear on the carrying out of their roles. It is the boards responsibility to ensure good governance and to account to shareholders for their record in this regard. The above is a synopsis of approach adopted by the Hampel Committee to the area of Corporate Governance an approach which stresses that codes are not meant to obstruct the functioning of companies but to enhance it and make it profitable through recommending a set of broad principles. It is more concerned with how companies abide by these principles instead of how far are they complied with. It also stresses that Corporate Governance is actually good for the profitability of companies and that the profit-making dimension of companies is fundamental and should not be lost sight of by a prescriptive and limiting approach towards the codes. Given below are the more detailed recommendations derived from the Hampel Report, which against the backdrop of the principles already enumerated, gives a complete picture of the Hampel Committees worldview of Corporate Governance.
14
Summary of Conclusions and Recommendations 1. Principles of Corporate Governance The Hampel Committee recommends that companies should include in their annual reports a narrative account of how they apply the broad principles of Corporate Governance set out in the Hampel Report. Application of the Principles Companies should be ready to explain their governance policies, including any circumstances justifying departure from best practice; and those concerned with the evaluation of governance should apply the principles in the Hampel Report flexibly, with common sense, and with due regard to companies individual circumstances. Box ticking is neither fair to companies nor likely to be efficient in preventing abuse.
2.
The Future 3. The Hampel Committee intends to produce a set of principles and code of good corporate governance practices, which will embrace the Cadbury and Greenbury recommendations and its own work. The Hampel Committee shall pass this to the London Stock Exchange. 4. The Hampel Committee envisages that the London Stock Exchange will in future make minor changes to the principles and code; and it is suggested that the Financial Reporting Council should keep under review the possible need for further studies on Corporate Governance. There is no need for a permanent Hampel Committee on Corporate Governance.
Directors 5. Executive and non-executive directors should continue to have the same duties under the law. 6. Management has an obligation to provide the board with appropriate and timely information and the chairman has a particular responsibility to ensure that all directors are properly briefed. This is essential if the board is to be effective. An individual should receive appropriate training on the first occasion that he or she is appointed to the board of a listed company and subsequently as necessary. Boards should appoint as executive directors only those executives whom they judge able to take a broad view of the companys overall interests. The majority of non-executive directors should be independent and boards should disclose in the annual report which of the non-executive directors are considered to be independent. This applies to companies of all sizes. There is overwhelming support in the UK for the unitary board, and virtually none for the two-tier board. The Hampel Committee suggests that boards should consider introducing procedures for assessing their own collective performance and that of individual directors. The Hampel Committee considers that to be effective, non-executive directors need to make up at least one third of the membership of the board. The Hampel Committee believes that people from a wide range of backgrounds are able to make a real contribution as non-executive directors.
7. 8. 9.
10. 11. 12. 13.
15
14. 15.
Separation of the roles of chairman and chief executive officer is to be preferred, other things being equal, and companies should justify a decision to combine the roles. Whether or not the roles of chairman and chief executive officer are combined, a senior nonexecutive director should be identified in the annual report, to whom concerns can be conveyed. Companies should set up a nomination committee to make recommendations to the board on all new board appointments. All directors should submit themselves for re-election at least every three years, and companies should make any necessary changes in their Articles of Association as soon as possible. Names of directors submitted for re-election should be accompanied by biographical details. There should be no fixed rules for the length of service or age of non-executive directors; but there is a risk of their becoming less efficient and objective with length of service and advancing age, and boards should be vigilant against this. It may be appropriate and helpful for a director who resigns before the expiry of his term to give an explanation.
16. 17.
18. 19.
20.
Directors Remuneration 21. The Hampel Committee urges caution in the use of inter-company comparisons and remuneration surveys in setting levels of directors remuneration. 22. The Hampel Committee does not recommend further refinement in the Greenbury Code provisions relating to performance related pay. Instead the Hampel Committee urges remuneration committees to use their judgment in devising schemes appropriate for the specific circumstances of the company. Total rewards for such schemes should not be excessive. The Hampel Committee sees no objection to paying a non-executive directors remuneration in the companys shares, but does not recommend this as universal practice. The Hampel Committee considers that boards should set as their objective the reduction of directors contract periods to one year or less but recognizes that this cannot be achieved immediately. The Hampel Committee sees some advantage in dealing with a directors early departure by agreeing in advance on the payments to which he or she would be entitled in such circumstances. Boards should establish a remuneration committee, made up of independent non-executive directors, to develop a policy on remuneration and devise remuneration packages for individual executive directors. Decisions on the remuneration packages of executive directors should be delegated to the remuneration committee; the broad framework and cost of executive remuneration should be a matter for the board on the advice of the remuneration committee. The board should itself devise remuneration packages for non-executive directors.
23. 24.
25.
26.
27.
16
28.
The requirement on directors to include in the annual report a general statement on remuneration policy should be retained. The Hampel Committee hopes that these statements will be made more informative. Disclosure of individual remuneration packages should be retained; but the Hampel Committee considers that this has become too complicated. It welcomes recent simplification of the Companies Act rules; and it is hoped that the authorities concerned will explore the scope for further simplification. The Hampel Committee considers that the requirement to disclose details of individual remuneration should continue to apply to overseas based directors of UK companies. The Hampel Committee supports the requirement to disclose the pension implications of pay increases, which has been included in the Stock Exchange Listing Rules. It is suggested that companies should make clear that transfer values cannot meaningfully be aggregated with annual remuneration. The Hampel Committee agrees that shareholder approval should be sought for new longterm incentive plans; but it does not favour obliging companies to seek shareholder approval for the remuneration report.
29.
30. 31.
32.
Shareholders and the AGM 33. The Hampel Committee recommends pension fund trustees to encourage fund managers to take a long view in managing their investments. 34. The Hampel Committee believes that institutional investors have a responsibility to their clients to make considered use of their votes; and it strongly recommends institutional investors of all kinds, wherever practicable, to vote the shares under their control. But it does not recommend that voting should be compulsory. The Hampel Committee suggests that the problem caused by the existence of different and incompatible shareholder voting guidelines be examined. The Hampel Committee recommends that institutions should make available to clients, on request, information on the proportion of resolutions on which votes were cast and nondiscretionary proxies lodged. The Hampel Committee encourages companies and institutional shareholders to adopt as widely as possible the recommendations in the report Developing a Winning Partnership. Companies whose AGMs (Annual General Meetings) are well attended should consider providing a business presentation at the AGM, with a question and answer session. The Hampel Committee recommends that companies should count all proxy votes and announce the proxy count on each resolution after it has been dealt with on a show of hands. The Hampel Committee looks forward to the implementation by DTI (defined in that report) of their proposals on the law relating to shareholder resolutions, proxies and corporate representatives. The Hampel Committee considers that shareholders should be able to vote separately on each substantially separate issue; and that the practice of bundling unrelated proposals in a single resolution should cease.
35. 36.
37. 38. 39. 40.
41.
17
42. 43.
The chairman should, if appropriate, provide the questioner with a written answer to a significant question, which cannot be answered on the spot. The decision on who should answer questions at the AGM is one for the chairman; but the Hampel Committee considers it good practice for the chairmen of the audit, remuneration and nomination Committees to be available. Companies should propose a resolution at the AGM relating to the report and accounts. Notice of the AGM and related papers should be sent to shareholders at least 20 working days before the meeting. Companies may wish to prepare a resume of discussion at the AGM and make this available to shareholders on request. The Hampel Committee commends the practice of some companies in establishing in-house nominees, in order to restore rights to private investors who use nominees.
44. 45. 46. 47.
Accountability and Audit 48. Each company should establish an Audit Committee of at least three non-executive directors, at least two of them independent. The Hampel Committee does not favour a general relaxation for smaller companies, but recommends shareholders to show flexibility in considering cases of difficulty on their merits. 49. 50. The Hampel Committee does not recommend any additional requirements on auditors to report on governance issues, nor the removal of any existing prescribed requirements. The Hampel Committee suggests that the bodies concerned should consider reducing from 10% the limit on the proportion of total income, which an audit firm may earn from one audit client. The Hampel Committee suggests that the Audit Committee should keep under review the overall financial relationship between the company and its auditors, to ensure a balance between the maintenance of objectivity and value for money. The Hampel Committee recommends that the word effectiveness should be dropped from point 4.5 in the Cadbury Code, which would then read The directors should report on the companys system of internal control. The Hampel Committee also recommends that the auditors should report on internal control privately to the directors, which allows for an effective dialogue to take place and for best practices to evolve. Directors should maintain and review controls relating to all relevant control objectives, and not merely financial controls. Companies, which do not already have a separate internal audit function, should from time to time review the need for one. The requirement on part of directors to include a going concern statement in the annual report should be retained. Auditors are inhibited from going beyond their present functions by concerns about the law on liability. Account should be taken of these concerns by those responsible for professional standards and in taking decisions on changes in the law.
51.
52.
53. 54. 55. 56.
18
Main areas of change and modification in the Combined Code vis--vis the Cadbury Report While the Hampel Report, outlined above, reiterates many of the principles enumerated in the Cadbury Report, the following are the areas, in brief, where it makes new contributions:8 (a) (b) Appropriate and on-going training of directors; Requirement to give public justification if the post of chairman and chief executive combined in a company; (c) Non Executive Directors to comprise not less than one-third of the board; (d) Non Executive Directors considered by the board to be independent to be identified in the annual report; (e) Nomination Committees to be appointed, unless the board is small, to make recommendations to the board on all new appointments; (f) All directors subject to election at first opportunity and re-election at intervals of no more than three years, to preclude the possibility of insulation of elections on part of any director; (g) Performance-related elements of remuneration to form a significant proportion of the total remuneration package of the executive directors; (h) Remuneration Committees to consider what compensation commitments their directors contracts of service, if any, would entail in the event of early termination; (i) Remuneration Committees to be constituted of independent Non Executive Directors to avoid conflicts of interest; (j) All proxy votes to be counted and level of proxies lodged on each resolution to be indicated etc. (k) Companies to propose a separate resolution at the Annual General Meeting on each substantially separate issue etc., to prevent different issues being bundled together in a single resolution; (l) Chairman of the board to arrange for chairmen of audit, remuneration and nomination committees to be available for questions at the Annual General Meeting; (m) Notice of the Annual General Meeting and related papers to be sent to shareholders at least 20 working days before the meeting; (n) Boards responsibility to present a balanced and understandable assessment extends to interim and other price-sensitive public reports and reports to regulators as well as information required to be presented by statutory requirements; and (o) At least on an annual basis, there should be a review of the effectiveness of the system of internal controls including financial, operational and compliance controls and risk management and a report to the shareholders that such a review has taken place. Conclusion A quick review of the above and a comparison with the Cadbury Report shows that these are further refinements of and add-ons to the superstructure already provided by the Cadbury Report as a result of market feedback as well as regulator scrutiny conducted after the introduction of the same. In other words, the Hampel Report does not depart in any major way from its predecessors. It primarily bolsters and elaborates upon what had already been said.
8
Ibid.
19
2.2 The UK Code and the Pakistani Code: A Comparative Analysis

Introduction As mentioned earlier, the Hampel Report, which incorporated the recommendations from both the Cadbury and Greenbury Committees as well as some amendments from the London Stock Exchange, was published as the Combined Code in June 1998. The Combined Code is appended to, but is not part of, the London Stock Exchange Listing Rules. However, the Combined Code is now the final authority in the field of Corporate Governance in the United Kingdom. It is divided into two sections. The first section focuses on companies and the second section deals with institutional shareholders. Section I of the Combined Code, which is the most relevant part for purposes of this Report, contains fourteen governance principles and boards are asked to report on the way in which they have applied them. The intention is that boards should have a free hand in explaining their governance policies in the light of these principles. The section then has forty-five provisions in respect of which boards are required to state whether they comply with them and to provide an explanation where they do not. Section 2 of the Combined Code, focusing on institutional shareholders, contains three governance principles and as many specific provisions. Thus, the Combined Code brings together the work of all three committees (Cadbury, Greenbury and Hampel) in a form, which is aimed at enabling boards to obtain positive benefits from compliance. The Combined Code supersedes all previous codes and hence is the code which ultimately determines the effect of the various Corporate Governance initiatives on the boards of UK listed companies. The Broad Comparative Analysis Below please find the broad principles of the Combined Code with a comment at the end of each stated principle as to whether the code of best practices in Pakistan (the Code) has anything similar to offer or if it does not address a particular area at all. PRINCIPLES OF GOOD GOVERNANCE SECTION 1: COMPANIES A. 1. DIRECTORS The Board Every listed company should be headed by an effective board, which should lead and control the company. Many provisions in the Code try to ensure this and are discussed below. Chairman and CEO 2. There are two key tasks at the top of every public company 1. the running of the board and 2. the executive responsibility for the running of the companys business. There should be a clear division of responsibilities at the head of the company, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision.
20
While such a clear division of responsibilities at the head of the company is not sought by the Code, Clause ix of the Code tries to bring about reform in this area. Board Balance 3. The board should include a balance of executive and non-executive directors (including independent non-executives) such that no individual or small group of individuals can dominate the boards decision taking. The Code addresses this issue and Clauses i (a), (b) & (c) of the Code are relevant for this purpose. Supply of Information 4. The board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties. Once again the Code recognizes this and Clause xiii of the Code is relevant for this purpose. Appointments to the Board 5. There should be a formal and transparent procedure for the appointment of new directors to the board. The Code does not quite address the procedure for the appointment of directors. Re-election 6. All directors should be required to submit themselves for re-election at regular intervals and at least every three years. Clause vi of the Code mentions the same tenure of office of directors but does not clearly address the topic of re-election. B. 1. DIRECTORS REMUNERATION The Level and Make-up of Remuneration Levels of remuneration should be sufficient to attract and retain the directors needed to run the company successfully, but companies should avoid paying more than is necessary for this purpose. A proportion of executive directors remuneration should be structured so as to link rewards to corporate and individual performance. Clause viii (e) of the Code is relevant here but it should be noted that the area of directors remuneration is otherwise not addressed in the Code. Procedure 2. Companies should establish a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. No director should be involved in deciding his or her own remuneration. The area of directors remuneration is not addressed in the Code. Disclosure 3. The companys annual report should contain a statement of remuneration policy and details of the remuneration of each director. The area of directors remuneration is not addressed in the Code.
21
C. 1.
RELATIONS WITH SHAREHOLDERS Dialogue with Institutional Shareholders Companies should be ready, where practicable, to enter into a dialogue with institutional shareholders based on the mutual understanding of objectives. The area of institutional shareholders is not addressed in the Code. Constructive Use of the AGM
2.
Boards should use the AGM to communicate with private investors and encourage their participation. There is no counterpart for this in the Code. ACCOUNTABILITY AND AUDIT Financial Reporting The board should present a balanced and understandable assessment of the companys position and prospects. The Code focuses on this area through its Clauses xix to xxv. Internal Control
D. 1.
2.
The board should maintain a sound system of internal control to safeguard shareholders investment and the companys assets. Clause viii (c) of the Code deals directly with this though no guidance is provided as to the components and criteria of sound internal control. Audit Committee and Auditors
3.
The board should establish formal and transparent arrangements for considering how they should apply the financial reporting and internal control principles and for maintaining an appropriate relationship with the companys auditors. This area receives a lot of attention in the Code and its Clauses xxx-to xliv deal with it.
SECTION 2: INSTITUTIONAL SHAREHOLDERS E. 1. INSTITUTIONAL INVESTORS Shareholder Voting Institutional shareholders have a responsibility to make considered use of their votes. The area of institutional shareholders is not addressed in the Code. Dialogue with Companies 2. Institutional shareholders should be ready, where practicable, to enter into a dialogue with companies based on the mutual understanding of objectives. The area of institutional shareholders is not addressed in the Code. Evaluation of Governance Disclosures 3. When evaluating companies governance arrangements, particularly those relating to board structure and composition, institutional investors should give due weight to all relevant factors drawn to their attention.
22
The area of institutional shareholders is not addressed in the Code. The Detailed Comparative Analysis Below please find the broad principles as well as detailed provisions of the Combined Code with a comment at the end of each provision as to whether the Code in Pakistan has anything similar to offer or if it does not address a particular area at all. COMBINED CODE SECTION 1: COMPANIES A. A.1 DIRECTORS The Board
Principle: Every listed company should be headed by an effective board, which should lead and control the company. Code Provisions A.1.1 The board should meet regularly. Clause xi of the Code The Board of Directors of a listed company shall meet at least once in every quarter of the financial year directly deals with this requirement. A.1.2 The board should have a formal schedule of matters specifically reserved to it for decision. The following clauses of the Code have recommendations for formalization and qualitative improvement of decision-making on part of directors. Clause xiii of the Code In order to strengthen and formalize corporate decisionmaking process, significant issues shall be placed for the information, consideration and decision of the Boards of Directors of listed companies. Significant issues for this purpose may include (a list of significant issues/matters given). Clause viii (b) - requirement of a vision statement for formulation of significant policies. Clause viii (d) - powers exercised by the Board of Directors vis--vis material transactions and significant matters. Clause xi - requirement for circulation of written notices (including agenda) of meetings. A.1.3 There should be a procedure agreed by the board for directors in the furtherance of their duties to take independent professional advice if necessary, at the companys expense. There is no mention of any procedure to take independent professional advice at the companys expense by the Board in the Code although the explanation to Clause viii (b) in the Code does state that The Board of Directors shall define the level of materiality, keeping in view the specific circumstances of the company and the recommendations of any technical or executive sub-committee of the Board that may be set up for the purpose. A.1.4 All directors should have access to the advice and services of the company secretary, who is responsible to the board for ensuring that board procedures are followed and that
23
applicable rules and regulations are complied with. Any question of the removal of the company secretary should be a matter for the board as a whole. The role of the Company Secretary is not as explicitly defined in the Code as it is above. The Code, however, deals with the appointment, qualifications and requirement to attend board meetings vis--vis the Company Secretary Clauses xv to xviii. A.1.5 All directors should bring an independent judgment to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct. Clause vii of the Code specifically states that the directors of listed companies shall exercise their powers and carry out their fiduciary duties with a sense of objective judgment and independence in the best interests of the listed company. A.1.6 Every director should receive appropriate training on the first occasion that he or she is appointed to the board of a listed company, and subsequently as necessary. Clause xiv of the Code deals with orientation courses for directors to acquaint them with their duties and responsibilities and to enable them to manage the affairs of the listed companies on behalf of shareholders. A.2 Chairman and CEO Principle: There are 2 key tasks at the top of every public company the running of the board and the executive responsibility for the running of the companys business. There should be a clear division of responsibilities at the head of the company, which will ensure a balance of power and authority, such that no one individual has unfettered powers of decision. Code Provision A.2.1 A decision to combine the posts of chairman and chief executive officer in one person should be publicly justified. Whether the posts are held by different people or by the same person, there should be a strong and independent non-executive element on the board, with a recognized senior member other than the chairman to whom concerns can be conveyed. The chairman, chief executive and senior independent director should be identified in the annual report. (Certain words have been put in bold letters for emphasis by the author of this Report). Clause ix of the Code does not preclude the possibility of one individual holding the posts of the Chairman and Chief Executive. It states that the Chairman of a listed company shall preferably be elected from among the non-executive directors of the listed company. The Board of Directors shall clearly define the respective roles and responsibilities of the Chairman and the Chief Executive, whether or not these offices are held by separate individuals or the same individual. There is no requirement in the Code that a decision to combine the posts of chairman and chief executive officer in one person should be publicly justified or the mechanism whereby concerns can be forwarded to a an independent non-executive element along with a recognized senior member other than the chairman. However, there are provisions in the Code for a strong and independent non-executive element on the board (See Clause i (b) & (c)).
24
A.3 Board Balance Principle: The board should include a balance of executive and non-executive directors (including independent non-executives) such that no individual or small group of individuals can dominate the boards decision making. Code Provisions A.3.1 The board should include non-executive directors of sufficient calibre and number for their views to carry significant weight in the boards decisions. Non-executive directors should comprise not less than one third of the board. Clauses i (b) & (c) of the Code are pertinent in relation to the above. Clause i (b) calls for the inclusion of at least one NED representing institutional equity interest in the board of each company. Clause i (c) states that executive directors, i.e. working or whole time directors, are not more than 75% of the elected directors including the Chief Executive. A.3.2 The majority of non-executive directors should be independent of management and free from any business or other relationship, which could materially interfere with the exercise of their independent judgment. Non-executive directors considered by the board to be independent in this sense should be identified in the annual report. Apart from the above quoted Clauses, the Code explains that for the purpose of Clause i (b), the expression independent director means a director who is not connected with the listed company or its promoters or directors on the basis of family relationship and who does not have any other relationship, whether pecuniary or otherwise, with the listed company, its associated companies, directors, executives or related parties. The test of independence principally emanates from the fact whether such person can be reasonably perceived as being able to exercise independent business judgment without being subservient to any apparent form of interference. There is no requirement in the Code for identifying independent non-executive directors in the annual report. A.4 Supply of Information Principle: The board should be supplied in a timely manner with information in a form and of a quality appropriate to enable it to discharge its duties. Code Provisions A.4.1 Management has an obligation to provide the board with appropriate and timely information, but information volunteered by management is unlikely to be enough in all circumstances and directors should make further enquiries where necessary. The chairman should ensure that all directors are properly briefed on issues arising at board meetings. Clause xiii of the Code deals with key information to be placed for decision by Board of Directors. However, there is no particular stipulation for directors to make further enquiries where necessary. Whereas, Clause xii of the Code states that the Chairman shall ensure that minutes of board meetings are appropriately recorded. A.5 Appointments to the Board Principle: There should be a formal and transparent procedure for the appointment of new directors to the board.
25
Code Provision A.5.1 Unless the board is small, a nomination committee should be established to make recommendations to the board on all new board appointments. A majority of the members of this committee should be non-executive directors, and the chairman should be either the chairman of the board or a non-executive director. The chairman and members of the nomination committee should be identified in the annual report. Clause viii (e) of the Code ascribes responsibility to the Board of Directors for determining and approving the appointment, remuneration and terms and conditions of employment of the CEO and other executive directors. However, there is no provision for the establishment of a nomination committee in charge of all new board appointments in the Code. A.6 Re-election Principle: All directors should be required to submit themselves for re-election at regular intervals and at least every three years. Code Provisions A.6.1 Non-executive directors should be appointed for specified terms subject to re-election and to Companies Act provisions (the UK Companies Act, Companies Ordinance, 1984 in our case) relating to the removal of a director, and reappointment should not be automatic. Clause vi of the Code states that the tenure of office of directors is three years, however, there is no specific mention of re-election. Sections 174-197-A of the Companies Ordinance, 1984 deal with this area. Also, see Clause i paragraph 3 of the Code containing the Explanation of independent director. A.6.2 All directors should be subject to election by shareholders at the first opportunity after their appointment, and to re-election thereafter at intervals of not more than three years. The names of directors submitted for election or re-election should be accompanied by sufficient biographical details to enable shareholders to take an informed decision on their election. Clause i (a) of the Code provides for minority shareholders as a class to contest election of directors by proxy solicitation. The Code does not provide for the election or reelection of other directors in detail. The Companies Ordinance, 1984, Sections 174-197A, however, deals with this area and some of the relevant sections have been mentioned in Chapter 4 of this Report. B. B.1 DIRECTORS REMUNERATION The Level and Make-up of Remuneration
Principle: Levels of remuneration should be sufficient to attract and retain the directors needed to run the company successfully, but companies should avoid paying more than is necessary for this purpose. A proportion of executive directors remuneration should be structured so as to link rewards to corporate and individual performance.
26
Code Provisions Remuneration Policy There is no separate treatment and discussion of the area of remuneration policy for directors in the Code. In fact, the Code is all but silent about the level and make-up of remuneration for directors and the only clause in the Code which specifically mentions remuneration (of directors) is clause viii (e) which states that the Board of Directors should determine and approve the appointment, remuneration and terms and conditions of employment of the CEO and other executive directors of the listed company. There is also no specific provision for a remuneration committee anywhere in the Code. Thus, remuneration is one area, which may in the future require some attention in the Pakistani context and this is discussed at a later stage in the Report. This explanation applies to all of the following specific provisions of the Combined Code. Companies Ordinance, 1984, Section 191(b) says that the remuneration to be paid to any director for attending the meetings of the directors or a committee of directors shall not exceed the scale approved by the company or the directors, as the case may be, in accordance with the provisions of the articles. The same applies to remuneration of a director for performing extra services such as the holding of the office of the chairman according to clause (a) of the same section. Thus unlike the Code, the Ordinance allows either the company or the directors to make this decision and this is thus an area of conflict. B.1.1 The Remuneration Committee should provide the packages needed to attract, retain and motivate executive directors of the quality required but should avoid paying more than is necessary for this purpose. Remuneration Committees should judge where to position their company relative to other companies. They should be aware what comparable companies are paying and should take account of relative performance. But they should use such comparisons with caution, in view of the risk that they can result in an upward ratchet of remuneration levels with no corresponding improvement in performance. Remuneration Committees should be sensitive to the wider scene, including pay and employment conditions elsewhere in the group, especially when determining annual salary increases. The performance-related elements of remuneration should form a significant proportion of the total remuneration package of executive directors and should be designed to align their interests with those of shareholders and to give these directors keen incentives to perform at the highest levels. Executive share options should not be offered at a discount save as permitted by paragraphs 13.30 and 13.31 of the Listing Rules. In designing schemes of performance related remuneration, Remuneration Committees should follow the provisions in Schedule A to this code. Service Contracts and Compensation B.1.7 There is a strong case for setting notice or contract periods at, or reducing them to, one year or less. Boards should set this as an objective; but they should recognize that it might not be possible to achieve it immediately.
27
B.1.2
B.1.3
B.1.4
B.1.5 B.1.6
B.1.8 B.1.9
If it is necessary to offer longer notice or contract periods to new directors recruited from outside, such periods should reduce after the initial period. Remuneration Committees should consider what compensation commitments (including pension contributions) their directors contracts of service, if any, would entail in the event of early termination. They should in particular consider the advantages of providing explicitly in the initial contract for such compensation commitments except in the case of removal for misconduct. Where the initial contract does not explicitly provide for compensation commitments, Remuneration Committees should, within legal constraints, tailor their approach in individual early termination cases to the wide variety of circumstances. The broad aim should be to avoid rewarding poor performance while dealing fairly with cases where departure is not due to poor performance and to take a robust line on reducing compensation to reflect departing directors obligations to mitigate loss.
B.1.10
B.2 Procedure Principle: Companies should establish a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. No director should be involved in deciding his or her own remuneration. Once again, apart from Clause viii (e) of the Code (discussed above), which is one safeguard against potential conflicts of interest, the Code is silent about remuneration policies. This applies to all of the following provisions of the Combined Code. Code Provisions B.2.1 To avoid potential conflicts of interest, boards of directors should set up Remuneration Committees of independent non-executive directors to make recommendations to the board, within agreed terms of reference, on the companys framework of executive remuneration and its cost; and to determine on their behalf specific remuneration packages for each of the executive directors, including pension rights and any compensation payments. Remuneration Committees should consist exclusively of non-executive directors who are independent of management and free from any business or other relationship, which could materially interfere with the exercise of their independent judgment. The members of the Remuneration Committee should be listed each year in the boards remuneration report to shareholders (B.3.1 below). The board itself or, where required by the Articles of Association, the shareholders should determine the remuneration of the non-executive directors, including members of the Remuneration Committee, within the limits set in the Articles of Association. Where permitted by the Articles, the board may however delegate this responsibility to a small sub-committee, which might include the chief executive officer. Remuneration Committees should consult the chairman and/or chief executive officer about their proposals relating to the remuneration of other executive directors and have access to professional advice inside and outside the company.
B.2.2
B.2.3 B.2.4
B.2.5
28
B.2.6
The chairman of the board should ensure that the company maintains contact as required with its principal shareholders about remuneration in the same way as for other matters.
B.3 Disclosure Principle: The companys annual report should contain a statement of remuneration policy and details of the remuneration of each director. The area of disclosure of remuneration policies is untouched by the Code and this applies to all of the following provisions of the Combined Code. Code Provisions B.3.1 The board should report to the shareholders each year on remuneration. The report should form part of, or be annexed to, the companys annual report and accounts. It should be the main vehicle through which the company reports to shareholders on directors remuneration. The report should set out the companys policy on executive directors remuneration. It should draw attention to factors specific to the company. In preparing the remuneration report, the board should follow the provisions in Schedule B to this code. Shareholders should be invited specifically to approve all new long-term incentive schemes (as defined in the Listing Rules) save in the circumstances permitted by paragraph 13.13A of the Listing Rules. The boards annual remuneration report to shareholders need not be a standard item of agenda for AGMs. But the board should consider each year whether the circumstances are such that the AGM should be invited to approve the policy set out in the report and should minute their conclusions. RELATIONS WITH SHAREHOLDERS Dialogue with Institutional Shareholders
B.3.2 B.3.3 B.3.4
B.3.5
C. C.1
Principle: Companies should be ready, where practicable, to enter into a dialogue with institutional shareholders based on the mutual understanding of objectives. There is no direct reference to institutional shareholders or to companies entering into a dialogue with institutional shareholders per se in the Code. Clause i (b) of the Code, however, calls for the inclusion of at least one independent director representing institutional equity interest of a banking company, Development Financial Institution, Non-Banking Financial Institution (including a modaraba, leasing company or investment bank), mutual fund or insurance company. Furthermore, in terms of independent directors representing institutional investors, the Code provides that such directors shall be selected by such investor through a resolution of its Board of Directors and the policy with regard to selection of such person for election on the Board of Directors of the investee company shall be disclosed in the Directors Report of the investor company (Explanation of Clause i (b) as given in the Code). C.2 Constructive Use of the AGM Principle: Boards should use the AGM to communicate with private investors and encourage their participation.
29
There is no explicit reference as such to the constructive use of the AGM in the Code in the above manner. Clause i (a) of the Code, however provides mechanisms for facilitating minority shareholders as a class to contest election of directors by proxy solicitation at a general meeting at which directors are to be elected. Code Provisions C.2.1 Companies should count all proxy votes and, except where a poll is called, should indicate the level of proxies lodged on each resolution, and the balance for and against the resolution, after it has been dealt with on a show of hands. There is no express provision in the Code for proxy votes vis--vis resolutions as such, however, Clause i (a) mentioned above does provide that minority shareholders as a class are facilitated to contest election of directors by proxy solicitation. C.2.2 Companies should propose a separate resolution at the AGM on each substantially separate issue, and should in particular propose a resolution at the AGM relating to the report and accounts. There is no provision for separate resolutions for separate issues in the Code, however, as to audited accounts of the company, Clause xliv of the Code states that every listed company shall require a partner of the firm of its external auditors to attend the Annual General Meeting at which audited accounts are placed for consideration and approval of shareholders. C.2.3 The chairman of the board should arrange for the chairmen of the audit, remuneration and nomination committees to be available to answer questions at the AGM. There are no provisions for remuneration and nomination committees in the Code. However, the chairman of the audit committee is not required to be available to answer questions at the AGM. Only a partner of the firm of a companys external auditors is required to attend the AGM as per Clause xliv of the Code. C.2.4 Companies should arrange for the Notice of the AGM and related papers to be sent to shareholders at least 20 working days before the meeting. There is no such provision in the Code. However the Companies Ordinance 1984 Section 158(3) addresses this and requires that the notice of an AGM is to be sent to shareholders at least twenty-one days before the date fixed and in case of listed companies there is a further requirement that such a notice be published in a newspaper in the stated manner. D. D.1 ACCOUNTABILITY AND AUDIT Financial Reporting
Principle: The board should present a balanced and understandable assessment of the companys position and prospects. Clause xix of the Code deals with the Directors report to shareholders which is envisioned to be comprehensive in scope (see sub-clauses (a) to (g). Directors Report to shareholders falls under Section 236 of the Companies Ordinance, 1984. Clause xix (a) states that the financial statements, prepared by the management of the listed company, present fairly its state of affairs, the result of its operations, cash flows and changes in equity. Whereas Clause xix (f) states that the Directors Report should contain a
30
statement signifying that there are no significant doubts upon the listed companys ability to continue as a going concern. Code Provisions D.1.1 The directors should explain their responsibility for preparing the accounts, and there should be a statement by the auditors about their reporting responsibilities. Clause xix (b) of the Code states that the Directors Report should contain a statement signifying that proper books of account of the listed company have been maintained. Whereas Clause xxxiii, inter alia, states that the terms of reference of the Audit Committee include ascertaining that the internal control system including financial and operational controls, accounting system and reporting structure are adequate and effective. D.1.2 The boards responsibility to present a balanced and understandable assessment extends to interim and other price-sensitive public reports and reports to regulators as well as to information required to be presented by statutory requirements. Though the Code does not specifically say this, the key information to be placed for decision-making before the board under Clause xiii of the Code is quite far-reaching and extensive. D.1.3 The directors should report that the business is a going concern, with supporting assumptions or qualifications as necessary. As per Clause xix (f) of the Code, the Directors Report should contain a statement signifying that there are no significant doubts upon the listed companys ability to continue as a going concern. Under the same Clause the Directors Report shall also include where necessary if the listed company is not considered to be a going concern, the fact along with reasons shall be disclosed. D.2 Internal Control Principle: The board should maintain a sound system of internal control to safeguard shareholders investment and the companys assets. Clause viii (c) of the Code provides that the Board of Directors establish a system of sound internal control, which is effectively implemented at all levels within the company. However, there is not much elaboration on what sound internal control entails. In the UK, detailed directions are now available in this regard. (Also, see Page 42 of this Report). Code Provisions D.2.1 The directors should, at least annually, conduct a review of the effectiveness of the groups system of internal control and should report to shareholders that they have done so. The review should cover all controls, including financial, operational and compliance controls and risk management. The Directors Report to shareholders under Clause xix (e) of the Code should include a statement to the effect that the system of sound internal control is sound in design and has been effectively implemented and monitored. There is no express provision in the Code that the directors should review all controls including financial, operational and compliance controls and risk management. Nevertheless, the responsibilities assigned to
31
directors under Clause viii, xiii and xix cover significant ground as far as the task of reviewing all internal controls and related disclosures is concerned. D.2.2 Companies, which do not have an internal audit function, should from time to time review the need for one. Clauses xxxv and xxxvi cover the area of internal audit in the Code. D.3 Audit Committee and Auditors Principle: The board should establish formal and transparent arrangements for considering how they should apply the financial reporting and internal control principles and for maintaining an appropriate relationship with the companys auditors. Audit is an area, which is dealt with in great detail by the Code, and Clauses xxx to xliv of the Code are all relevant in this regard. Code Provisions D.3.1 The board should establish an audit committee of at least three directors, all nonexecutive, with written terms of reference which deal clearly with its authority and duties. The members of the committee, a majority of who should be independent non-executive directors, should be named in the report and accounts. Clause xxx of the Code, which deals with the composition of the audit committee, is almost the same as the above provision. D.3.2 The duties of the audit committee should include keeping under review the scope and results of the audit and its cost effectiveness and the independence and objectivity of the auditors. Where the auditors also supply a substantial volume of non-audit services to the company, the committee should keep the nature and extent of such services under review, seeking to balance the maintenance of objectivity and value for money. Clause xxxiii of the Code is relevant here and enumerates the various components of the terms of reference for audit committees. The audit committees have also been given the role of recommending external auditors to the company and in this regard they are to keep in mind considerations like those mentioned in the provision above. In the absence of strong grounds to proceed otherwise, the board is expected to follow the recommendations of the audit committee in decisions pertaining to external auditors. SECTION 2: INSTITUTIONAL SHAREHOLDERS E. INSTITUTIONAL INVESTORS There is no direct reference to institutional shareholders in the Code. However, in terms of independent directors representing institutional investors, the Code provides that such directors shall be selected by such investor through a resolution of its Board of Directors and the policy with regard to selection of such person for election on the Board of Directors of the investee company shall be disclosed in the Directors Report of the investor company (Explanation given in the Code of its Clause i (b)). The Code does not contain any provisions corresponding to the following provisions. E.1 Shareholder Voting Principle: Institutional shareholders have a responsibility to make considered use of their votes.
32
Code Provisions E.1.1 Institutional shareholders should endeavour to eliminate unnecessary variations in the criteria which each applies to the Corporate Governance arrangements and performance of the companies in which they invest. Institutional shareholders should, on request, make available to their clients information on the proportion of resolutions on which votes were cast and non-discretionary proxies lodged. Institutional shareholders should take steps to ensure that their voting intentions are being translated into practice. Dialogue with Companies
E.1.2
E.1.3 E.2
Principle: Institutional shareholders should be ready, where practicable, to enter into a dialogue with companies based on the mutual understanding of objectives. E.3 Evaluation of Governance Disclosures Principle: When evaluating companies governance arrangements, particularly those relating to board structure and composition, institutional investors should give due weight to all relevant factors drawn to their attention. The Combined Code also contains the following Schedules. Schedule A: Provisions on the Design of Performance Related Remuneration Schedule B: Provisions on what should be included in the Remuneration Report Concluding Comments A review of the comparative analysis conducted above shows that the Code, keeping aside the areas of remuneration and institutional shareholders (which have not been addressed in the Code; the Report comments further on that aspect in Chapter 6) is very much along the lines of the detailed provisions of the Combined Code. The following, however, are some provisions of the Combined Code for which the Code does not provide any corresponding provisions and these require some attention, though keeping in mind the level of development of the corporate markets in Pakistan. Whether or not there is a case for incorporating any of these in the Code is also discussed in Chapter 6 where an analysis of the corporate markets in Pakistan is conducted and some conclusions thereby drawn. (The section references below are from the Combined Code). Sections. A.1.3: (Access to professional advice). A procedure laid out for directors to seek independent professional advice if necessary, at the companys expense. Section. A.2.1: (Explanation for combining the Chief Executive and Chairman positions). A decision to combine the posts of chairman and chief executive officer in one person to be publicly justified or the establishment of a mechanism whereby concerns can be forwarded to an independent nonexecutive element along with a recognized senior member other than the chairman. Section. A.3.2: (Requirement that NEDS be identified in the Annual Report). Section. A.4.1: (Stipulation that Directors make further inquiries where necessary while making decisions). Section. A.5.1: (Establishment of Nomination Committees for appointment of Directors).
33
Section. A.6.2: (Names of Directors submitted for election or re-election should be accompanied by sufficient biographical details to enable Shareholders to take an informed decision on their election). Section. C.2.1: (Proxy Votes) Companies should count all proxy votes and, except where a poll is called, should indicate the level of proxies lodged on each resolution, and the balance for and against the resolution, after it has been dealt with on a show of hands. Section. C.2.2: (Separate Resolutions for Separate Issues). Companies should propose a separate resolution at the AGM on each substantially separate issue, and should in particular propose a resolution at the AGM relating to the report and accounts. Section. C.2.3: (Availability for answering questions at the AGM). The chairman of the board should arrange for the chairmen of the audit, remuneration and nomination committees to be available to answer questions at the AGM. Section D.2.1: (Elaboration on Sound Internal control) The directors should, at least annually, conduct a review of the effectiveness of the groups system of internal control and should report to shareholders that they have done so. The review should cover all controls, including financial, operational and compliance controls and risk management. Currently the Code does not provide much explanation of the requirements of Sound Internal Control and from the UK experience one can see that such elaboration was eventually provided due to market demand. Implementation of the Combined Code by the London Stock Exchange London Stock Exchange has introduced a requirement on listed companies to make a disclosure statement in two parts. In the 1st part of the disclosure statement, the company is required to report on how it applies the principles in the Combined Code. There is no prescribed form or content of this part of the statement. Companies should have a free hand to explain their governance policies in the light of the principles, including any special circumstances applying to them, which have led to a particular approach. It must be for shareholders and others to evaluate this part of the companys statement. In the 2nd part of the disclosure statement, the company is required to confirm that it complies with the Combined Code provisions or, (where it does not) otherwise, provide an explanation. Again, it must be for shareholders and others to evaluate such explanations. Companies are expected to be ready to explain their governance policies, including any circumstances justifying departure from best practice; and those concerned with the evaluation of governance are required to do so with common sense, and with due regard to companies individual circumstances.
34
CHAPTER 3. ASSESSMENT AND REVIEW OF THE LAWS GOVERNING THE CORPORATE SECTOR IN PAKISTAN. RECOMMENDATIONS, WHERE APPLICABLE, FOR AMENDING THE SAME TO HARMONIZE THEM WITH THE CODE
Code of Corporate Governance and Corporate Regulatory Laws in Pakistan
The following is a brief description of the Code of Corporate Governance as well as the main corporate regulatory laws in Pakistan. These laws have been ascribed the following specific defined terms for ease of reference. Code of Corporate Governance, 2002 (the Code). The Code was introduced by the Securities and Exchange Commission of Pakistan (the SECP) in early 2002 for the stated purpose of establishing a framework of good Corporate Governance whereby a listed company can be managed in compliance with the best business practices. The Code has been prepared after a review of the leading international reports prescribing best practices for Corporate Governance, (including the Cadbury Report, which seems to have had a strong influence on its eventual shape) and is exhaustive in scope. The Code has been adopted by all the stock exchanges of the country by way of its incorporation in their respective listing regulations, so that all the listed companies in Pakistan are now required to comply with the provisions of the Code, according to a time frame stated in the Code itself. The SECP plans to supervise such compliance by requiring that: (a) All listed companies are to publish and circulate a statement along with their annual reports to set out the status of their compliance with the best practices of Corporate Governance; (b) All listed companies are to ensure that the statement of compliance with the best practices of Corporate Governance is reviewed and certified by statutory auditors, where such compliance can be objectively verified, before publication by listed companies; and (c) Where the SECP is satisfied that it is not practicable to comply with any of the best practices of Corporate Governance in a particular case, SECP may, for reasons to be recorded, relax the same subject to such conditions as it may deem fit. The following are the laws reviewed, which have either been listed in the TOR for this Report, or which though not listed in the TOR, were considered important for purposes of review and analysis. Banking Companies Ordinance, 1962 (the Banking Companies Ordinance). The Banking Companies Ordinance consolidates and amends the laws relating to banking companies. This is the most important, basic banking law in Pakistan upon which the banking regulation legal regime of the country is based. The Bank of Punjab Act, 1989 (the Bank of Punjab Act). The Bank of Punjab Act is a province-specific act to constitute the Bank of Punjab. The preamble of the Act mentions as its purpose, the establishment of a Bank for providing banking facilities in the Punjab. The Bank is to be a body corporate.
35
Chartered Accountants Ordinance, 1961 (the Chartered Accountants Ordinance). An Ordinance for regulating the profession of accountants in Pakistan and for that purpose, to establish the Institute of Chartered Accountants. The Institute is a body corporate and its members comprise of all persons whose names are entered in its Register at the commencement of the Ordinance and all those who may thereafter have their names entered in the Register under the provisions of the Ordinance. The Companies (General Provisions & Forms) Rules, 1985 (the Companies Rules). The Rules made under Section 506 of the Companies Ordinance, 1984 for, inter alia, laying down the procedures relating to registration and alteration of memorandum and articles of a company, for enquiries as to availability of companies names, for grant of license for charitable associations, for conversion of a public company into a private company, for service of documents on the SECP or the Registrar (defined below), for laying down the mode of submission of returns, circulation of reports and notices, submission of prospectus with the SECP, verification of copies of contracts, verification of copies of instruments creating or evidencing any charge, rules for extension in the period for holding annual general meetings and rules pertaining to balance sheets, filing of copies of resolutions with the SECP or the Registrar, procedures for Auditors reports on the accounts of companies, certification of documents (translated documents) etc. Companies Ordinance, 1984 (the Ordinance). This is the main overarching law in Pakistan relating to the governance and regulation of entities incorporated as companies and certain other associations. The Ordinance consolidates and amends the earlier laws relating to this area. The Ordinance also lays out the powers and functions of the Corporate Law Authority (now replaced by the SECP, which inherits all the powers of the Corporate Law Authority under the Ordinance). The Ordinance further establishes the office of the Registrar (the Registrar) who supervises the registration of companies and related documents as well as the corporate disclosure requirements and performs other related tasks. The Registrar is also equipped under the Ordinance with certain important investigative and fact-finding powers. It should be noted here that in October 2002, certain amendments were introduced to the Ordinance through the Companies (Amendment) Ordinance, 2002 (the Companies Amendment Ordinance) which have also been looked at and are referred to, where applicable and discussed, under this designated term. Financial Institutions (Recovery of Finances) Ordinance, 2001 (the Recovery of Finances Ordinance). This Ordinance has been promulgated with the stated objective of safeguarding the interests of creditors/financial institutions and is the latest in a series of ordinances promulgated for expeditious loan recovery. It prescribes a summary procedure for the swift recovery of defaulted loans. Institute of Chartered Accountants of Pakistan (The ICAP) Circulars (the ICAP Circulars). The formulation of the Code has involved active participation of ICAP. ICAP has consequently issued various circulars making it mandatory for all the audits conducted by its members of the accounts of the Listed Companies, that certificates be issued to the effect that companies so audited have complied with the provisions of the Code. Insurance Ordinance, 2000 (the Insurance Ordinance). This is an Ordinance to provide for the regulation of insurance business in Pakistan, to protect the interests of insurance policy holders and to promote sound development of the insurance industry in Pakistan. By this Ordinance, the SECP has been given very wide supervisory powers to ensure proper regulation of insurance business in Pakistan. These include rule making and direction giving powers in
36
almost every matter including those concerned with administration of companies. It may also be noted that the SECP has issued SRO 68(1)/2003 dated 21.01.2002, in exercise of powers given to it under the Ordinance whereby all insurance companies have been directed to follow the Code with effect from March 1, 2003. This SRO has two Sections. Section A is required to be followed by listed insurance companies while Section B is required to be followed by all other insurance companies. Listed Companies (Prohibition of Insiders Trading) Guidelines, 2002 (the Insider Trading Guidelines). The Insider Trading Guidelines deal extensively with the insider-trading phenomenon and are a significant advancement in its regulation in Pakistan. The Modaraba Companies & Modaraba (Floatation And Control) Ordinance, 1980 (the Modaraba Ordinance). An Ordinance promulgated to provide for matters relating to the registration of Modaraba Companies and the floatation, management and regulation of Modarabas and other related matters. The Ordinance applies to those Modaraba companies, which are, amongst other stated requirements, incorporated and registered under the Companies Ordinance, 1984 or are bodies corporate formed under any law in force and owned or controlled by the Federal or a Provincial Government. A Modaraba has been defined in the Ordinance as a business in which a person participates with his money and another with his efforts or skill or both his efforts and skill and shall include Unit Trust and Mutual Funds by whatever name called. A Modaraba Company has been defined in the Ordinance as a company engaged in the business of floating and managing Modarabas. And a Modaraba Fund has been defined in the Ordinance to mean a fund raised through the floatation of a Modaraba. The Modaraba Companies & Modaraba Rules, 1981, (the Modaraba Rules). The Rules formulated under Section 41 of the Modaraba Ordinance, to lay down the rules and procedures relating to, inter alia, the functions of the Registrar, the registration of a Modaraba, the constitution and functioning of a Tribunal and a Religious Board, eligibility requirements for companies also engaged in an other business to register as a Modaraba company, rules relating to accounts and audit, auditors, and use of capital of the company, disclosure requirements and preparation of financial statements, distribution of profit and reserves, maintenance of a register of certificate holders, penalty for fraudulent trading etc,. National Bank of Pakistan Ordinance, 1949 (the National Bank Ordinance). The National Bank Ordinance was promulgated to constitute a National Bank of Pakistan during the early years of Pakistan to handle the emergency situation of a lack of a banking set up at that time. The preamble of the Ordinance states the Banks purpose to be the extension of banking facilities generally and the provision of credit for agriculture and agricultural produce. The National Bank of Pakistan is also to be a body corporate. The Pakistan International Airlines Corporation Act, 1956 (the PIA Act). An Act that established a new Corporation called the Pakistan International Airlines Corporation to take over the undertaking of the then existing Orient Airways Limited. The Corporation is a body corporate, and under its Section 4 (1), the main functions of the Corporation are to provide and further develop safe, efficient, adequate, economical and properly co-ordinated air-transport services, internal as well as international; and the Corporation is also to exercise its powers to secure that air-transport services are developed to the greatest possible advantage of the country. Pakistan National Shipping Corporation Ordinance, 1979 (the National Shipping Ordinance). An Ordinance that merged/amalgamated the two earlier existing corporations
37
respectively established under the National Shipping Corporation Ordinance, 1963 and the Pakistan Shipping Corporation Act, 1976, in order to establish a new Corporation called the Pakistan National Shipping Corporation. The Corporation is a body corporate, and under its Section 6 (1), the main functions of the Corporation are to provide and further develop safe, efficient, adequate, economical and properly co-ordinated shipping services, coastal as well as international, and to engage in all forms of activities connected with or ancillary, incidental or conducive to shipping. Pakistan Telecommunication (Re-organization) Act, 1996 (the Pakistan Telecommunication Act). This Act was promulgated with the objective of re-organizing the telecommunication system, for regulating the telecommunication industry and for transferring telecommunication services to the private sector. The Act, pursuant to its objectives, established the Pakistan Telecommunication Authority (the PTA), the Pakistan Telecommunication Company Limited (the PTCL), the Frequency Allocation Board (the FAB), the National Telecommunication Corporation (the NTC) and the Pakistan Telecommunication Employees Trust (the PTET). Provincial Insolvency Act, 1920 (the Provincial Insolvency Act). The Provincial Insolvency Act consolidates and amends the laws relating to insolvency in the province of Punjab. Securities and Exchange Ordinance, 1969 (the SE Ordinance). The SE Ordinance has been promulgated for the stated purpose of providing for the protection of investors, regulation of markets and dealings in securities and related matters and includes important provisions for the prevention of fraud and insider trading. This is the basic law pertaining to regulation of stock markets and investor protection in Pakistan. The Securities and Exchange Rules, 1971 (the SE Rules). The SE Rules made under Section 33 of the SE Ordinance, in order to define various procedural matters which include, inter alia, qualifications for membership of stock exchanges, recording of transactions, maintenance of accounts and other documents by members, audit of accounts maintained by members, maintenance of books of accounts and other documents by stock exchanges and submission of periodical returns and annual reports by the stock exchanges. Securities and Exchange Commission of Pakistan Act, 1997 (the SECP Act). The SECP Act has established the Securities and Exchange Commission of Pakistan (the SECP) for the beneficial regulation of the capital markets and the superintendence and control of corporate entities. The SECP enjoys wide powers in this regard under the SECP Act. The SECP Act also lays out important provisions defining, inter alia, fraudulent and unfair trade practices as well as provisions defining the powers of the SECP relating to the protection of minority shareholders, creditors, the regulation of the board of directors of listed companies and the internal management of the SECP. SECP Circulars (the SECP Circulars). These are some of the relevant circulars issued by the SECP, which have been analyzed in this Report due to some nexus with the applicability of the Code. State Bank of Pakistan Circulars (the State Bank Circulars). These are some of the relevant circulars issued by the State Bank of Pakistan, which have been analyzed in this Report due to some nexus with the applicability of the Code.
38
The two basic categories of the laws analyzed in this Report: The Ordinance, the Companies Rules, the SE Ordinance, the SECP Act and the SE Rules constitute the most significant overarching laws of Corporate Governance in Pakistan. They will be referred to individually hereinafter by their individually designated terms and collectively as the Ordinance and Related Laws. The rest of the laws defined above are more specific as in they either regulate a particular statutory entity i.e. the National Bank of Pakistan or are geared towards the regulation/prevention of a certain kind of market activity i.e. insider trading. They will be referred to by their individually designated names but discussed under the broad category of Other Laws. Different laws having varying ambit and level of detail: Given the varying nature and ambit of the abovedescribed categories of law, it is apparent that they may vary a lot from each other in terms of underlying purpose, ambit of operation and level of detail. Therefore, it is only natural that while comparing them with the Code, all of them will not address all the areas covered in the Code. For example the Chartered Accountants Ordinance is primarily concerned with the regulation of the profession of Chartered Accountancy in Pakistan while the Ordinance tackles a huge and diverse area of corporate business in Pakistan with its myriad manifestations and issues. As a result the Ordinance will make an appearance under all the categories of analysis ascribed to the Code (given below) while the Chartered Accountants Ordinance may not. Contradictions, overlaps and areas which contain neither: The following basic approach has been adopted in this Report. A contradiction between any of the above-described laws and the Code, which may hamper the applicability and promotion of the Code within the sphere of operations of any of these laws, has been pointed out in bold, underlined text.. This is a more important dimension of this analysis because any contradictions can stall the mission of the Code. As to overlaps, which are comparatively of lesser importance because they do not undermine the Code but rather promote it, only those provisions of these laws have been discussed which put forward a significant additional requirement, structure, mechanism etc., towards the fulfilment of a value also enshrined in the Code. At the same time, there are many instances where either a law is essentially saying the same thing as the Code or importantly not saying something, corresponding to something, which can be found in the Code. This is simply because the special nature of that law does not require that there be an equivalent provision in that law to that of the Code or because it operates under the overall governing regime of the Ordinance. In the latter case, the analysis extended to the relevant Ordinance provisions in that context also becomes applicable to that particular law. For Example the Insider Trading Guidelines will necessarily have a lot to say about Prevention of Minority Shareholder Oppression a category under the Code and something which these Guidelines primarily set out to promote but not necessarily anything corresponding to another category under the Code i.e. Role of the Non-Executive Directors (NEDs), Chief financial Officer and Company Secretary. In such situations, nothing will be said about these laws under those inapplicable categories of the Code for the sake of greater focus on the real contradictions and overlaps. The Categories of Analysis under the Code: Keeping in mind the above approach and assumptions, the following is a synopsis and assessment of the laws, legal processes and guidelines, which currently exist in Pakistan and selected for analysis for this Report, presented and structured under the standards derived from the Code. These standards, based on a close study of the objects and text of the Code are laid out under the following broad thematic categories given below. For every category, the Report also gives the basic underlying philosophy as to why these rules have come about, primarily in view of the International Corporate Governance Reports, which were discussed in
39
Chapter 3 and which it was opined in that Chapter to have many overlaps with and influence on the philosophy and contents of the Code itself. These categories are: The Structure and Responsibilities of the Board of Directors Powers and Duties of Executive Directors Role of the Non-Executive Directors (NEDs), Chief financial Officer and Company Secretary Financial Disclosure and Reporting Requirements of the Company The Role of Internal and External Auditors Prevention of Minority Shareholder Oppression Other Shareholder Rights as well as the Rights of the Creditors
1. The Structure and Responsibilities of the Board of Directors

The Basic Philosophy: The basic idea being propounded by the UK Corporate Governance Reports mentioned in Chapter 3 is that every public company should be headed by an effective board (with a Chairman of the Board of Directors, the Executive and Non-Executive directors etc.,), which can both lead and control the business. The Board should meet regularly, retain full and effective control over the company and monitor the executive management. Furthermore, there should be a clearly accepted division of responsibilities at the head of the company, in order to ensure a balance of power and authority, such that no one individual has unfettered powers of decision. Given the importance and particular nature of the Chairmans role, it should in principle be separate from that of the Chief Executive. Where the Chairman is also the Chief Executive, it is essential that there should be a strong and independent element on the board, with a recognized senior member. The Board is to collectively ensure, regardless of the particular responsibilities of certain directors, that it is meeting its obligations. In short this view of Corporate Governance underlines the fundamental importance and significance of the role of Boards in running efficient and ethical companies. The Code seems to be promoting the same philosophy, with a few minor differences, which shall be noted below. Specific proposals: The following can be regarded as the specific areas to look at under the Code: Role of the Chairman Role of the Chief Executive Quorum and Frequency of Meetings of Boards of Directors Appointment of Committees by Boards of Directors The Decision Making Process of the Boards of Directors. (a) Vision Statement and Overall Corporate Strategy of the Boards; (b) Key information to be placed before the Boards Overall Functioning of the Boards (a) System of Sound Internal Control; (b) Orientation Programs for Directors; (c) Statement of Ethics and Business Practices to govern Boards Prevention of Fraudulent Acts and Insider Trading
40
1.1
Role of the Chairman
The Code The Code makes a significant attempt at giving some definite shape and direction to the role of the Chairman in the Pakistani Corporate Governance environment. The Code (Clause ix) lays down that the Chairman of a listed company is to be preferably elected from among the NEDs of the listed company and that the Board of Directors is to clearly define the respective roles and responsibilities of the Chairman and the Chief Executive, whether or not these offices are held by separate individuals or the same individual (the possibility of a single person holding both these offices has thus not been precluded (which is in line with the Combined Code discussed in Chapter 3, though without the additional requirements imposed in the Combined Code in case these two offices are combined in one person)). The Code (Clauses x and xii) makes further attempts to formalize the role of the Chairman, by requiring that, inter alia, (i) the Chairman, if present, preside over meetings of Board of Directors (which are required to meet at least once in every quarter of the financial year), and (ii) the Chairman is to ensure that the minutes of meetings of the Board of Directors are appropriately recorded and circulated. Ordinance and Related Laws At the very outset, it should be stated that the Ordinance and Related laws do not lay down a welldefined and distinct role for the Chairman of the Board of Directors by laying out specific duties and responsibilities. This essentially means that an integral component of the above standards, that is the Chairman, has not received any detailed attention by the Ordinance and Related laws. Therefore, it can be said that there is at least no existing statutory framework to ensure that the Chairman is actually required to meet the above-listed standards. While this may not be regarded as a contradiction, this is an omission, which is now taken care of through the entrenchment of more detailed requirements in the Code. The following are some of the relevant provisions in the Ordinance, which do extend the philosophy of the Code as to the functioning of Boards of Directors. Section 160 of the Ordinance deals with provisions as to general meetings and votes. Clause (3) of that Section says: The Chairman of the Board of Directors, if any, shall preside as Chairman at every general meeting of the company, but if there is no such Chairman, or if at any meeting he is not present within fifteen minutes after the time appointed for holding the meeting, or is unwilling to act as Chairman, any one of the directors present may be elected to be Chairman, and if none of the directors are present or are unwilling to act as Chairman, the members present shall choose one of their numbers to be Chairman. This shows that the Ordinance does not visualize a distinct individual performing a definite, continuing role as the Chairman; a role entailing a stated regulatory purpose along the lines of the above-described standards. Furthermore, the Ordinance also does not specifically preclude the possibility of the same person holding the office of Chairman and Chief Executive, thus leaving that possibility open. An important amendment relating to the quorum required for a general meeting has been made by the Companies Amendment Ordinance to Section 160(2)(a) of the Ordinance so that now it
41
specifically refers to a public listed company and requires that unless the articles provide for a larger number, not less than ten members (instead of the earlier requirement of three members) present personally who represent not less than twenty-five percent of the total voting power, either of their own account or as proxies. Other Laws It is instructive to take a look at some of the specific statutory regimes governing specialized statutory bodies which have dealt with in some detail with the appointment and role of the Chairman. National Shipping Ordinance: According to Section 18 of the National Shipping Ordinance, the Chairman of the Pakistan National Shipping Corporation is to be nominated by the Federal Government from the five appointed directors (directors appointed by the Federal Government). The Federal Government also determines the Chairmans remuneration, fees, allowances, and privileges if any. The Chairmans term of office is the same as the term of appointment of a Director (usually three years). The Chairmans role is clearly defined under Section 19 of the National Shipping Ordinance, which describes the Chairman as the Chief Executive of the Corporation. Important duties of the Chairman include direction and control of the business and affairs of the Corporation; to preside at every meeting of the Board and every general meeting of the Corporation; and to ensure orderly conduct of the business of the Board. The Chairman is also duty bound to obey all the rules and regulations and the Federal Governments orders and directives on question of policy. Section 20 of the National Shipping Ordinance provides for the appointment and role of the ViceChairman. The Federal Government nominates an appointed Director to be the Vice-Chairman of the Board. The Board delegates powers and duties to the Vice-Chairman as and when it is necessary for the efficient performance of its day-to-day administration under Section 22. The ViceChairmans role becomes particularly important in the absence of the Chairman as he assumes responsibility of all those functions that are assigned to the Chairman. National Shipping Ordinance is thus much closer to the Code in terms of laying out a specific position for a Chairman with special duties as well as the position of a Vice Chairman. However, it visualizes the Chairman as the Chief Executive, which combines two roles into one, something, which the Code allows. Though it can be argued that the position of Vice-Chairman redresses the balance somewhat. PIA ACT: According to Section 8 of the PIA Act, the Federal Government appoints one Chairman out of the six directors appointed by the Federal Government for a period of three years. In contrast to the Chairman of the Board, the Managing Director of the Corporation is appointed on terms and conditions of service of the Federal Government for a period that is determined by the Federal Government in consultation with the Board. Under Section 6 (3), the Managing Director is to enjoy powers and functions, which are prescribed to him, whereas the Board assigns every other Director special duties. The administration of the affairs of the company under Section 5 (1) vests in the Board of Directors and hence the Chairman of the Board is responsible for giving direction and focus to the Corporation. The role of the Chairman in the PIA Act is not as well defined as in the Shipping Ordinance. The Federal Government may also intervene in matters of policy of the Corporation and issue directives, which are binding on the Corporation. However, once again the specific position of the Chairman is provided for and the additional position of the Managing
42
Director, synonymous to that of a Chief Executive, provides for a designated two-tiered leadership role at the top of the organization, which the UK Corporate Governance Reports favour. Pakistan Telecommunication Act: Chapter II of the Pakistan Telecommunication Act focuses on the establishment, functions, powers and responsibilities of the PTA, established for, inter alia, regulating the establishment, operation and maintenance of telecommunication systems and the provision of telecommunication services in Pakistan. Section 3 of the Act states that the PTA is a body corporate, established by the Federal Government to consist of three members appointed by the Federal Government for four years. One of the members is required to be a professional telecommunication engineer and another, a financial expert. No qualifications/standing of the third member have been laid down who may, therefore, be any person to be appointed by the Federal Government in its discretion. From amongst these members, the Federal Government is required to appoint a Chairman. Under Section 3(8) of the Act, the Chairman may exercise powers in matters relating to the administration and the staff of PTA. In other matters the decisions are to be taken with the concurrence of the majority of its members. Chapter IV of the Act focuses on the establishment and functioning of the PTCL, for the principal object of provision of domestic and international telecommunication and related services consistent with the provisions of the Act. Section 34 of the Act states that the PTCL is to be limited by shares and is to be incorporated under the Ordinance. Section 34(2) of the Act provides that the Federal Government is to nominate seven persons to subscribe to the Memorandum and Articles of Association of the Company. Whereas sub-section (6) of the same Section states that on incorporation of the Company, the Federal Government has to fix a date for election of the Board of Directors of the Company consisting of seven directors in accordance with the provisions of the Ordinance. Chapter V of the PT Act focuses on the NTC, which, under Section 41(3) of the PT Act provides telecommunication services within Pakistan on a non-exclusive basis only to the armed forces, defence projects, Federal Government, Provincial Governments or such other Government agencies or Government institutions as the Federal Government may determine. Section 41 of the PT Act states that the NTC is to be a body corporate, which is to be managed by a Management Board consisting of a Chairman and two other members, who are to be appointed by the Federal Government. Chapter VI of the PT Act focuses on the FAB, which under Section 41(3) of the PT Act has exclusive authority to allocate and assign portions of the radio frequency spectrum to the Government, providers of telecommunication services and telecommunication systems, radio and television broadcasting operations, public and private wireless operators and others. Section 42 states that the FAB is to replace and take over the functions performed by the Pakistan Wireless Board. The FAB under sub-section (2) of the same, is to consist of the following six individuals -- a Chairman (who shall be the Secretary, Ministry of Communications); a Vice-Chairman (who shall be an Executive Director appointed by the Federal Government); the Chairman of the PTA; and a nominee each of the Ministry of Defence (Corps of Signals), Ministry of Information and Broadcasting and Ministry of Interior. Sub-section (3) of the same provides for the Vice-Chairman who is to be an employee of the Board who shall devote his full time to the business of the Board and shall not hold any other office or position during his tenure as Vice-Chairman. A review of the above shows that the Pakistan Telecommunication Act clearly visualizes the importance of the role of the Chairman of the Board of Directors and provides for the appointment of the same in the various bodies, which it has created.
43
Bank of Punjab Act: Under Section 9 of the Bank of Punjab Act, the general superintendence and direction of the affairs and business of the Bank is entrusted to a Board (Board of Directors) of the Bank. Under Section 10 of the Act, the Board is to be headed by the Chairman, appointed by the Government of Punjab from amongst the Directors. As per Section 10(1) of the Act, the elevenmember Board comprises of one Managing Director (to be appointed by the Government of Punjab) for a period of at least three years and a maximum of five years, four Directors elected in a special meeting by the shareholders for a term of three years. The remaining six directors are to be appointed by the Government of Punjab. Under Section 10 of the Act, the Directors elected by the shareholders cannot be re-elected after a second consecutive term without a break of one term. Under Section 14, the Directors appointed by the Government of Punjab shall hold office only during the pleasure of the Government. No term is specified. As per Section 11(3), the Managing Director is also the Chief Executive Officer of the Bank. The Bank of Punjab Act, however, does not specifically state the responsibilities of the Chairman and the Managing Director i.e. the Chief Executive. There is consonance with the Code, however in the sense that management at the top has been divided between these two offices. Under this law the Chairman is to preside over the Board meetings, which is once again in harmony with the Code. Chartered Accountants Ordinance: It is to be noted that instead of a Board, the Chartered Accountants Ordinance visualizes a Council. Under Section 9, affairs of the Institute are to be managed by a Council, which is to comprise of at least twelve members, having at least five years standing, appointed through election with a maximum of four persons nominated by the Federal Government. The elected persons are elected from the two prescribed regional constituencies comprising of two zones namely - A and B, at least one person to be elected from each zone. The electoral college for this election comprises of the members of the Institute belonging to such constituencies. Under Section 15 of this Ordinance, it is the duty of the Council to carry out the provisions of the Chartered Accountants Ordinance and to discharge other functions assigned to it under this Ordinance. Under Section 14, the Council is to be elected for a period of four years from the date of its first meeting. Under Section 12 of this Ordinance, the President and Vice-President(s) of the Council are to be elected from amongst its members. Under Section12 (2) of this Ordinance, the President has been described as the Chief Executive Authority of the Council. The Presidents and Vice-President(s) term of office is one year, but it should not extend beyond their tenure as members of the Council. The President and the Vice-President(s) are eligible for re-election for a total period not exceeding three consecutive years. The Chartered Accountants Ordinance thus provides for designated positions equivalent to a Chief Executive Officer/Chairman of Board as well as his/her deputies but does not clearly lay down the roles/powers of the President or the Vice-President(s) of the Council. National Bank Ordinance: Under this Ordinance, general superintendence and direction of the affairs and business of the Bank is entrusted with the Central Board (equivalent in purpose and functions to a Board of Directors) of the Bank. The Central Board is to be headed by a Chairman, appointed by the Federal Government from amongst the Directors under Section 14(2). As per Section 14 (1) of the Ordinance, the ten-member Central Board comprises of one Managing Director (to be appointed by the Federal Government) for a period of five years, four Directors elected in local or special local meetings by the shareholders of the areas specified by the Federal Government before
44
the elections, in such number as may be prescribed by the Government for that specific area. The remaining five directors are to be appointed by the Federal Government. Section 13 of the Ordinance also allows for the setting up of two local boards to be established at Karachi and Lahore to transact all the usual business of the Bank in their respective jurisdictions. Under Section 15, the local boards consists of one Managing Director, one Member appointed by the Central Board from amongst the Directors elected by the shareholders, two Members appointed by the Federal Government from the area in which the Local Board is established, three Members elected in a local or special local meeting from amongst themselves by the shareholders registered in the branch register of that area. Just like the Bank of Punjab Act, this Ordinance does not specifically state the responsibilities of the Chairman and the Managing Director i.e. the Chief Executive. There is consonance with the Code and the UK Corporate Governance Reports, however in the sense that management at the top has been divided between these two offices. State Bank Circular: BPD Circular No. 35 of 2002 (Fit and proper test for appointment of President/Chief Executive and Board of Directors) contains detail criteria for the appointment of President/Chief Executive and Directors of all the Banks listed as well as non-listed. Conclusion: The laws reviewed above are in conformity with the Code and to the extent that they currently do not provide detailed provisions as to the functioning of the Chairman of the Board, the Code takes some important steps in that direction. Since the Code allows the two offices of Chairman and Chief Executive to be combined in one person, that does not then remain an issue and many of the laws already have this arrangement. 1.2 Role of the Chief Executive
The Code The Code (Clause ix) requires the Board of Directors to clearly define the role and responsibilities of the Chief Executive, and further requires (Clause viii-e) that the appointment, remuneration and other terms and conditions of employment of the Chief Executive and other executive directors of the listed company be determined and approved by the Board of Directors. Ordinance and Related Laws Once again, the Ordinance and Related Laws do not lay down a well-defined and distinct role for the Chief Executive, laying out specific duties and responsibilities. The Ordinance, however, does provide certain important checks on the powers of the Chief Executive. Section 203 of the Ordinance mandates that the Chief Executive cannot engage, directly or indirectly, in a business competing with the companys business. The Section further requires that the Chief Executive disclose to the company in writing, the nature of such business and his interest therein. The mechanism for removing a Chief Executive who entrenches himself against the wishes of the directors is provided under Section 202 of the Ordinance which allows such a removal through a special resolution (passed by at least three fourths of the total number of directors at the time being). Other laws PIA Act: Please see the relevant text under 1.1.
45
National Shipping Ordinance: Please see the relevant text under 1.1. PT Act: Please see the relevant text under 1.1. Bank of Punjab Act: Please see the relevant text under 1.1. Chartered Accountants Ordinance: Please see the relevant text under 1.1. National Bank Ordinance: Please see the relevant text under 1.1. Conclusion: The laws reviewed above are in conformity with the Code and to the extent that they currently do not provide detailed provisions as to the functioning of the Chief Executive, the Code takes some important steps in that direction. Since the Code allows the two offices of Chairman and Chief Executive to be combined in one person, that does not then remain an issue and many of the laws already have this arrangement. 1.3 Quorum and Frequency of Meetings of Board of Directors
The Code The Code (Clause xi) says that the Board of directors of a listed company is to meet at least once in every quarter of the financial year. The Code does not address the question of a requisite quorum, which has been addressed in the International Corporate Governance Reports. The Ordinance, however, does address the issue of quorum. Ordinance and Related Laws Section 193 of the Ordinance fills the gap by laying down the quorum for a meeting of directors of a listed company as not less than one-third of their number or four, whichever is greater. The directors of a public company are required to meet at least twice a year (amended to once in each quarter of year by the Companies Amendment Ordinance). In case of any default regarding the above, there are financial penalties for the Chairman and the Directors. We can see that the difference between the frequency of meetings required by the Code and the frequency of meetings required of the directors of a public company under the Ordinance, which was less onerous in case of the Ordinance and has now been amended to bring the Ordinance in line with the Code. Other Laws
[
It is instructive to take a look at some of the specific statutory regimes governing specialized statutory bodies which have dealt with in some detail with the quorum requirement and frequency of Board Meetings. National Shipping Ordinance: Section 23 of the National Shipping Ordinance deals with Board meetings. The Chairman of the Board may convene a meeting whenever he thinks it necessary. Otherwise, the Board has the power to make regulations (pursuant to its general power to make regulations under Section 39) which prescribe the times and places of board meetings. There is no minimum number of Board meetings required. This is an area of contradiction with the Code. However, under Section 38, the Federal Government has the power to make rules for the purpose of giving effect to the provisions of the Ordinance and thus this mechanism can be used to make specific provisions of the Code applicable through this mode. Not less than three Directors, including the Chairman and Vice-Chairman should be present to constitute a quorum at a Board meeting. Section 23(4) provides for a Board meeting to be presided
46
by the Vice-Chairman, if for any reason the Chairman is unable to preside at a meeting and by other Directors in similar eventualities. Section 23(3) states that each Director, including the Chairman has one vote, and in the event of an equality of votes, the person presiding for the time being has a second or casting vote. PIA Act: Section11 (1) of the PIA Act deals with Board meetings whereas sub-sections (2), (3) and (4) deal with quorum. Sub-section (1) states that Board meetings may be held at such time and place as may be prescribed (this can be done in two ways: either through rules made by the Federal Government or regulations made by the Board under Sections 29 and 30 respectively). However, a meeting may also be convened whenever the Chairman thinks it fit, and if two or more Directors so request in writing addressed to the Chairman. This is an area of contradiction with the Code. Similar to what has been stated above, it is possible for the Code provisions to apply to the Corporation through rules made by the Federal Government or regulations made by the Board. To constitute a quorum at a meeting of the Board, there must be at least three Directors present. Each Director including the Chairman has one vote and if there is an equality of votes, the Chairman is entitled to a second or casting vote. If the Chairman is unable to attend a meeting, the Directors choose a Chairman of the meeting from among themselves. Bank of Punjab Act: Under Section 16 of the Act, a general meeting is to be held in the first week of March every year. Special Meetings are to be convened and held in the manner and at the time and place, as may be prescribed. This is an area of contradiction with the Code and the Ordinance and requires amendment. There are no provisions relating to quorum in the Act. National Bank Ordinance: Under Section 22 of the Ordinance, a general meeting is to be held in the first week of March every year. Special Meetings are to be convened and held in the manner and at the time and place, as may be prescribed. This is an area of contradiction with the Code and the Ordinance and requires amendment. Conclusion: As can be see n from the above analysis, this is an area where some of the laws contain conflicting provisions as regards frequency of meetings of the Board of Directors and the Code. These provisions thus require to be amended in order to harmonize them with the Code. 1.4 Appointment of Committees by Boards of Directors
The Code The Code has some important provisions relating to the appointment and functioning of Audit Committees, which are discussed under the Audit Committees heading, later in this Report. The Code generally visualizes and mentions the role of technical and executive sub-committees of the Board (in the Explanation to Clause viii (b)) but does not elaborate much upon their exact duties and role. Ordinance and Related Laws The Ordinance and Related Laws do not elaborate upon this role of the Boards of Directors. Other Laws It is instructive to take a look at some of the specific statutory regimes governing specialized statutory bodies which have dealt with in some detail with the appointment of Committees.
47
National Shipping Ordinance: Section 24 of the National Shipping Ordinance deals with Board Committees, which may be appointed according to necessity to accomplish a specific assignment or to help and aid the Board in its day to day functioning. The Board is responsible for appointing such Committees from among the Directors. PIA Act: The PIA Act does not deal with Board Committees directly although Section 7(4) mentions the method of remuneration of Directors who are not servants of the Government for attending meetings of any Executive Committee appointed by the Board of which they are members. Section 10 deals with the appointment of such officers, advisers and employees as the Corporation considers necessary for the efficient performance of its functions on such terms and conditions as it may deem fit. Chartered Accountants Ordinance: Section 15(2) paragraph (m) provide that the Council may constitute such Standing Committees as may be prescribed and paragraph (mm) provides for constitution of an Investigation Committee consisting of such members as may be prescribed. Under Section 20, for the purposes of investigation into professional misconduct by a member or a student, the Council and the Investigation Committee shall be deemed to be a Civil Court. The Council and the Committee shall have the same powers as are vested in a Civil Court under the Code of Civil Procedure, 1908 for the purposes of summoning and enforcing the attendance of any person and examining him on oath, discovery and production of any document and receiving evidence on affidavits. Under Section 20, the Council may constitute such Regional Committees as and when it deems necessary for one or more regional constituencies. Main purpose of such Regional Committees is to advise and assist the Council on matters concerning its functions.
[
Conclusion: The above-discussed laws visualize an active role for various kinds of committees, which though not an area of emphasis in the Code, is in line with the UK Corporate Governance Reports. 1.5
[
The Decision Making Process of the Board of Directors
The Code The Code comes up with some important provisions to formalize and structure the decision making process of the Board of Directors. One way that it tries to achieve this objective is through requiring more and better quality information at the disposal of the Board so that the decisions of the Board are informed and thought through. The other way is through laying out a fairly exhaustive list of areas, which should be analyzed and should remain in the knowledge of the Board while engaging in strategic decision-making. While the Ordinance and Related Laws provide mechanisms to ensure that directors have constant recourse to legal and financial advice from the companys advisers, they do not provide the directors with a right to seek independent legal and financial advice, as visualized in the Combined Code. The Code has also not addressed this area. (a) Vision/Mission Statement More specifically the Code (Clause viii-b) requires that every listed company should ensure that its Board of Directors adopts a vision/mission statement and overall corporate strategy for their company. The Code lays out an extensive list of areas for which such significant policies may be made. It further requires that a complete record of the particulars of any such policies should be maintained by the company along with the dates on which they were approved or amended by the Board of Directors. The Boards of Directors are required further to define the level of materiality,
48
keeping in view the specific circumstances of the company and the recommendations of any technical or executive sub-committee of the board that may be set up for the purpose. (b) Key information to be placed for decision by Board of directors Further, the Code (Clause xiii) proposes a list of significant issues which should be put before the Board of Directors for information, consideration and decision, in order to strengthen and formalize the corporate decision making process. Ordinance and Related Laws
[
The Ordinance and Related Laws do not shed any light on these areas. Other laws
[
It is instructive to take a look at some of the specific statutory regimes governing specialized statutory bodies, which have dealt with these matters in some detail. (a) Vision/Mission Statement National Shipping Ordinance. Section 6 of the National Shipping Ordinance talks extensively about the various functions of the Corporation. The broad vision of the Corporation may be inferred from Section 6(1) which lays out the mission to provide and further develop safe, efficient, adequate, economical and properly co-ordinated shipping services, coastal as well as international, and to engage in all forms of activities connected with or ancillary, incidental or conducive to shipping. The preamble also talks about the establishment of the Corporation with a view to making better provision for the operation of shipping and ocean-transport services and the development of maritime shipping industry. Section 6(2) Clauses (a) to (g) enumerate particular powers of the Corporation, which may be construed as its aims as well as tools for the promotion of those aims. PIA Act: Section 4 of the PIA Act focuses on the many different functions of the Corporation. Section 4(1) clearly resolves that the Corporation will provide and further develop safe, efficient, adequate, economical and properly co-ordinated air-transport services, internal as well as international; and the Corporation shall so exercise its powers as to secure that air-transport services are developed to the greatest possible advantage in the interests of the country. The preamble also talks about the establishment of the Corporation with a view to make further and better provision for the operation and development of air-transport services and purposes connected therewith. Section 4(2) clauses (a) to (e) enumerate particular powers of the Corporation, which may be construed as its aims as well as tools for the promotion of those aims. Pakistan Telecommunication Act: The role of the PTA is to implement the policies of the Government through the exercise of its powers and the performance of its functions under this Act and the rules made thereunder. The PTA is thus visualized as an independent regulatory authority. Section 4 clauses (a) to (h) list the many different functions of the PTA, whereas Section 5 clauses (2)(a) to (o) list its powers. The PTA is to ensure under Section 6 (responsibilities of the PTA) that the rights of licensees are duly protected; that all of its decisions and determinations are made promptly, in an open, equitable, non-discriminatory, consistent and transparent manner; that all applications made to it are disposed of expeditiously; that the persons affected by its decisions or determinations are given a due notice thereof and provided with an opportunity of being heard; that it encourages fair competition in the telephone sector; and that the interests of users of telecommunication services are duly safeguarded and protected. Under Section 8, the Federal Government may issue directives relating to telecommunication policy to the PTA when it considers necessary, which have to be complied with by the PTA.
49
Under Section 34 of this Act, the principal object of the PTCL is the provision of domestic and international telecommunication and related services consistent with the provisions of this Act. Under Section 41 (3) of this Act, the PTA is to grant a license to the NTC for provision of telecommunication services within Pakistan on a non-exclusive basis only to the armed forces, defence projects, Federal Government, Provincial Governments or such other Governmental agencies or Governmental institutions as the Federal Government may determine. Under Section 43 (1) of this Act, the FAB has exclusive authority to allocate and assign portions of the radio frequency spectrum to the Government, providers of telecommunication services and telecommunication systems, radio and television broadcasting operations, public and private wireless operators and others. Bank of Punjab Act: The preamble of the Act states the Banks vision/mission i.e. to provide for the establishment of a Bank for providing banking facilities in the Punjab. The businesses, which the bank is authorized to transact are clearly set out in Sections 18 and 20 of the Act and these are very much the kinds of activities which normal banking institutions engage in. There is no other vision statement, mentioned as such. Chartered Accountants Ordinance: The preamble of the Chartered Accountants Ordinance relates to its vision/mission i.e. to make provision for the regulation of the profession of accountants and for this purpose it also provides for the establishment of the Institute of Chartered Accountants. The vision of the Institute and the Council, through which it functions, is contained mainly in Section 15 of the Ordinance. As per Section 15, the Council is vested with the duty to carry out provisions of the Ordinance. Under its sub-section (2), the Council is required to perform various functions including; maintaining accounting standards, conducting research in the field of accountancy, addition to and removal of names of members from the Register, publication of books and periodicals relating to accountancy, exercise of disciplinary powers, constitution of an Investigation Committee, examination of candidates for enrolment with the Institute of Chartered Accountants, prescribing and collection of fees for this purpose, training of students, prescribing qualifications for entry in the Register,. The Council is also to perform such other powers as may be conferred on it by the Federal Government. National Bank Ordinance: The preamble of the National Bank Ordinance relates to its vision/mission i.e. to constitute a National Bank of Pakistan. The Bank was established in 1949 in order to extend banking facilities generally and also to provide credit facilities for agriculture in particular. The businesses, which the Bank is authorized to transact, are clearly set out in Sections 25 and 26-A of this Ordinance and these are very much the kinds of activities which normal banking institutions engage in. There is no other vision statement, mentioned as such. Modaraba Ordinance: The preamble of the Modaraba Ordinance lays out its purpose i.e. to provide for matters relating to the registration of Modaraba companies and the floatation, management and regulation of Modarabas and other related matters . The general scheme of this Ordinance is to ensure smooth and proper functioning of Modaraba Companies. For this purpose the Ordinance also provides for the establishment of office of the Registrar, a Religious Board and a Tribunal by the Federal Government. Since the provisions of the Ordinance provide the broad legal regime under which Modaraba Companies operate, the analysis conducted of the Ordinance itself becomes relevant here. The Modaraba Ordinance itself is silent about the requirements under the Code in the context of adoption of a vision statement etc.
50
Conclusion: The above laws generally state the formation purpose and ambit of activities of the institutions created by them and there is no specific mention of formal adoption and maintenance of a vision/mission statement and overall corporate strategy for these institutions in the manner prescribed by the Code. The Code, therefore, breaks new ground in this area. (b) Key information to be placed for decision by Board of directors
Conclusion: Nothing pertinent was found under this heading in the above-discussed laws. The Code, therefore, breaks new ground in this area. 1.6 Overall functioning of the Board
The Code The Code comes up with some additional provisions for bringing about more efficient and ethical functioning of companies. (a) System of Sound Internal Control9 The Code (Clause viii-c) requires that the Boards of Directors of listed companies establish a system for sound internal control, which is effectively implemented at all levels within the company. It then lays out certain areas which should be focused upon by boards of Directors and the resultant decisions documented through board resolutions, which include (with stated exceptions) (i) investment and disinvestments of funds; (ii) nature and limit of the loans advanced by the company; (iii) write-off of bad debts etc; (iv) write-off of inventories; and (v) compromise/waiver of law suits. The Code is once again a progressive document, which fills a gap in this area, created by the absence of such requirements in the Ordinance and Related Laws. (b) Orientation Programs for Directors The Ordinance and Related Laws do not mandate that companies ensure any such compulsory training. The Code (Clause xiv), however, has addressed this issue by requiring that all listed companies are to make appropriate arrangements to carry out orientation courses for their directors to acquaint them with their duties and responsibilities and to enable them to manage the affairs of the company on behalf of shareholders. (c) Statement of Ethics and Business Practices The Code (Clause viii-a) has tried to take an initiative in the area by requiring that every listed company is to prepare and circulate a Statement of Ethics and Business Practices on an annual basis to establish a standard of conduct for directors and employees, which statement is to be signed
Paragraph 13 of Internal Control: Guidance for Directors on the Combined Code, published by the Internal Working Party of the Institute of Chartered Accountants in England and Wales states that a sound system of internal control depends on a thorough and regular evaluation of the nature and extent of the risks to which the company is exposed. And the purpose of internal control is to help manage and control risk appropriately rather than to eliminate it. Furthermore, paragraph 16 states that the board of directors is responsible for the companys system of internal control. It should set appropriate policies on internal control and seek regular assurance that will enable it to satisfy itself that the system is functioning effectively. The board must further ensure that the system of internal control is effective in managing risks in the manner which it has approved. This detailed guidance was provided in view of the confusion faced by various companies in the UK after the Cadbury Report came out, in understanding the dynamics and ambit of internal control. The provision of such guidance in Pakistan, therefore, also merits attention.
9
51
by each director and employee in acknowledgement of his acceptance and understanding of the standard of conduct. Ordinance and Related Laws As mentioned above, the Ordinance and Related Laws do not have any specific provisions for assurance of a system of sound internal control, orientation programs for directors and formulation of a statement of ethics and business practices. However, they have some other provisions, which are essentially geared towards the prevention of unethical business practices in companies. The Ordinance does contain some important restrictions on certain practices, which form part of the governing ethical regime of companies, which also promote the above-mentioned initiatives by the Code. For instance, Section 195 of the Ordinance provides an extensive ban on the direct or indirect extension by a company of any loans to, or the provision of any guarantee or security in connection with a loan made by any other person to, or to any other person by, a director of the company or his relatives. Section 197 of the Ordinance prohibits a company from contributing any amount to any political party or for any political purpose to any individual or body, or else face penalties. Section 197-A of the Ordinance prohibits the distribution of gifts by a company in any form to its members at its meetings, or face penalties. Section 191 of the Ordinance says that the remuneration of a director, for performing extra services, including holding the office of the chairman, shall be determined by the directors or the company in general meeting in accordance with the provisions in the companys articles. The remuneration to be paid to any director for attending the meetings of the directors or a committee of directors shall not exceed the scale approved by the company or the directors, as the case may be, in accordance with the provisions of the articles. Other than this, the process of setting the remuneration, the disclosure of such information and the idea of appointment of remuneration committees do not find mention in the Ordinance and Related laws. Other Laws
[
It is instructive to take a look at some of the specific statutory regimes governing specialized statutory bodies which have dealt with in some detail with these matters. (a) System of Sound Internal Control National Shipping Ordinance: Section 33 (3) of the National Shipping Ordinance gives shareholders present at the annual general meeting the right to discuss and adopt or make recommendations to the Board with regards to annual accounts, the annual report of the Board on the working of the Corporation and the auditors report on the annual balance sheet and accounts. The above provision thus in some way necessitates a review of all internal controls including financial and operation controls and thus tests the boards performance in maintaining a sound system of internal control to safeguard shareholder investment and the companys assets. More generally, Section 6(3) of the National Shipping Ordinance lays down that the Corporation shall have careful regard to sound business principles and practices in performing its functions. PIA Act: Similar to the National Shipping Ordinance, Section 18(2) of the PIA Act gives the shareholders present at the annual general meeting the right to discuss the annual accounts, the
52
annual report of the Board on the working of the Corporation and the auditors report on the annual balance sheet and accounts. More generally, Section 4(3) states that in discharging its functions the Corporation shall have careful regard to business principles. Pakistan Telecommunication Act: Section 6 of the Pakistan Telecommunication Act deals with various responsibilities of the PTA, which reflect and ensure that a sound system of internal control is in place. Furthermore, in order to strengthen its internal organization, the PTA, under Section 10, may appoint and remove its employees and exercise discipline and control over them. Sub-section (b) provides that the PTA may regulate and manage its internal organization, set up divisions within the PTA and make appropriate appointments to those divisions. The PTA may also appoint advisory bodies, consultants and advisors on contract to advise the Authority in relation to its functions and powers. Whereas Section 18 (1) requires the PTA to submit a report to the Federal Government on the conduct of its affairs, including action taken for protection of consumer interests, for that year. Under sub-section (4) of Section 41 of the PT Act, the NTC has the power to appoint, promote, remove and exercise discipline and control over its staff, and to set up its internal organizations, including bureaus, divisions or offices and make appointments thereto. Bank of Punjab Act: The Bank of Punjab Act does not have any specific provisions in this regard. National Bank Ordinance: The National Bank Ordinance does not have any specific provisions in this regard. Chartered Accountants Ordinance: The Chartered Accountants Ordinance does not have any specific provisions in this regard. Modaraba Ordinance: The Modaraba Ordinance does not have any specific provisions in this regard. State Bank Circulars: The State Bank of Pakistan through BPD Circular No. 15 (Responsibilities of Board of Directors) has issued detailed guidelines for Effective Corporate Governance -- Clear lines of responsibility of Board of Director of Non Banking Financial Institutions (NBFIs). These include approval and monitoring of objective strategy and overall business plans of the NBFI, and also require the board to oversee that the affairs of the NBFI are carried out prudently. It also calls upon the board to clearly define the authority and key responsibilities of both the directors and senior management and to ensure that the management is under hands of qualified personals. As per the Circular, the board shall ensure implementation of policies in various areas including but not limited to internal audit and control, compliance, risk management, human resources, prevention of fraud and forgeries etc. The Circular also requires the board to ensure an effective management information system to remain fully informed of the activities, operating performance etc. of the Banks. The Circular further requires that the Board should preferably meet on the monthly basis and in any event not less than once in quarter. The Circular calls upon the board to share the load of activities to form specialized committees that will define objectives, authorities and tenure. These committees preferably should comprise on non-executive board members and shall oversee areas like audit, risk control, recruitment, credit etc. This Circular very much advances the system of Sound Internal Control, which the Code envisions.
[
Conclusion: This is by and large a hitherto under-explored territory and the Code has taken an important step in this direction to formalize systems of sound internal control in companies. However, the comment made earlier about the desirability of the provision by the SECP of a clearer understanding of the concept of sound internal control should be considered.
53
(b)
Orientation Programs for Directors
Chartered Accountants Ordinance: Under Section 15(2)(i) of this Ordinance, it is one of the functions of the Council to regulate and maintain the status and standard of professional qualifications of the members of the institute. Under Section 27(2)(k), the Council may also formulate byelaws for this purpose. There is no other provision specifically relating to orientation/refresher courses. The other laws also do no address this area. Conclusion: Once again very much an under-explored territory and the Code has taken an important step in this direction to ensure better training for directors resulting in greater efficiency. (c)
[
Statement of Ethics and Business Practices
National Shipping Ordinance: As mentioned earlier, Section 6(3) of the National Shipping Ordinance explicitly lays down that the Corporation shall have careful regard to sound business principles and practices in performing its functions. However, there is no stipulation for a Statement of Ethics and Business Practices to be prepared and circulated within the Corporation to be understood and signed by the Directors as well as employees as is required by the Code. PIA Act: Section 4(3) of the PIA Act states that the Corporation shall have careful regard to business principles in discharging its functions. Section 19 of the PIA Act provides that every Director, auditor, officer or servant of the Corporation shall, before entering upon his duties make a declaration of fidelity and secrecy in the form set out in the Schedule to this Act. Pakistan Telecommunications Act: Section 6 of this Act deals with the responsibilities of the PTA. Section 6(b) clearly states that the PTA is to ensure that all of its decisions and determinations are made promptly, in an open, equitable, non-discriminatory, consistent and transparent manner. Chartered Accountants Ordinance: Under Section 15(2)(l) of this Ordinance, it is one of the functions of the Council to exercise such disciplinary powers over the members and servants of the Institute as may be prescribed. Under Chapter V-A of this ordinance, the Investigation Committee of the Council may hold an inquiry against any member or student of the Institute who is alleged to have committed professional misconduct. Under Section 27(2)(s) the Council is empowered to make byelaws in respect of the matters relating to professional and other misconduct and the exercise of disciplinary power by it. Besides this there is no provision for a Statement of Ethics and Business Practices to be prepared and circulated within the Corporation to be understood and signed by the Directors as well as employees as is required by the Code. The rest of the laws do not seem to be specifically addressing this area. Conclusion: This is by and large a hitherto under-explored territory and the Code has taken an important step in this direction to formalize the formulation and pursuit of a statement of ethics and business practices by companies. 1.7
[
Prevention of Fraudulent Acts/Insider Trading
The Code This is not an area addressed specifically by the Code but has been included here as any mechanisms/provisions to prevent such actions are clearly another manifestation of the commitment of the Boards of Directors to the honest and ethical running of companies.
54
Ordinance and Related Laws

[
The Ordinance and Related Laws do not dwell upon any mandatory mechanisms under a specific heading, which the directors are required to employ for the prevention of the commission of fraud. The preventive measures for detection and prevention of fraud can be analyzed, however, under four heads, namely: Statutory Penalties. Under Pakistani law, these exist in the form of penalties which are expected to act as a deterrent against fraud, which are described below; The Control by Creditors and Shareholders through information made available to them. Also dealt with below are directors duties, and the disclosure and reporting requirements on part of the company, containing important disclosure requirements, which are the primary mechanism for shareholders and creditors to scrutinize the board and to detect the commission of any fraud; The Role of Auditors. Both the internal and external audit functions of a company play a cardinal role in the detection and prevention of fraud. These are discussed in the separate section dealing with audits; Insider Trading. This is a specific kind of fraudulent activity, which has become increasingly important to manage in recent years and is dealt with in detail below;
However, the Ordinance does contain some specific penalties for fraudulent acts, which are as follows: Penalty for fraudulently inducing persons to invest money. Section 66 of the Ordinance carries a penalty of up to three years imprisonment and up to a fine of Rs.20, 000 for anyone making any statement, promise or forecast which is untrue to induce other persons to acquire or dispose of shares (etc). Penalty for fraudulent entries or omissions from register of company. Section 153 lays down imprisonment of up to one year as a penalty.
Other Laws
[
Prevention of fraudulent activity in general and penalties Chartered Accountants Ordinance: Chapter VI of this Ordinance relates to the penalties prescribed for various unlawful acts which include: (i) falsely representing to be a chartered accountant or a member of the Institute or falsely representing to be holder of a certificate of practice, the person found guilty of any of these offence, on first conviction, is punishable with fine of Rs. 1,000/- and on any subsequent conviction with 6 months imprisonment or a fine of Rs. 5,000/-; (ii) using common seal of the Institute or the one resembling it so closely that it may cause deception, awarding of false degree, diploma or certificate, seeking to regulate the profession of chartered accountants. The person found guilty of any of these offences, on first conviction, is punishable with a fine of Rs. 1,000/- and on any subsequent conviction with 6 months imprisonment or a fine of Rs. 5,000/-; (iii) If any company which starts practicing as chartered accountants, every director, manager, secretary and any other officer thereof who knowingly takes part in this offence shall, on first conviction, be punishable with a fine of Rs. 1,000/- and on any subsequent with a fine of Rs. 5,000/- and; (iv) if any unqualified person, who is not a member of the Institute signs any document
55
on behalf of a chartered accountant, he shall be punishable with a fine of Rs. 1,000/- and on any subsequent conviction with 6 months imprisonment or a fine of Rs. 5,000/-. Under Section 25 a person can be prosecuted under this Ordinance only on a complaint made by or under the order of the Council or of the Federal Government. Modaraba Ordinance: Penalties for certain fraudulent acts. Under section 31 of the Modaraba Ordinance, whoever contravenes the provisions of Section 4, 13, 14, 16 or 17 (described below) shall be punishable with imprisonment for a maximum term of three years and a fine of maximum 500,000/-. In addition to this if such contravention causes any loss to the Modaraba or any other person then a further fine to the extent of such loss may also be imposed. Section 4: No Modaraba Company shall operate without registration with the Registrar under the Modaraba Ordinance. Section 13 says that allotment of Modaraba certificates only to be made after a prospectus approved by the Registrar has been duly issued and minimum amount stated therein has been subscribed. Furthermore, that money received from Modaraba applicants to be kept in the account of a scheduled bank until the Registrar satisfied that Modaraba certificates of minimum required amount have been allotted. It further deals with refund of money received through Modaraba certificates if the subscription therefor has not been received by the date specified in the prospectus, issuance of Modaraba certificates within 30 days from the date of allotment, maintenance of register of holders of Modaraba Certificates, maintenance of separate bank account, funds, assets and liabilities of each Modaraba. Section 14: Preparation and circulation of annual balance sheet, profit and loss account, report of auditors on the balance sheet and profit and loss account, report by the Modaraba company on the state of affairs, achievements and business prospectus of the Modaraba and the amount of profits to be distributed to the certificate holders. Furnishing of reports, as required, to the Registrar. Section 16: Prohibition to furnish false statements in any documents. Section 17: No Modaraba Company is to engage in any business, which is of the same nature and competes with the business carried on by a Modaraba floated or controlled by it. Modaraba Rules: Penalties for certain fraudulent acts. Under Rule 15, if it is shown that proper books of accounts were not kept in relation to the Modaraba, every director and officer of the Modaraba Company who is in default shall be criminally liable. Company Rules: Penalties for certain fraudulent acts. Rule 35 provides that failure or non-compliance of the Companies Rules, in addition to any other liability under the Ordinance, shall be punishable with a maximum fine of Rs. 2,000/- and in case of continuing failure a fine of Rs. 100 per day during its continuance. SE Ordinance: Section 15-A of the SE Ordinance defines an insider and the act of insider trading in more or less the same terms as contained in Para 3 of the Insider Trading Guidelines, discussed below. Under Section 15-B of the SE Ordinance, the SECP may ask a person accused of insider trading to show cause as to why he should not be required to compensate any person who has suffered loss as a result of insider trading. If the explanation given by the insider is not found satisfactory by the SECP then such person, in addition to his liability to compensate the sufferer, shall be punishable with the imprisonment for a term which may extend to three years or with a fine which may extend to three times the amount gained or loss avoided by such person.
56
Insider Trading Guidelines: The main objective of the Insider Trading Guidelines, a very recent legal initiative in this area, is to curb insider trading in the security markets. The Insider Trading Guidelines prohibit the use of unpublished price sensitive information by any person who at any time during the preceding six months has been associated with the concerned company either on his own or on behalf of someone else by dealing in such securities, disclosing such information to someone else or aiding him to deal in securities on the basis of such information (Para 3). The Insider Trading Guidelines define unpublished price sensitive information as the information concerning a company, which is not generally known or published by that company and is likely to materially affect the price of its securities. Any person found guilty of insider trading is liable to penal action under section 15-B of the SE Ordinance (Para 4). The Insider Trading Guidelines further provide that a person, dealing with the securities on the basis of unpublished price sensitive information shall be liable to compensate the person/entity suffering any loss or damage as a result of such transaction (Para 5). If the issuer of a security fails to obtain prosecution of an action commenced against a person guilty of insider trading then the SECP or the person affected by such insider trading may obtain sanction of the court to enforce the liability (Para 6). Under Para 7, the SECP may, on an application or suo moto, undertake to investigate into the books of accounts of an insider to check insider trading. The SECP may appoint an enquiry officer, who may be an auditor ([Para 12), for carrying out such investigation and the insider shall be under obligation to allow such officer access to his books and records etc. (Para 9). Before taking any action on the basis of any enquiry, the SECP is bound to give the insider an opportunity of being heard and also to consider the explanations, if any, given by him (Para 11). After receiving such explanation the SECP may, in order to protect the interest of investors and security markets and for due compliance of the SE Ordinance, restrain the insider from dealing in securities in any particular manner, or prohibit the insider from disposing of any of the securities acquired in violation of these regulations, or restrain the insider from communicating or providing counsel to any person in relation to dealing with the securities. Conclusion: The above is an overview of the various provisions of existing Pakistani law, which act as a deterrent against fraudulent acts and insider trading. These form a useful backdrop against which the Code is going to operate.
2. Powers and Duties of Executive Directors

The basic philosophy: The basic qualification requirements for directors are an important first check to ensure that inappropriate people are not entrusted with the fiduciary position of a director. Duties to disclose information on part of directors serve as the main mechanism for shareholders and creditors to remain abreast of the exact functioning and the performance of the directors. Furthermore, the quantity and quality of information disclosed determines their chances of detecting any foul play or conflict of interest, which may cloud the judgment and commitment to the welfare of the company of the directors. The quantity and quality of information which directors are obliged to communicate and the kind of activities they are precluded by law from engaging in are thus two important indications of the level of accountability control which the shareholders and creditors exercise over them. Specific proposals: The following are the specific areas of reform under the Code: Qualifications and Eligibility to Act as a Director. Tenure of Office.
57
2.1
Disclosure of Interest by Directors and Officers. Restrictions on Activities of Interested Director and Additional Prohibitions. Qualifications and Eligibility to Act as a Director
The Code The Code (Clauses iii, iv and v) supplements basic eligibility criteria provided in the existing law which are enumerated below, with some additional mandatory requirements for listed companies, non-observance of which lead to disqualification of an ineligible nominee or director. These requirements are briefly as follows: In order to be eligible to become a director, a person should (i) have his name present on the register of National Tax Payers, except where such person is a nonresident; and (ii) such a person should have no prior conviction by a court as a defaulter in payment of any loan. Additionally, the Code says that listed companies are to endeavour that no person is elected or nominated as director if he or his spouse are engaged in the business of stock exchange brokerage (unless specifically exempted by the SECP). Also, that no listed company shall have a director, a person who is serving as a director of ten other listed companies. These additional requirements are self-explanatory in terms of the kind of people they want to exclude from directorships of listed companies and the reasons for doing so. Ordinance and Related laws
[
Companies Amendment Ordinance amends Section 174 of the Ordinance. For our purposes it is important to note that it lays down that every Listed Company shall have not less than seven directors to be elected in a general meeting in the manner provided in the Ordinance. Section 187 of the Ordinance lays out some basic requirements for eligibility. These requirements pertain to requisite age, soundness of mind, solvency, absence of any conviction by a court for an offence involving moral turpitude, absence of an earlier debar from holding such office under the Ordinance and absence of any betrayal of lack of fiduciary behaviour with a declaration to that effect by a court and membership of company. Companies Amendment Ordinance introduces two new ineligibility criteria to the ones given under Section 187 above, which are: he has been declared by a Court of Competent jurisdiction as defaulter in repayment of loan to a financial institution (which definition has also been expanded by the Companies Amendment Ordinance under the amended Section 2(15A) of the Ordinance), exceeding such amount as may be notified by the Commission from time to time; and is a member of a Stock Exchange engaged in the business of brokerage, or is a spouse of such member. The additional clauses are only applicable to Listed Companies. This amendment brings the eligibility criteria under the Ordinance very much in line with the requirements of the Code. Other laws
[
It is instructive to take a look at some of the specific statutory regimes governing specialized statutory bodies which have dealt with in some detail with these matters. National Shipping Ordinance: Section 14(3) of the National Shipping Ordinance makes it a necessary qualification for an elected Director to hold shares in his own name of the nominal value of at least one thousand rupees. Section 17 of the Ordinance deals with the disqualification of Directors and
58
bars minors, lunatics/people of unsound minds, people adjudicated as insolvent, and people convicted of an offence involving moral turpitude from being Directors of the Corporation. Section 17(e) also disqualifies an elected Director who is also a Director of a company or a partner of a firm carrying on the business of shipping in Pakistan, or who is an employee of any such company or firm so as to prevent conflict of interest. A Director is also disqualified under clause (g) if he is absent from three consecutive Board meetings without leave of absence. Thus, the above provisions are fairly comprehensive and stringent in terms of ensuring that only capable and well-qualified individuals qualify and become responsible directors. Though, the eligibility criteria in this ordinance do not specifically contain the provisions of the Code as laid down above but then they can apply over and above what is already provided here. Also moral turpitude may include loan default. PIA Act: Section 9 of the Act bars people convicted of an offence involving moral turpitude, people adjudicated as insolvent, lunatics/people of unsound minds, and minors from being Directors of the Corporation. Section 9(2) also provides for disqualification of members of the salaried staff of the Corporation from being appointed or elected as Directors (this does not apply to the Managing Director, who is appointed by the Federal Government on its terms and conditions of service). Whereas Section 9(3) restricts those Directors from continuing in office who absent themselves from three consecutive Board meetings without the leave of the Chairman, or in the case of the Chairman, of the Federal Government. The same analysis applies here as the one given for the National Shipping Ordinance above. Pakistan Telecommunication Act: Under Section 11, the members and employees of the PTA are public servants within the meaning of the Pakistan Penal Code. Under Section 3(5) of the Act, a member of the PTA may be removed from his office if, on an enquiry by the Federal Public Service Commission, if he is found unable to perform the functions of his office because of mental or physical disability or misconduct including corruption and dishonesty. Under Section 3(4), a member of the PTA is barred from having any direct or indirect financial interest in, or have business connection with, any person, any establishment or firm which renders telecommunication services in Pakistan or abroad or supplies telecommunication equipments to any telecommunication sector in Pakistan or abroad. Furthermore, any involvement of the spouse or any blood relation of any member of the PTA with any telecommunication establishment or firm is considered as a direct financial interest or connection of the member with such establishment or firm. Thus, the PT Act, is quite strict in ensuring that only capable individuals with objective judgment become members of the PTA. The Code further enhances the existing eligibility criteria. Bank of Punjab Act: Section 12 prescribes qualifications and disqualifications of the Directors and Members elected by the Shareholders. These provisions do not apply to the NEDs appointed by the Federal Government. In order for a person to be eligible to act as a Director or Members: a. He should hold in his own right unencumbered shares of the Bank of the amount Rs. 25,000/b. He should not be a salaried officer of any Government, in or outside Pakistan and has not been authorized by the Federal Government to serve as a Director or Member. c. Should not have been convicted of any offence involving moral turpitude. d. His services should not have been terminated by the Bank, if he was in its service at any time.
59
e. Should not be a director of any commercial bank other than a bank sponsored or established by or under the authority of the Federal Government or the State Bank for the development of industry or agriculture, or a bank, which is a society registered under the Co-operative Societies Act, 1912. f. Should not be employed by any other banking company, whether on salary or on commission or for any other remuneration. g. Should not have been disqualified for membership of any body established by or under any law for the time being in force of which the constituent members are wholly or partly chosen through election. h. Should not have been found by any court to have acted against the interest of a person with whom he had a fiduciary relationship. While the above requirements are stringent and have a degree of overlap with the Code provisions, the Code provisions can further tighten these requirements. Chartered Accountants Ordinance: As per Section 9, in order to be eligible for being elected as a Member of the Council, the candidates must have a 5 years standing in the field of accountancy. There are no other requirements mentioned. Here especially, the Code provisions can further tighten these requirements. National Bank Ordinance: Section 17 prescribes qualifications and disqualifications of the Directors and Members elected by the Shareholders. These provisions also do not apply to the NEDs appointed by the Federal Government. In order for a person to be eligible to act as a Director or Members: a. He should hold in his own right unencumbered shares of the Bank of the amount Rs. 10,000/b. He should not be a member of the Federal or Provincial Legislature c. He should not be a salaried officer of any Government, in or outside Pakistan and should not be authorized by the Federal Government to serve as a Director or Member. d. Should not have been convicted. e. His services should not have been terminated by the Bank, if he was in its service at any time. f. Should not be a director of any commercial bank other than a bank sponsored or established by or under the authority of the Federal Government or the State Bank for the development of industry or agriculture, or a bank, which is a society, registered under the Co-operative Societies Act, 1912. g. Should not be employed by any other banking company, whether on salary or on commission or for any other remuneration. h. Should not have been disqualified for membership of an elective body under the Elective Bodies (Disqualification) Order 1959 or any other relevant law. i. His office as Director or Member should not have been vacated earlier, and three years should not have passed since then.
60
While the above requirements are stringent and have a degree of overlap with the Code provisions, the Code provisions can further tighten these requirements. Banking Companies Ordinance: Section 20 of this Ordinance enumerates situations in which a person may not be a director of a Banking Company. Though the Section is titled Prohibition of Common Directors it speaks of other situations also; e.g. a Federal Minister or a Provincial Minister may not be director in a Banking Company. Section 20 merely lists a limited type of disabilities i.e. those, which may hamper independent exercise of directorial duties in a company while Clause iii of the Code provides for a general disability and hence adds to the existing requirements of Section 20. Insurance Ordinance Section 6: By virtue of this Section no person may carry on insurance business in Pakistan without a certificate of registration issued by the SECP. Subsection (6) requires an application for registration to be accompanied by such documents, reports, certificates and other material as may be prescribed by rules under this ordinance, while subsection (8) lists the particulars that must accompany such an application. Under Section 7, the SECP shall satisfy itself as a condition precedent for granting a registration certificate, inter alia, that the applicant meets and is likely to continue to meet criteria for sound and prudent management (clause f of Section 7(1)) including criteria laid down in Section 12, and the applicant has appointed an auditor recognized by the SECP as appropriately qualified to audit the business of life or non life insurance as may be relevant (clause g of Section 7(1)). Subsection (7) of Section 7 further provides that the SECP, subject to certain limitations, may require a registered insurance company or a company seeking registration, to comply with further conditions prescribed by it provided they are not inconsistent with the provision of the Insurance Ordinance. Clearly, by the force of this section, it can be ensured that the auditors appointed by insurance companies meet the criteria and qualification stated in the Code as also various other provisions of the Code may be made applicable to Insurance Companies. Section 32 to 39 extensively deal with solvency requirements for insurance companies. Here too, the SECP has a substantial supervisory role by way of having authority to prescribe guidelines and issuing directions in various matters. State Bank Circulars: BPD circular No. 15 (Guidelines for ineligibility to act as Director of Bank/NBFI) stipulates that no person can become Director of Bank/NBFI unless he has a minimum holding of 10% or above in the Bank/NBFI where he intents to become nominee director. Circular BPD Letter No. 32 (Management/Board of Directors) State Bank of Pakistan has restricted the number of Directors of the same family on the Board of all Banks to a maximum of 25% of the total number of Directors. Conclusion: The eligibility criteria given in the laws above cover a lot of ground and the Code further adds to them to make eligibility criteria even tighter The above-mentioned amendment to the Ordinance, on the other hand, brings the eligibility criteria under the Ordinance very much in line with the requirements of the Code.
61
2.2
Tenure of Office
The Code The Code (Clause vi) affirms the existing tenure limit in the Ordinance by saying that the tenure of office of directors is to be three years and further says that any casual vacancy is to be filled up within thirty days. Ordinance and Related Laws
[
This is an area where the Ordinance gives a specific mandatory direction. Section 180 of the Ordinance states that a director elected under the provisions of the Ordinance shall hold office for a period of three years unless he resigns earlier, becomes disqualified from being a director or otherwise ceases to hold office. Other laws
[
It is instructive to take a look at some of the specific statutory regimes governing specialized statutory bodies which have dealt with in some detail with these matters. National Shipping Ordinance: Every appointed Directors tenure of office according to Section 15 (1) of the National Shipping Ordinance is three years from the date of appointment, although a Director may resign or otherwise be removed from office by the Federal Government before the expiry of his term. A Director shall also be eligible for re-appointment after his tenure of three years. An elected Directors tenure of office is also three years from the date of his election. After the expiry of his term, an elected Director is obliged to continue in office until his successor is elected, and is also eligible for re-election. PIA Act: Under Section 7 of the PIA Act, an appointed Directors term of office is three years unless sooner removed by the Federal Government. An appointed Director is eligible for reappointment for a further term or terms of such duration as determined by the Federal Government after three years. An elected Directors term of office is also three years and he continues in office after the expiry of his term until his successor is elected, and is also eligible for re-election. Pakistan Telecommunication Act: Section 3 (2) of the Pakistan Telecommunication Act states that the PTA will consist of three members appointed by the Federal Government for four years, and who will also be eligible for appointment for a similar term or terms. This is an area of contradiction with the Code and requires amendment to remove this conflict. Bank of Punjab Act: As per Section 10(1) of the Bank of Punjab Act, the Managing Director shall be appointed by the Government of Punjab for a period of at least three years and maximum five years, four Directors shall elected in a special meeting by the shareholders for a term of three years. Six directors to be appointed by the Government of Punjab can only hold office during the pleasure of the Government. No term is specified. Under Section 10, the Directors elected by the shareholders cannot be re-elected after a second consecutive term without a break of one term. There are thus contradictions with the Code, which require amendments to remove the conflict. Chartered Accountants Ordinance: Under Section 14 of the Chartered Accountants Ordinance, the tenure of Council, and its members, is four years. However, an existing Council continues to function as such until newly elected members come and take charge. There is thus a contradiction with the Code, which requires an amendment to remove the conflict.
62
National Bank Ordinance: Under Section 20 of the National Bank Ordinance, one third of the elected Directors shall stand retired who have been longest in the office. A Director appointed by the Federal Government, other than the Managing Director, shall hold office only during the pleasure of the Federal Government. This Ordinance does not seem to clearly specify the tenure of the elected Directors but it can be read to mean that the tenure is no more than three years though Directors may be retiring at different points in time, owing to their different dates of appointment. Banking Companies Ordinance: Section 15 of the Banking Companies Ordinance permits the State Bank of Pakistan to require a banking company to call a general meeting of its shareholders to elect in accordance with the voting rights permissible under the Ordinance, fresh directors and the banking company shall be bound to comply with such an order of the State Bank of Pakistan. Directors so elected shall hold office till the date that their predecessors would have if such election had not taken place. Clause vi of the Code fixes the tenure of directors as three years. An order by the State Bank of Pakistan under Section 15 would override this provision of the Code and hence an amendment to entrench the tenure limit laid down by the Code may be necessary. Section 15A: Under this overriding Section, the State Bank of Pakistan may appoint one person to be director of a Banking Company not withstanding that he or she does not hold any qualification shares. This section does not affect the provisions of the Code. Section 15B: This provides, inter alia, that a director of a Banking Company other than a Chief Executive or a person nominated under Section 15A shall not hold office for more than six consecutive years (the Chief Executive and a director under Section 15A may hold office for a longer period also). This implicitly allows a director to hold office for six years and thus violative of Clause vi of the Code, fixing the tenure of directors at three years. Once again an amendment is required to remove the conflict.
[
Conclusion: As can be seen from the analysis conducted above, some of the laws lay down tenure limits different from the three-year limit proposed by the Code. These conflicts require to be removed through requisite amendments. 2.3 Disclosure of Interest by Directors and Officers
The Code The Code has come up with some important disclosure requirements. Disclosure requirement for transactions in shares of the company. For listed companies, the Code (Clause xxvi) has come up with the further requirement that any director, chief executive, executive or their spouses selling, buying or taking any position, whether directly or indirectly, in the shares of a listed company of which he is director, chief executive or executive, as the case may be, is to immediately notify the Company Secretary of such intentions and deliver a written record of the price, number of shares, form of share certificates and nature of the transaction. Such notice will be presented by the Company Secretary at the meeting of the board of directors immediately subsequent to such transaction. Bar on transaction during closed period. There is also (Clause xxvi) a further provision requiring that each company determine a closed period prior to the announcement of interim/final results and any business decision, which may materially affect the market price of its shares, and no director,
63
chief executive or executive shall, directly or indirectly, deal in the shares of that company in any manner during the closed period. Ordinance and Related Laws As to disclosure requirements on part of directors, the Ordinance provides some important checks and balances. The following are the main requirements. Disclosure of interest by Directors and Officers. Directors and Officers are mandated by Sections 214 and 215 of the Ordinance respectively, to disclose the nature of their direct or indirect concerns or interests in any contract or arrangement entered into or to be entered into by or on behalf of the company. Other laws It is instructive to take a look at some of the specific statutory regimes governing specialized statutory bodies which have dealt with in some detail with these matters. Pakistan Telecommunication Act: Under Section 3(4) of the Act, a member of the PTA shall not have any direct or indirect financial interest in, or have business connection with, any person, any establishment or firm which renders telecommunication services in Pakistan or abroad or supplies telecommunication equipments to any telecommunication sector in Pakistan or abroad. Any involvement of the spouse or any blood relation of any member of the PTA (for the purposes of this sub-section), with any telecommunication establishment or firm is considered as a direct financial interest or connection of the member with such establishment or firm. None of the other laws seem to propose any relevant provisions in this area. Conclusion: Given the above, the provisions of the Code introduced in this area are an important addition. 2.4 Restrictions on activities of Interested Director and Additional Prohibitions
The Code There is no specific provision but this category has been added because the Ordinance and Related Laws have some important provisions pertaining to this, which contribute towards the ethical running of a company. Ordinance and Related Laws
[
Interested director not to participate or vote in the proceedings of directors. Section 216 of the Ordinance precludes discussion of or voting on any contract or arrangement in which the said director is, directly or indirectly, concerned or interested. A violation of the above sections can (apart from a financial penalty) lead to a court, declaring a director as lacking fiduciary behaviour, under Section 217 of the Ordinance. Disclosure to members of directors interest in contracts appointing chief executive, managing agent, whole-time director or secretary. Section 218 mandates such a disclosure and non-compliance lead to a fine. There are prohibitions under Section 223 of the Ordinance on short selling and under Section 224 of the Ordinance on trading (in listed companies) of listed equity securities within six months of
64
appointment on part of any director, Chief Executive, managing agent, chief accountant, secretary or auditor of a listed company or any person owning at least 10% beneficial interest in listed equity securities, either directly or indirectly. The authority given to the Federal Government and the Registrar have now been handed over to the SECP through an amendment to this section by the Companies Amendment Ordinance. Other Laws Insurance Ordinance: Section 37 provides for restrictions on grant of loans and temporary advances by an insurer to its directors, Chief Executive, appointed actuary and auditor as well as their family members except a loan secured by a life policy issued by the insurer of not more than eighty percent of the surrender value of that policy. Subject to the same exception, the section also prohibits grant of any loan or temporary advance to a firm or company in which a director, manager, officer, appointed actuary or auditor of an insurance company or any of their family member has any interest as proprietor, partner, director, manager or managing agent, unless two thirds of the total number of directors give prior approval for such a loan in a regularly convened meeting. The section also prohibits the director concerned from voting at such a meeting. This section further provides that if any event occurs which, if it subsisted at the time of the grant of loan or temporary advance, would have violated the above said provisions, the loan shall be payable within three months of such event happening failing which, in addition to other penalties to which director, Chief Executive, officer, manager, actuary or auditor may be liable, he/she shall also cease to hold the respective office. Section 38 provides that in addition to any other penalty as they may be liable to, every such person who is responsible for knowingly contravening Section 37 shall be liable to make good the loss suffered due to such contravention, jointly and severally. Under Section 46 every insurer is required to deliver to the SECP, its annual statutory accounts audited by an (SECP approved) auditor at the end of each year. An insurer is also required to furnish to the SECP, quarterly statements of assets and liabilities certified by the insurers principal officer. Section 47 requires an insurer to supply to the SECP, in the manner prescribed, such number of additional copies as may be prescribed, of accounts, documents, reports and returns as are required to be filed under the Ordinance at the same time as are required thereunder. Under Section 53 every insurance company is required to furnish to the SECP, by this section, a copy of every report on its affairs, which is submitted to the members or policyholders immediately after it is so submitted. Section 54 requires every insurance company to furnish to the SECP minutes of the proceedings of every general meeting as entered in its Minutes Book within thirty days of the meeting to which it relates. The other laws do not seem to directly speak about this but address it indirectly through the qualification requirements for Directors. Conclusion: The above are important restrictions on the activities of interested directors and form the backdrop against which the Code is to operate.
65
3. Role of Non-Executive Directors (the NEDs) and the Corporate Secretary

The basic philosophy: The Cadbury Report and the Combined Code attach special importance to the role of the NEDs. They visualize the NEDs as performing two significant functions, namely: (1) A careful independent review of the performance of the Board and of the Chief Executive and an insurance that the Chairman (if the Chairman is also the Chief Executive, then a senior nonexecutive director) is aware of their views addressed to him regarding any concerns which they may have; and (2) Taking the lead where potential conflicts of interest arise with the recognition that the specific interests of the executive management and the wider interests of the company may at times diverge e.g. over takeovers, boardroom succession, or directors pay. According to the Cadbury Report and the Combined Code, the calibre of the non-executive members of the board is of special importance in setting and maintaining standards of Corporate Governance. NEDs are expected to bring an independent judgement to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct. The Cadbury Report discusses in detail, various aspects of the role and rights of NEDs such as the desirable term in office, calculation of remuneration, the process of selection and the access to information. A brief synopsis of these recommendations would be useful to then use as a standard to gauge the situation in Pakistani corporate environment. The additions made to this by the Combined Code have already been described in Chapter 3. a. Term in office: NEDs should be appointed for specified terms so that they do not lose their independent edge (which could be the case if they remain on a board too long). Their letters of appointment should set out their duties, terms of office, remuneration and its review. Reappointment should not be automatic, but a conscious decision by the board and the director concerned. b. Process of selection: Given the importance of their distinctive contribution, NEDs should be selected with the same impartiality and care as senior executives. Their appointment should be a matter for the board as a whole and there should be a formal selection process, which will reinforce the independence of NEDs and make it evident that they have been appointed on merit and not through any form of patronage. c. Remuneration: On fees, a balance should be struck between recognizing the value of the contribution made by NEDs and not undermining their independence. In order to safeguard their independent position, it as good practice for NEDs not to participate in share option schemes and for their service as NEDs, not to be pensionable by the company. d. Access to information: As to their right to access information, since NEDs lack the inside knowledge of the company of the executive directors, but have the same right of access to information as they do, their effectiveness depends considerably on the quality of information which they receive and the use which they make of it. Boards should regularly review the form and the extent of the information, which is provided to all directors. Specific proposals: The following are the specific areas of reform under the Code: Required Number of NEDs in a Board, Term in Office, and Process of Selection Remuneration, Functioning, and Access to Information Qualifications, Appointment, and Role of Company Secretary Qualifications, Appointment, and Role of Chief Financial Officer
66
3.1 Required Number of NEDs in a Board, Their Term in Office, and Process of Selection The Code
[
The Code (Clause i-a) takes some progressive and highly significant steps in this direction by encouraging listed companies to ensure effective representation of independent NEDs, including those representing minority interests, on their Boards of Directors. The Code visualizes and lays out certain helpful procedural steps to ensure that minority shareholders as a class are facilitated to contest election of directors by proxy solicitation. Additionally, the Code (Clause i-b) recommends that the Boards of Directors of listed companies include at least one independent director representing institutional equity interest of a banking company, Development Financial Institution, Non-Banking Financial Institutions (including a modaraba, leasing company or investment bank), mutual funds and insurance companies. An independent director in this context is defined to mean a director who is not connected with the listed company or its promoters or directors on the basis of family relationship and who does not have any other relationship, whether pecuniary or otherwise, with the listed company, its associated companies, directors, executives or related parties. Such an independent director is to be selected by such investor through a resolution of its Board of Directors and the policy for such selection for election on the Board of Directors of the investee company is to be disclosed in the Directors Report of the investor company. It is further recommended by the Code (Clause i-c), that for listed companies, the executive directors (working or whole-time directors) be not more than 75% of the elected directors including the Chief Executive. It must be noted that unlike all the other requirements in the Code, which are mandatory, the provisions pertaining to having NEDs on boards of directors of listed companies, are on a voluntary adoption basis and just a recommended best practice. Since the idea of introducing NEDs in Pakistani companies is still in relative infancy, the Code does not at this stage go into the further details pertaining to NEDS, which the Cadbury Report and the Combined Code discuss. Ordinance and Related Laws The Ordinance and Related laws do not visualize and provide for a role for NEDS and are silent on the subject. Other Laws
[
The statutory regimes analyzed in this study do not address the appointment and role of NEDS in the sense of Clause i (b) of the Code. They do, in most cases make provision for directors appointed by the Federal or Provincial Government along with directors elected by the shareholders, as discussed in the earlier sections of this report. So that extend there are two kinds of directors who man their boards. Most of these laws also propound that the directors are expected to attach independent and objective judgment. Conclusion: This is a significant area under the Code and it could be argued that the Ordinance and Related Laws should perhaps be revisited to provide for statutory provision for the incorporation of NEDS in companies. However, there are persuasive arguments against such a step as well which are discussed in Chapter 6.
67
3.2
Remuneration, Functioning, and Access to information
The Code The Code does not go into any details regarding this. Ordinance and Related Laws
[
As already mentioned, the Ordinance and Related Laws do not visualize NEDS in their scheme of things. Other laws The statutory regimes analyzed in this study do not address the appointment and role of NEDS in the sense of Clause i (b) of the Code. They do, in most cases make provision for directors appointed by the Federal or Provincial Government along with directors elected by the shareholders, as discussed in the earlier sections of this report. So, there are two kinds of directors who man their boards. Most of these laws also propound that the directors are expected to attach independent and objective judgment. Conclusion: This does not require any further comment in view of what has been stated above in the conclusions pertaining to Section 3.1 of this Report. 3.3 Qualifications, Appointment and Role of Company Secretary
The Code The Code takes an important step in this direction, as discussed below. The Code looks upon the office of the Company Secretary as an important one and propounds that it should be occupied by a distinct individual. The Code (Clause xv) takes initiative in this area by formalizing the appointment and qualification requirements of the Company Secretary. The Code requires that the Company Secretary be appointed and his remuneration, terms and conditions of employment as well as removal be determined by the Chief Executive with the approval of the board of directors. Qualifications of Company Secretary: The Code (Clause xvii) requires that a Company Secretary be (a) a member of a recognized body of professional accountants; or (b) a member of a recognized body of corporate/chartered secretaries; or (c) a lawyer; or (d) a graduate from a recognized university or equivalent, having at least five years experience of handling corporate affairs of a listed public company or corporation. Additional important task for Company Secretary: The Company Secretary (Clause xii) is required to play an additional specific and important role, which is that in the event the director of a listed company is of the view that his dissenting note has not been satisfactorily recorded in the minutes of a meeting of the board of directors, he may refer it to the Company Secretary, requiring that the note be appended to such minutes (failing which he may file an objection with the SECP). Attendance of meetings: The Company Secretary is required by the Code (Clause xviii) to attend meetings of the board of directors.
68
Ordinance and Related Laws While Company Secretaries exist in the Pakistani corporate environment, the Ordinance and Related laws do not specifically deal with the appointment and duties of the Company Secretary. Companies Amendment Ordinance, however, introduces a new Section 204 A to the Ordinance which says Section 204 A .Certain companies to have secretaries. A Listed Company shall have a whole time secretary and a single member company shall have a secretary possessing such qualifications as may be prescribed. This amendment thus provides statutory protection to the initiative taken by the Code in this direction.
[
Other laws Chartered Accountants Ordinance: Formalization of appointment of the Company Secretary and the CFO . Under Section 16, the Council, for efficient performance of its duties, may appoint a full time Secretary who may also act as Treasurer. The Council may also require the Secretary to furnish a security for due performance of his duties. Salary, fees, allowances and other conditions of Secretarys service are also to be fixed by the Council. The precise duties of the Company Secretary are not elaborated upon in this Ordinance. The following eligibility criteria have been laid out for the Secretary of the Council requiring that he be a: a. a member of a recognized body of professional accountants; or b. a member of a recognized body of corporate/chartered accountants; or c. a graduate having 5 years experience of handling corporate affairs; or d. a lawyer. The above provisions are exactly in conformity with the Code. The other laws looked at do not address the appointment and role of the Company Secretary. Conclusion: The formalization of the role of the Company Secretary by the Code is an important step and will fill an existing void in this area. The aforementioned amendment to the Ordinance goes on to provide statutory protection to the initiative taken by the Code in this direction. 3.4. Qualifications, Appointment, and Role of Chief Financial Officer The Code The Code (Clause xv) takes initiative in this area by formalizing the appointment and qualification requirements of the Chief Financial Officer (CFO), an office, which the Code considers important and prescribes that should be occupied by a distinct individual. The Code requires that the CFO be appointed and their remuneration, terms and conditions of employment as well as removal be determined by the Chief Executive with the approval of the board of directors. Qualifications of CFO: As to the qualifications of the CFO, the Code (Clause xvi) requires that he be either, (a) a member of a recognized body of professional accountants; or (b) a graduate from a recognized university or equivalent, having at least five years experience in handling financial or corporate affairs of a listed public company or a bank or a financial institution.
69
Attendance of meetings: The CFO is required by the Code (Clause xviii) to attend meetings of the board of directors. Ordinance and Related Laws While CFOs exist in the Pakistani corporate environment, the Ordinance and Related Laws do not specifically deal with the appointment and duties of the CFO. Other Laws The other laws looked at do not address the appointment and role of the CFO. Conclusion: The formalization of the role of the CFO by the Code is an important step and will fill an existing void in this area.
4. Financial Reporting and Disclosure Requirements

The basic philosophy: The International Corporate Governance Reports underline the advantages to investors, analysts, and other account users and ultimately to the company itself of financial reporting rules which limit the scope for uncertainty and manipulation. They emphasize that the lifeblood of markets is information and barriers to the flow of relevant information represent imperfections in the market. What shareholders (and others) need from the report and accounts is a coherent narrative, supported by the companys performance and prospects. The cardinal principle of financial reporting is that the view presented should be true and fair. Boards should aim for the highest level of disclosure consonant with presenting reports, which are understandable, while avoiding damage to their competitive position. Boards should also aim to ensure the integrity and consistency of their reports and they should meet the spirit as well as the letter of reporting standards. Specific proposals: The following are the specific areas of reform under the Code: Nature, Quality, and Frequency of Financial Reporting. Additional Rights of Shareholders to get Information from the Company. Nature, Quality, and Frequency of Financial Reporting
The Code Further formalization of the issuance of financial statements: The Code (Clause xxiv) tightens and augments the existing provisions in this area by requiring that a listed company cannot circulate its financial statements unless the Chief Executive and the CFO present such statements, endorsed under their signatures, for consideration and approval by the board of directors and the board after such consideration and approval, authorizes their issuance and circulation. In addition to this, the Company Secretary is required to furnish a secretarial compliance certificate with the Registrar to certify that the secretarial and corporate requirements of the Ordinance have been duly complied with. The Code (Clause xix) further bolsters the categories of information to be provided under a Directors Report under Section 236 of the Ordinance by requiring that it provide statements to the effects that: a) the financial statements of the company present a fair picture;
70
b) proper books of account have been maintained; c) appropriate accounting policies have been consistently applied; d) international accounting standards, as applicable in Pakistan, have been followed; e) a sound internal control system has been effectively implemented and monitored; f) the listed company can continue as a going concern, beyond significant doubt; and g) there has been no departure from the best practices of Corporate Governance, as detailed in the amended listing regulations of the stock exchanges after the introduction of the Code. The Code further requires additional disclosures, where necessary, which pertain to diverse areas such as key operating and financial information and deviations, dividends, taxes, corporate plans and decisions, investments, director attendance at board meetings, pattern of shareholding and trading in shares of company by directors, chief executive, other executives and their spouses and minor children. Additional requirements including submission of quarterly reports: The Code (Clauses xx, xxi, xxii and xxiii) takes the disclosure requirements a huge step further by requiring, inter alia, (a) publication and circulation of quarterly unaudited financial statements along with directors report; (b) limited scope review of half-yearly financial statements by statutory auditors in a manner approved by the SECP; (c) immediate dissemination to the SECP and stock exchanges, of all such material information relating to business and other affairs of company that will affect its market price (the Code lists potential areas such information may relate to). Ordinance and Related Laws The Ordinance provides a regime of detailed financial disclosure requirements on part of a company. The following are the main requirements. Annual accounts and balance sheet: Section 233 of the Ordinance mandates the presentation by directors of a balance sheet and a profit and loss account at every annual general meeting. These reports are to be accompanied by a proper auditors report and a directors report which is then required to be sent to every member of the company and specified number of copies are required to be sent to the SECP, the stock exchange and the Registrar. The Ordinance also addresses the quality of information to be disclosed. Contents and preparation of balance sheet and profit and loss statements: Section 234 of the Ordinance states that the contents of the balance sheet should give a true and fair view of the affairs of the company and the profit and loss account/income and expenditure statement should give a true and fair view of the profit and loss/income and expenditure of the company for the financial year. Detailed standard schedules (provided in the Ordinance) are required to be followed in the preparation of these financial statements. In the case of listed companies, International Accounting Standards notified by the SECP in the Official Gazette are to be followed. Furthermore, a statement of changes in the financial position or statement of sources and application of funds is to form part of the balance sheet and profit and loss account. Accounting policies are required to be stated and if there is any change in such policies, auditors are to report whether they agree with such a change. The Ordinance also mandates the preparation of Directors Reports. Directors Report: Section 236 of the Ordinance requires such reports for public companies or private companies which are subsidiaries of a public company, to disclose, inter alia, (while stating the
71
companys affairs, recommended dividends etc.,) (i) any material changes and commitments affecting the financial position of the company; (ii) any material changes that have occurred during the financial year concerning the nature of the business of the company or in the classes of business in which the company has interest; (iii) full information and explanation as regards any reservation, observation, qualification or adverse remark contained in the auditors report; (iv) information about the pattern of holding of shares; (v) earning per share information; (vi) reasons for incurring loss and reasonable indication of future profit prospects; and (vii) information about defaults in payment of debts, if any, and reasons thereof. The penalties for violation of the above section have been enhanced by an amendment brought about by the Companies Amendment Ordinance which also now requires a similar a report from directors of a holding company preparing consolidated financial statements. The extensive amendments to Section 237 of the Ordinance are also very noteworthy in this regard. The Ordinance contains a specific provision as regards submission of half-yearly financial statements for listed companies. Preparation of Half-Yearly Statements: Section 245 of the Ordinance mandates listed companies to prepare (audited or otherwise) half-yearly profit and loss accounts as well as balance sheets. This has now been amended by the Companies Amendment Ordinance to read as quarterly instead of half yearly. Authority of SECP to require additional information from companies: Section 246 of the Ordinance gives SECP the authority to require companies to prepare and send to members, Registrar etc; such other periodical statements of accounts, information or other reports in such form and manner and within such time as may be specified by it. Other Laws It is instructive to take a look at some of the specific statutory regimes governing specialized statutory bodies which have dealt with in some detail with these matters. (a) Nature, quality and frequency of financial reporting National Shipping Ordinance: Section 31 of the National Shipping Ordinance requires the Corporation to maintain its accounts as prescribed under the Ordinance and the SE Ordinance. Whereas, Section 32 of the National Shipping Ordinance deals with an annual report on the conduct of the Corporations affairs for that year, which is to be furnished by the Corporation to the Federal Government after the end of every financial year in such form and in such manner as laid down by the rules. The scope of financial reporting under this law is thus to be seen as what is already provided in the general law of companies i.e. the Ordinance. PIA Act: Under Section 16(4) of the PIA Act, the auditors are required to report to the shareholders upon the annual balance sheet and accounts, In that report, the auditors must state whether in their opinion the balance sheet is a full and fair balance sheet containing all necessary particulars and properly drawn up so as to exhibit a true and correct view of the state of the Corporations affairs and in case they have called for any explanation or information from the Board, whether it has been given and whether it is satisfactory. Section 17 (1) of the PIA Act provides that a statement of the Corporations accounts audited by the auditors and a report by the Directors on the statement of its accounts is to be furnished to the Federal Government by the Corporation within seven months of the close of every financial year. Section 17(2) states that the statement and the report must be put before the National Assembly as soon as the Federal Government receives them.
72
Pakistan Telecommunications Act: According to Section 18 (1) of the Pakistan Telecommunication Act, the PTA is to submit a report to the Federal Government on the conduct of its affairs, including action taken for protection of consumers interests after the end of every financial year but before the last day of the following September. Under sub-section (2) a copy of this report along with a copy of the audit report is to be placed before the National Assembly within three months after the finalization of the audit report by the Auditor-General. Whereas sub-section (3) states that the above-mentioned reports may be scrutinized and examined by the Public Accounts Committee of the National Assembly. The Federal Government may also require the PTA to supply any return, statement, estimate, statistics or other information in respect of any matter under the control of the PTA or a copy of any document in the custody of the PTA. These are fairly stringent checks on the PTA to ensure transparent and timely financial reporting which the additional provisions in the Code can further bolster. (b) Directors Report
National Shipping Ordinance: Section 33(3) of the National Shipping Ordinance mentions the annual report of the Board of Directors on the working of the Corporation but does not delve into the specifics of the report, which is found in Clause xix of the Code. PIA Act: Section 18(2) of the PIA Act also mentions the annual report of the Board of Directors on the working of the Corporation. In addition to this, however, under Section 17(1) a further report by the Directors on the statement of accounts audited by the auditors is required. There is no mention of the specific contents of the reports, as enumerated in Clause xix of the Code. (c) (d) Who is responsible for financial reporting and corporate compliance Annual accounts and balance sheet
National Shipping Ordinance: Section 31 of the National Shipping Ordinance provides for the maintenance of accounts in terms that the Corporation is responsible for maintaining its accounts as may be required for a Company under the Companies Ordinance of 1984 (Sections 230-247) and the Securities and Exchange Ordinance of 1969 (Section 6). Section 33(3) of the National Shipping Ordinance which extends the power of shareholders to discuss, adopt or make recommendations to the Board vis-a vis the annual accounts and auditors report on the annual balance sheet and accounts of the Corporation, is relevant here. PIA Act: As mentioned before, Section 16, subsections (3) and (4) are applicable here. Section 17 (1) of the PIA Act provides that a statement of the Corporations accounts audited by the auditors and a report by the Directors on the statement of its accounts is to be furnished to the Federal Government by the Corporation within seven months of the close of every financial year. Sub-section (2) of Section 17 states that the statement and the report must be put before the National Assembly as soon as they are received by the Federal Government. PTA Act: Under Section 12 of the PT Act, the PTA has to prepare its own budget in respect of each financial year and submit it to the Federal Government three months before the commencement of every financial year. Under sub-section (2), the budget statement is to specifically state the estimated receipts and expenditure and the sums which are likely to be required by the PTA from the Federal Government for the relevant financial year. Whereas sub-section (3) deals with surplus and deficit vis--vis the actual expenditure in a year.
73
Under sub-sections (7) and (8) of Section 41 of the PTA Act, the NTC has to prepare its own budget in respect of each financial year and submit it for the approval of the Federal Government before the first of June every year. The budget statement is to specifically state the estimated receipts, current and development expenditure and the sums, which are likely to be required by the NTC from the Federal Government for the relevant financial year. (e) All investment made by a company on its own behalf to be held in its own name. Record to be maintained of shares and securities invested in by a Company
National Shipping Ordinance: Section 28 of the National Shipping Ordinance focuses on investment of funds of the Corporation. On approval of the Board of Directors, the Corporation may invest its funds in any securities of the Federal Government or a Provincial Government, and may make other such investments. However, there are no requirements as to the investment to be held in the Corporations own name nor for any record to be maintained. PIA Act: Section 14 of the PIA Act states simply the Corporation may invest its funds in any securities of the Federal or Provincial Government. (f) Maintenance of proper book of accounts by the Company.
PTA Act: Section 14 of the PTA Act deals with maintenance of accounts and provides that the accounts of the Authority are to be maintained in such form and in such manner as the Federal Government may determine in consultation with the Auditor-General of Pakistan. Sub-section (12) of section 41 of the PTA Act states that the accounts of the NTC are to be maintained in such form and manner as the Federal Government may determine in consultation with the Auditor-General of Pakistan who shall be responsible for audits of the accounts of NTC. Modaraba Ordinance: Under Section 14, the Modaraba Company is required to prepare and send to holders of Modaraba Certificates the following documents within six months from the close of the accounting year: (i) annual balance sheet and profits and loss account in such form and manner as may be prescribed; (ii) auditors report on the balance sheet and profit and loss account; (iii) companys report on the state of affairs, activities and business prospects of the Modaraba and the amount of profits; (iv) in addition to these, any other reports, accounts and information as may be required by the Registrar. Section 16 of this Ordinance prohibits the furnishing of false statements and lays out penalties for such an act. In addition, since the Ordinance applies to Modaraba Companies, the disclosure requirements under the Ordinance become applicable here. Modaraba Rules: Nature, quality and frequency of financial reporting Under Rule 8, Modaraba Companies are required to keep proper books of account for each Modaraba which should contain all sums of money received and expanded by the Modaraba and the matters in respect of which the receipt and expenditure takes place, all sales and purchases of goods by the Modaraba and the assets and liabilities of the Modaraba. The books of accounts are required to be kept at the registered office of the company or at any other place authorized by the Registrar.
74
Under Rule 9, the annual report (furnished under section 14 of the Modaraba Ordinance) must include a balance sheet and a profit and loss account and a statement of changes in financial position in respect of each Modaraba and fullest information and explanations in regard to any reservation, observation, qualification or adverse remarks contained in the auditors report. Under Rules 10 & 11, Every Modaraba Company is required to prepare half-yearly and annually a profit and loss account, balance sheet and a statement of financial changes and send the same to the Registrar as well as to the Certificate Holders. Under Rule 12 the above-mentioned three documents are required to be signed by the Chief Executive and two directors of the Company. (g) Who is responsible for financial reporting and corporate compliance
Chief Executive and the Directors under Rule 12 are required to sign the financial reports and comply with other such mandatory requirements. Contents and preparation of balance sheet and profit and loss statements The Third Schedule to the Modaraba Rules, requires Modaraba Companies to fulfil various requirements as to Balance Sheet, Profit and Loss Accounts and Auditors reports etc. These provisions are more specific and are more in consonance with the Code of Corporate Governance as compared to other statutes. SE Rules: Nature, quality and frequency of financial reporting Rule 4 of the SE Rules requires a member to maintain chronological record of the transactions (orders to buy or sell securities) made by him in the register. Particulars to be recorded in the register shall include the name, address of the person who placed the order, the name and number of the securities to be bought or sold or the period for which the order is to be valid. Under Rule 9 the stock exchanges are required to furnish periodical returns with the SECP within 15 days of the close of the month to which it relates. (h) Annual accounts and balance sheet
Under Rule 5, every Member is required to prepare a yearly balance sheet and a statement of income and expenditure. Under Rule 10 every stock exchange is required to furnish the annual report relating to affairs of stock exchanges, not less than 14 days before the meeting of the shareholders of such stock exchange, before whom the report is to be presented.
[
(i)
Who is responsible for financial reporting and corporate compliance
Members of Stock Exchanges under Rule 4 and by every stock exchange itself under Rule 7. Insurance Ordinance: Under Section 8, any person may, by payment of prescribed fees and expenses inspect and obtain copies of the material filed by an insurance company under Section 6. Section 55 provides that returns furnished to the SECP or certified copies thereof shall be open to inspection and copies thereof may be procured by any person on payment of prescribed fees. An insurer is required to supply to a shareholder or policy holder, printed or certified copies of the accounts, statements, and report furnished under Section 46 within fourteen days on an application made within two years from the date on which such document was furnished.
75
Under Section 68, when the approval of the Court is sought for an amalgamation or transfer scheme of a life insurance business, notice of the intention to make such an application to the Court together with the nature of the amalgamation or transfer along with reasons thereof shall be sent to the SECP at least sixty days before the making of an application. The SECP shall also be furnished with certified copies of a. a draft of the instrument under which it is proposed to effect the amalgamation or transfer b. statements of assets and liabilities in prescribed form relating to each insurer concerned in the amalgamation or transfer c. actuarial report on the financial conditions of each insurer concerned in the amalgamation and transfer d. a report on the proposed amalgamation or transfer, by an independent actuary who has never been professionally associated with any party concerned e. any other reports on which the scheme of amalgamation or transfer was founded. The above documents shall be kept for inspection by policyholders and shareholders at the principal office, branch offices and chief agencies of the insurers concerned for the next sixty days before the application is made to Court. Conclusion: It can be seen from the above analysis that existing law mandates many disclosure requirements, which are further supplemented and tightened by the requirements introduced by the Code. There are areas of overlap as far as some statutory regimes are concerned. One potential issue though is whether some of the additional requirements introduced by the Code may prove to be too onerous for the smaller listed companies in Pakistan. This issue is discussed in Chapter 6. 4.2 Additional Rights of Shareholders to get Information from the Company The Code There is nothing additional in the Code pertaining to this. Ordinance and Related Laws The following are some other disclosure requirements under the Ordinance, which give specific rights to the members of a company to have access to information. All these are tools for shareholders and creditors (when applicable) to remain informed as to how the company is being run and to protect their respective rights. Copies of updated memorandum and articles of the company: Sections 35 and 36 of the Ordinance require the Company to provide the same, upon request, within fourteen days of such a request. Right to inspect copies of instruments creating mortgages and charges and the companys register of mortgages: Section 136 of the Ordinance provides this right to members, creditors and other persons during prescribed times and a defaulting company faces penalties. Register of Members and Debenture Holders: Sections 147 and 149 of the Ordinance require a company to maintain a register of members and a register of debenture holders in the prescribed form. Section 150 of the Ordinance mandates that these registers be open to inspection at prescribed times and default entails penalties.
76
Requirement on part of a company to file annual list of members with the Registrar: Section 156 of the Ordinance mandates this and default carries a penalty. Minutes of proceedings of general meetings and meetings of directors: Section 173 of the Ordinance mandates the maintenance of books containing this information, which are open to the inspection of members at prescribed times. The Companies Amendment Ordinance also introduces additional language here, which is A copy of the minutes of meeting of the board of directors shall be furnished to every director within fourteen days of the date of the meeting. Register of directors and other officers: Section 205 of the Ordinance mandates the maintenance by companies of a regularly updated register of their directors and officers, at its registered office, which is to be open to inspection of members and other persons at prescribed times. All investments made by a company on its own behalf to be held in its own name: Record to be maintained of shares and securities invested in by a Company. Permissible investments under Section 209 of the Ordinance are required to be recorded and open to the inspection of members, debenture-holders and creditors, during prescribed times. Maintenance of Register of contracts, arrangements and appointments in which directors, etc are interested: Section 219 of the Ordinance mandates the maintenance of such a register, open to inspection of members of the company during prescribed times. Register of directors shareholdings: Section 220 of the Ordinance requires every listed company to maintain a register as respects each director, chief executive, managing agent, chief accountant, secretary or auditor of the company and every person holding at least ten percent of the beneficial interest in the company, the number, description and amounts of any shares in or debentures of the company and other related entities, which are held by him or in trust for him etc. Such register is to be open to inspection during prescribed times. It is the duty of directors etc to make disclosures to the company under Section 221 of the Ordinance for it to comply with the requirements of Section 220 of the Ordinance. Maintenance of proper book of accounts by the Company: Section 230 of the Ordinance requires that the books give a true and fair view of the state of affairs of the Company in order to qualify as proper. These are to be open to inspection by directors during business hours. The penalties for default of this section have been increased by an amendment brought about by the Companies Amendment Ordinance. The right of every member of a company to acquire from the company, on payment of a prescribed maximum sum, copies of balance sheet, income statement, directors and auditors reports: Section 243 of the Ordinance gives this right to the members and Section 247 of the Ordinance gives the same right to debenture holders. The Ordinance contains the following provisions relating to this area. Annual General Meetings: Section 158 of the Ordinance mandates that every company is to hold, in addition to any other meetings, a general meeting, as its annual general meeting, within eighteen months of its incorporation and thereafter once at least in every calendar year within a period of six months (amended to four months by the Companies Amendment Ordinance) following the close of its financial year and not more than fifteen months after the holding of its last preceding annual general meeting. For listed companies, the SECP, and for other companies, the Registrar may for any special reason extend the time within which any annual meeting, not being the first such meeting, shall be held by a period not exceeding ninety days (amended to sixty days by the Companies Amendment Ordinance).
77
Extraordinary General Meetings: Section 159 of the Ordinance, as more briefly described above, allows the directors to at any time call such a meeting to consider any matter which requires the approval of the company in a general meeting and on the requisition of members representing at least one-tenth of the voting power on the date of the deposit of the requisition, they are required to forthwith proceed to call an extraordinary general meeting. The requisitionists, or a majority of them in value, may themselves call a meeting, if the directors do not proceed within twenty-one days from the date of the requisition being so deposited to cause a meeting to be called. Any default entails penalties. Power of Registrar to call meetings: Section 170 gives the Registrar the power to call, inter alia, any annual general meeting or extraordinary general meeting, if there has been a default in the holding of any such meetings, either of his own motion or on the application of any director or member of the company and there is a penalty for any default in complying with the Registrars directions. The Companies Amendment Ordinance has amended the above Section so that the word Registrar has now been replaced with the word Commission i.e. the SECP and hence SECP now enjoys this power. A corresponding change has also been made to Section 171 of the Ordinance, which deals with penalties for default pertaining to Section 170. Other Laws
[
Chartered Accountants Ordinance: Under Section 18 of the Ordinance, the Council is required to maintain a Register of the Members of the Institute in the prescribed manner. The Council has also been given the power to add as well as remove the name of a Member from the Register of Member. The Council may reinstate the name of Member removed by it for any reason. Modaraba Ordinance: Under Section 13 of the Modaraba Ordinance, every Company is required to maintain a register of holders of Modaraba Certificates in the prescribed form. Modaraba Rules: Under Rule 22, Modaraba Companies are required to maintain a register of Certificate-Holders in the manner required in respect of register of shareholders under the Ordinance. Under Rule 14, Modaraba Companies are required to furnish information about the pattern of holding of certificates by subscribers with the Registrar. Rule 23 requires that every Modaraba Company shall make an annual list of its Certificate Holders, which should also contain particulars of such holders. Under Rule 24, Certificate holders or any other person may inspect the Register of certificate holders and may also require its copy. Under Rule 27, Modaraba Companies are required to get the mortgages and charges registered. In case of non-registration the same are considered to be void. Under Rule 14, the companies are required to circulate, along with the annual accounts, information about the pattern of holding of the certificates by the certificate-holders. SE Rules: Under Rule 8, every stock exchange is required to prepare and maintain such books of accounts and other documents, which could disclose a true and fair picture of the state of affairs of the exchange at any point of time. The members of stock exchanges are also required to maintain books of accounts and other documents for the same purposes under Rule 8. Conclusion: The above analysis supplements the analysis of the disclosure requirements under Pakistani law conducted in Section 4.1 of this Report. It is meant to visualize the existing regime of
78
access to meaningful information on part of shareholders in order to exercise better control over the running of the company. The additional disclosure provisions in the Code have to be gauged in this context and once again the issue as to whether some of the additional requirements introduced by the Code may prove to be too onerous for the smaller listed companies in Pakistan becomes relevant. This issue is discussed in Chapter 6.
5. The Role of Internal and External Auditors

The basic philosophy: The Cadbury Report and the Combined Code attach great importance to the audit dimension of Corporate Governance. In this direction, they essentially give recommendations for the audit function to be strengthened at three different levels, namely: Audit Committees; Internal Audit Function; and External Auditors.
It would be useful to give a brief synopsis of these recommendations in order to better gauge the legal regime pertaining to auditing in Pakistan. Audit Committees The Cadbury Report regards audit committees as an important safeguard against the commission of fraud in a company. According to it, the audit committees have an important role to play in considering whether any extra work should be undertaken in addition to the normal audit procedures to investigate defenses against fraud, and in reviewing reports on the adequacy of internal control systems. The audit committee also provides a forum in which auditors can discuss at board level any concern they may have about the possibility of fraud by senior management. It is the responsibility of boards to establish what their legal duties are and to ensure that they monitor compliance with them. This would be enhanced if the auditors role were to check that boards had established their legal requirements and that a working system for monitoring compliance was in place. The Cadbury Report goes into great detail as to their creation and functioning. It states that (a) audit committees should be formally constituted to ensure that they have a clear relationship with the board to whom they are answerable and to whom they should report regularly. They should be given written terms of reference which deal adequately with their membership, authority and duties, and they should normally meet at least twice a year; (b) audit committees should comprise of a minimum of three members. Membership should be confined to the NEDs of the company and a majority of the non-executives serving on the committee should be independent; (c) The external auditor should normally attend audit committee meetings, as should the finance director. As the board as a whole is responsible for the financial statements, other board members should also have the right to attend. The audit committee should have a discussion with the external auditors, at least once a year, without executive board members present, to ensure that there are no unresolved issues of concern; (d) The audit committee should have explicit authority to investigate any matters within its terms of reference, the resources which it needs to do so, and full access to information. The audit committee should be able to obtain external professional advice and to invite outsiders with relevant experience to attend if necessary.
79
Internal Audit Functions The Cadbury Report propounds it as a good practice for companies to establish internal audit functions to undertake regular monitoring of key controls and procedures. Heads of internal audit should have unrestricted access to the chairman of the audit committee in order to ensure the independence of their position. Directors should report on the effectiveness of their system of internal control, and the auditors should report on their statement. An effective internal control system is an essential part of the efficient management of a company. External Auditors The Cadbury Report emphasizes the annual audit as one of the cornerstones of Corporate Governance. Given the separation of ownership from management, the directors are required to report on their stewardship by means of the annual report and financial statements sent to the shareholders. The audit provides an external and objective check on the way in which the financial statements are prepared and presented, and it is an essential part of the checks and balances required. The question is not whether there should be an audit, but how to ensure its objectivity and effectiveness. Audits are a reassurance to all who have a financial interest in companies, quite apart from their value to boards of directors. The most direct method of ensuring that companies are accountable for their actions is through open disclosure by boards and through audits carried out against strict accounting standards. One central requirement of the entire process is to ensure that an appropriate relationship exists between the auditors and the management whose financial statements they are auditing. Shareholders require auditors to work with and not against management, while always remaining professionally objective that is to say, applying their professional skills impartially and retaining a critical detachment and a consciousness of their accountability to those who formally appoint them. Another important requirement is that there be a full disclosure of fees paid to audit firms for nonaudit work. The essential principle is that disclosure must enable the relative significance of the companys audit and non-audit fees to the audit firm to be assessed. It is also a good practice for audit committees to keep under review the non-audit fees paid to the auditor both in relation to their significance to the auditor and in relation to the companys total expenditure on consultancy. For listed companies, a periodic change of audit partners should be arranged to bring a fresh approach to the audit. The Cadbury Report clarifies that the auditors role is to report whether the financial statements give a true and fair view. The auditors role is not to prepare the financial statements, nor to provide absolute assurance that the figures in the financial statements are correct, nor to provide a guarantee that the company will continue in existence. The audit is essentially designed to provide a reasonable assurance that the financial statements are free of material misstatements. The external auditors should be present at board meetings when the annual reports and accounts are approved and preferably when the half-yearly report is considered as well. The further refinement of the above-described provisions of the Cadbury Report in light of the Combined Code has already been evaluated in Chapter 3. Specific proposals: The following are the specific areas of reform under the Code: Appointment, Powers and Obligations of Audit Committees. Appointment, Powers and Obligations of Internal Auditors. Appointment, Powers and Obligations of External Auditors.
80
5.1
Appointment, Powers, and Functions of Audit Committees
The Code The Code (Clauses xxx, xxxi, xxxii, xxxiii and xxxiv) comes up with detailed requirements for listed companies in the areas of audit committees with provisions as to their composition, frequency of meetings, attendance at meetings, terms of reference and reporting procedure. The following is a synopsis of these requirements under the Code. Composition of Audit Committee: Listed companies are required to establish such committees comprising of not less than three members (including the Chairman, and with the majority of the members coming from the NEDs of the company and the chairman of the audit committee preferably being an NED). It should be noted here that the Code regards its provisions relating to NEDs as voluntary at this point in time and hence a mandatory provision in the Code pertaining to the composition of audit committees as having NEDs creates an issue. Meetings of Audit Committee: The audit committee is required to meet once every quarter of a financial year and also whenever requested by the external auditor or head of internal audit. Attendance at meetings of Audit Committee: The CFO, head of internal audit and a representative of the external auditors are required to attend meetings of the audit committee, at which issues relating to account and audit are discussed. At least, once a year, the audit committee is required to meet the external auditors without the CFO and head of internal audit and once the head of internal audit and other members of internal audit function, without the CFO and external auditors. Terms of reference of Audit Committees: The board of directors of a listed company are required to determine the terms of reference of the audit committee and they shall, among other things, recommend the appointment of external auditors to the board of directors as well as provide direction in other related matters such as resignation/removal of external auditors, their audit fees and the provision of additional services by external auditors. The Code actually lays out several ingredients, which the terms of reference of the audit committee should contain, which include, inter alia, measures to safeguard companys assets, review of periodic financial statements with a focus on important stated areas, facilitation of the external audit, coordination of the internal and external audit functions, review of the scope and extent of internal audit, consideration of various major findings of internal investigations, internal financial and operational controls, accounting systems, reporting structures, compliance with statutory requirements, institution of special projects/value for money studies, monitoring compliance with the Code and other issues or matters assigned by board of directors. Reporting procedure: The audit committee is required to appoint a secretary of the committee responsible for circulating minutes of meetings of audit committee. Ordinance and Related Laws The Ordinance and Related Laws do not contain any relevant provisions pertaining to Audit Committees.
81
Other Laws
[
There is no provision pertaining to Audit Committees in the National Shipping Ordinance, the PIA Act, the Pakistan Telecommunication Act, the Bank of Punjab Act, the National Bank Ordinance, the Chartered Accountants Ordinance and the Modaraba Ordinance. Conclusion: Audit Committees are a new concept being introduced and formalized through the Code and serves as an additional tier of audit control in a company. The UK Corporate Governance Reports also emphasize its role. Once again, while one can see its obvious positives, the question again arises whether it is too much to ask and really necessary for a small listed company to maintain three tiers of audit. This will be discussed further in Chapter 6. 5.2 Appointment, Powers, and Obligations of Internal Auditors
The Code The Code (Clauses xxxv and xxxvi) also requires that there be an internal audit function in every listed company whose head has access to the person chairing the audit committee. All listed companies are required to ensure that internal audit reports are provided for the review of external auditors and that auditors discuss any major findings in relation to the report with the audit committee, which shall report matters of significance to the board of directors. Ordinance and Related Laws The Ordinance and Related Laws do not contain any relevant provisions pertaining to Internal Auditors. Other Laws There is no provision pertaining to the Internal Audit function in the National Shipping Ordinance, the PIA Act, the Bank of Punjab Act, the National Bank Ordinance, the Chartered Accountants Ordinance and the Modaraba Ordinance. Pakistan Telecommunication Act: Section 41 (16) of the Pakistan Telecommunication Act lays down that in addition to the audit by the Auditor-General, the NTC may cause its accounts to be audited by internal or other external auditors. This is the extent to which this Act talks about the Internal Audit function. Conclusion: Once again the same comments as those for audit committees made above. 5.3 Appointment, Powers, and Obligations of External Auditors
The Code The Code (Clauses xxxvii to xliv), bolsters and supplements existing law by reemphasizing and requiring, inter alia, that only those firms are appointed as external auditors; (a) which have been given a satisfactory rating by the Quality Control Review Program of Institute of Chartered Accountants of Pakistan (ICAP) and (b) which are compliant with International Federation of Accountants (IFAC) guidelines on Code of Ethics, as adopted by ICAP; Furthermore, the Code states that auditors will be required to only provide services in relation to audit except in accordance with the regulations and will be further required to observe applicable IFAC guidelines and it shall be ensured that they do not perform management functions or make management decisions.
82
Additionally, listed companies are now required to change their auditors every five years and if for any reason this is impractical then as a minimum they will rotate the partner in charge of its audit engagement after obtaining the consent of the SECP. The Code further requires that no listed company shall appoint as CEO, CFO, an internal auditor or a director someone who was a partner of the firm of its external auditors (or an employee involved in the audit of the listed company) at any time during the two years preceding such appointment or someone who is a close relative, i.e. spouse, parents, dependent and non-dependent children, of such partner (or employee). The Code also requires that a partner of the firm of the external auditors shall be required to attend the Annual General Meeting at which audited accounts are placed for consideration and approval of shareholders. Auditors not to hold shares: All listed companies are required by the Code (Clause xxvii) to ensure that the firm of external auditors or any partner in that firm and his spouse and minor children do not at any time, hold, purchase, sell or take any position in shares of the listed company or any of its associated companies or undertakings. Ordinance and Related Laws The Ordinance lays out a mechanism for the appointment and functioning of external auditors. Appointment process for external auditors: Section 252 of the Ordinance states that external auditors have to be appointed at every Annual General Meeting to serve till the next general meeting (in case of the appointment of the first auditors, the appointment is made by the directors) and where the company fails to appoint auditors at the stated time or there is a vacancy for any other reason, SECP can appoint a person to fill the vacancy. The remuneration of auditors is fixed by the directors or the SECP or the company in a general meeting or in such a manner as the general meeting may determine, depending on who makes the appointment. Companies Amendment Ordinance now further provides that auditor or auditors appointed in a general meeting may be removed before conclusion of the next annual general meeting through a special resolution, and that they may not be removed during their tenure in any other manner. Professional qualification requirements for external auditors: Section 254 of the Ordinance mandates that the auditor for a public company or a private company which is the subsidiary of a public company or a private company having a paid up capital of three million rupees or more, has to be a Chartered Accountant within the meaning of the Chartered Accountant Ordinance of 1961. A person cannot be appointed as an auditor if; (a) he was, at any time during the preceding three years, a director, other officer or employee of the company; (b) he/she is a partner of, or in the employment of a director, officer or employee of the company; (c) he/she is the spouse of a director of the company; (d) he/she is indebted to the company; and (e) it is a body corporate. Companies Amendment Ordinance adds another category of persons who cannot be appointed as auditor i.e. (f) a person or his spouse or minor children, or in case of a firm, all partners of such firm who hold any shares or an audit client or any of its associated companies: provided that if such a person holds shares prior to his appointment as auditor, whether as an individual or a partner in a firm the fact shall be disclosed on his appointment as auditor and such person shall disinvest such shares within ninety days of such appointment. The above brings the Ordinance more in line with the Code requirements.
83
Auditors right of access to company records/information: Section 255 of the Ordinance gives auditors the right of access at all times to books, papers, accounts and vouchers of the company and all information and explanation which he thinks necessary for performance of duties. Auditors are mandated to make a detailed report to members on the accounts and all related documents with their analysis and conclusions as to whether they meet the requirements of the Ordinance, and inter alia; (a) whether or not they have obtained all the information and explanations which to the best of their knowledge and belief were necessary for the audit; (b) whether proper books of accounts have been kept; (c) the balance sheet and profit and loss account have been drawn up in conformity with the Ordinance and are in agreement with the books of accounts; and (d) whether the said accounts give the information required by the Ordinance and give a true and fair view. Where the auditors answer in the negative as to any of the aforementioned matters or with a qualification, the report shall state the reasons for such an answer along with the factual position to the best of the auditors information. Right to attend meetings: Auditors are entitled to attend any general meeting and to be heard at such a meeting. For listed companies, the auditors are required to be present in the general meeting in which the balance sheet and profit and loss account and auditors report are to be considered. Other Laws National Shipping Ordinance: Section 30 of this Ordinance focuses on audit of the accounts of the Corporation. It lays down that two auditors (who are chartered accountants within the meaning of the Chartered Accountants Ordinance, 1961) are responsible for auditing the accounts of the Corporation and are appointed in the general meeting. The two auditors are to perform such duties and exercise such powers as are provided for an auditor of a Company under the Companies Ordinance of 1984 (Sections 252-260), and the Securities and Exchange Ordinance, 1969 (Section 6). Section 30(3) of the National Shipping Ordinance provides that the Board of Directors may issue directions to the two auditors requiring them to report to it upon the adequacy of measures taken by the Corporation for the protection of the interests of the shareholders and creditors, or upon the sufficiency of the information and other means placed at the disposal of the auditors in auditing the accounts of the Corporation. Section 30(4) stipulates that when required by the Federal Government, the Auditor-General of Pakistan shall undertake such audit of the accounts of the Corporation as the Federal Government may consider necessary. For the purpose of such an audit, the Corporation is required to produce the accounts and connected documents at such place or places as the Government may direct and furnish such explanation and information as may be asked for by the Auditor-General or any officer appointed by him in this behalf. The above provisions are adequate in terms of the Corporations audit arrangement; however, the provisions of the Code will now further bolster them. PIA Act: Section 16 of the PIA Act provides for the audit of the accounts of the Corporation. A minimum of two auditors is required for the audit that are appointed by the Federal Government in consultation with the Auditor-General of Pakistan. The Federal Government fixes the remuneration of the auditors, which is to be paid by the Corporation. Furthermore, the Auditor-General has the power to give directions to the auditors in regard to the extent and method of their audit subject, and to prescribe the forms of accounts to be maintained by the Corporation consistent with the requirements of the Ordinance. The Auditor-General also has the power to undertake such audit of
84
the accounts of the Corporation when necessary, either of his own motion or upon a request by the Federal Government. Section 16(3) of the PIA Act states that every auditor in charge of auditing the accounts of the Corporation shall have access to a copy of the annual balance sheet of the Corporation, which is to be examined together with the relevant accounts and vouchers. A list of all books kept by the Corporation is also to be delivered. Every auditor shall have access to the books, accounts and other documents of the Corporation at all reasonable times and have the power to examine any Director or officer of the Corporation in relation to such accounts. Under Section 16(4) of the PIA Act, the auditors are required to report to the shareholders upon the annual balance sheet and accounts. In the report, the auditors must state whether in their opinion the balance sheet is a full and fair balance sheet containing all necessary particulars and properly drawn up so as to exhibit a true and correct view of the state of the Corporations affairs, and in case they have called for any explanation or information from the Board, whether it has been given and whether it is satisfactory. Section 16(5) states that the Board of Directors may at any time issue directions to the auditors requiring them to report to the Board upon the sufficiency of the information and other means placed at the disposal of the auditors in auditing the affairs of the Corporation. Same observation about the Code bolstering the existing provisions as made above for the National Shipping Ordinance. However, the appointment procedure for external auditors under this law merits attentions as the Code empowers the audit committee in this area by saying that they shall, among other things, recommend the appointment of external auditors to the board of directors as well as provide direction in other related matters such as resignation/removal of external auditors, their audit fees and the provision of additional services by external auditors. Pakistan Telecommunication Act: Under Section 15 (1) of the Pakistan Telecommunication Act, the accounts of the Authority shall be audited at the close of each financial year by the Auditor-General of Pakistan. Section 15(2) of the Act stipulates that the PTA is to produce such accounts, books and documents and furnish such explanation and information as the Auditor-General or any officer authorized by him in this behalf may require for the purpose of the audit. Under Section 15(3) of this Act, copies of the Auditor-Generals report on the accounts shall be provided to the Authority and the Federal Government and shall also be available for public inspection. However, under Section 15 (4), the Authority may allow for its accounts to be audited by any other external auditors. Thus, Section 15(4) gives an option to the PTA to cause its accounts to be audited by any other external auditors. With the introduction of the Code, the accounts of PTA will now be compulsorily audited by external auditors as required by the Code. Under Section 38 (3) of the Pakistan Telecommunication Act, the accounts of the PTCL are not to be audited by the Auditor-General of Pakistan, but are to be audited in accordance with the provisions of the Ordinance. Under Section 41(12) of the Pakistan Telecommunication Act, the Auditor-General of Pakistan is responsible for audits of the accounts of the NTC. Section 41(13) requires that the NTC for the purpose of the audit is to produce such accounts and books and connected documents and furnish such explanations and information, as the Auditor-General, or any officer authorized by him on this behalf may require. Section 41 (14) of the Pakistan Telecommunication Act states that the audit report has to be sent to the NTC and to the Federal Government and is also to be available for public inspection. Section 41(12) delegates responsibility for audits of the accounts of the NTC to
85
the Auditor-General of Pakistan. Section 41(15) provides that the NTC has to comply with any directive issued by the Federal Government or the Public Accounts Committee of the National Assembly for the rectification of an audit objection. Furthermore, Section 41(16) states that in addition to the audit by the Auditor-General, the NTC may cause its accounts to be audited by internal or other external auditors. Same observations as above. Bank of Punjab Act: Under Section 21, two auditors who should be chartered accountants are elected at the Annual General Meeting of the shareholders. Under Section 23, the Auditors are required to furnish their report to the shareholders or to the Punjab Government, upon the balance sheet, statement of profit and loss and accounts, and in every such report they shall state whether the balance sheet and the statement are full and fair statements containing the prescribed particulars and properly drawn and exhibit a true and correct view of the state of affairs of the Bank. The Auditors are also required to state in their report any explanation called for by them from the Board and that whether such an explanation was found satisfactory or not. Auditors report furnished to the shareholders is required to be presented and read along with the report of the Board at Annual General Meetings of the shareholders. Under Section 23 every Auditor shall be supplied with a copy of the annual balance sheet and statement of profit and loss and he shall be under obligation to examine the same. The Auditor shall have access to the books, accounts and other documents of the Bank and he may employ accountants or other persons to assist him in investigating such accounts and he may also examine any director, member or any officer of the Bank for this purpose. Auditors may also call for any explanation from any director, member etc. of the Bank. The Code will further bolster the existing provisions. National Bank Ordinance: Under Section 27 of this Ordinance, two auditors are to be appointed at the Annual General Meeting of the shareholders. This Section allows the auditors to become shareholders of the Bank, which is clearly in contradiction with the Code, Clause (xxviii) which requires that the auditors should not hold shares in their client organization. However, the Section prohibits appointment of a director or a member as auditor during the tenure of his office. Whereas, the Code, has a wider ambit as it requires that the listed companies shall not appoint as CFO or CEO, an internal auditor, or a director who has been a partner of the firm of its external auditors or its employee involved in the audit of the company, at any time during the two years preceding such appointment. Without prejudice to Section 27, under Section 28 the Federal Government may also appoint its auditors to examine and report upon the accounts of the Bank. Section 29 provides that every auditor shall be supplied with a copy of the annual balance sheet and statement of profit and loss and he shall be under obligation to examine the same. The auditor(s) shall have access to the books, accounts and other documents of the Bank and he may employ accountants or other persons to assist him in investigating such accounts and he may also examine any director, member or officer of the Bank for this purpose. The auditor(s) may also call for any explanation from any director, member etc. for the Bank. Under Section 29, the auditors are required to furnish their report to the shareholders or to the Federal Government, upon the balance sheet, statement of profit and loss and accounts. In every such report auditor(s) shall state whether the balance sheet and the statement are full and fair statements containing the prescribed particulars, are properly drawn and exhibit a true and correct view of the state of affairs of the Bank. The auditor(s) are also required to state in their report any
86
explanation call for by them from the Central or Local Board and that whether such an explanation was found to be satisfactory or not. Auditors report is required to be furnished to the shareholders and shall also be presented and read along with the report of the Central Board at the Annual General Meeting of the shareholders. These provisions will be further bolstered by the Code. Modaraba Rules: Under Rule 19, every Modaraba company shall state in its prospectus the name and address of its Auditor. The terms of Auditors appointment shall be renewed every year with the approval of the Registrar. The Auditor may resign from his post with the approval of the Registrar. If the Modaraba Company desires to appoint an auditor other than the existing auditor it shall inform the existing auditor about this change, a copy of which shall also be sent to the Registrar. The final decision as to the proposed change of auditor shall be that of the Registrar. Under Rule 13, the Auditor shall have full access to the minute books of the Modaraba Company and the company shall provide him with authenticated copies of the minutes and its decisions, concerning the affairs of the Modaraba. Banking Companies Ordinance: Section 35 provides, inter alia, that the yearly balance sheet and profit and loss account as required by Section 34 shall be audited by a person who is duly qualified under the Chartered Accountants Ordinance or any other law for the time being in force to be an auditor of companies and who is on the panel of auditors maintained by the State Bank of Pakistan for the purposes of audit of Banking Companies. It further provides that an auditor shall hold office for a period of three years and shall not be removed before the expiry of that period except with the prior approval of the State Bank of Pakistan. The provisions of the Code (clauses xxxvii to xliv) relating to external auditors will be relevant to look at here. While the Codes requirement that external auditors should have a satisfactory rating under the Quality Control Review Programme of ICAP and should be compliant with the IFAC Guidelines on Code of Ethics may not contravene the provisions of Section 35 (since the panel maintained by the State Bank of Pakistan would, in all likelihood bear names of auditors compliant with these requirements of the Code) the provisions relating to term of office of auditors seem to be inconsistent with it. Clause xxxix of the Code states that the Board of Directors of a listed company shall recommend appointment of external auditors for a year. This appears to be in conflict with the three-year tenure contained in Section 35. The same clause requires that if the auditors are sought to be removed before three years the reasons for it should be recorded in the Directors Report. This does not seem to violate Section 35. However, the removal will have to be with the prior approval of the State Bank of Pakistan as required by the said section. Clause xli of the Code requires change of auditors every five years. This does not appear to violate Section 35. Section 36: Section 34 requires Banking Companies to prepare, at the expiration of each calendar year, a balance sheet and profit and loss account as on the last working day of the year in the prescribed forms, in respect of all business transacted by it in Pakistan. Section 36 requires these accounts and balance sheet along with the auditors report passed at an Annual General Meeting to be published as prescribed and three copies thereof to be sent to the State Bank of Pakistan within three months of the close of the period to which they relate unless such time limit is extended by the State Bank of Pakistan in special circumstances. According to Section 37 a listed company may send the balance sheet and accounts referred to in Section 34 along with the auditors report to the Registrar and when so sent, it shall not be necessary
87
for the company to file the balance sheet and accounts in accordance with the requirements of Section 242 of the Ordinance. It should be noted that the State Bank of Pakistan has a parental, over arching, supervisory role in respect of Banking Companies throughout Pakistan. This role includes giving of directions and calling for information from these companies for the State Bank of Pakistans satisfaction that they function and are governed properly. However, this role, as contained in the Ordinance does not seem to override or contradict anything contained in the Code. Insurance Ordinance: Under Section 48 an insurer is required to appoint an auditor approved by the SECP and authorized to perform the functions of an auditor of public companies under the Ordinance. The auditor is required to express his opinion as to whether: i. ii. iii. iv. v. the statements accurately reflect the books and records of the company; the company has maintained proper books and accounts; the statements present fairly the state of affairs of the company as at the balance date and the result of the company for the financial year ended on that date; in the case of a life insurer, the allocations (appointments) of assets and liabilities have been made in accordance with Section 17; the statements have been prepared in accordance with this ordinance.
The opinion of the auditor as above is required to be expressed in writing and is to be attached to the statements to which it relates when those statements are delivered to the SECP. Section 49 provides for special audit. The SECP may, at its discretion appoint an auditor approved by it as one qualified to perform audits of insurance companies, but not being an auditor appointed by the insurance company concerned, to perform an investigation of such accounts and statement, books and records of an insurer as the SECP may direct. Such auditors shall have access to such record as may be required by them for their purposes as also to seek information and explanations from directors and officers of the company. The report of special audit shall be submitted to the SECP. Conclusion: The additional provisions introduced by the Code can help create more effective external auditing of companies. It must be noted that the Code empowers audit committees by saying that they shall, among other things, recommend the appointment of external auditors to the board of directors as well as provide direction in other related matters such as resignation/removal of external auditors, their audit fees and the provision of additional services by external auditors. Therefore, audit committees in that sense are a sine qua non for the Codes regime of external auditors. Please note in this regard the comments made about audit committees earlier in this Report and some further discussion on this point in Chapter 6. Some other conflicts between the Code and some of the laws have been noted in the discussion above, which may require necessary amendments to those laws. These pertain to process of appointment of external auditors, tenure of such auditors and whether they can hold shares in their client company.
6. Prevention of Minority Shareholder Oppression

The Basic Philosophy: One of the fundamental themes underlying the contemporary Corporate Governance debate is that of the protection of minority shareholders, considered vulnerable due to their lack of say in the decision making process, relative unsophisticated understanding of the
88
running of the company and lesser recourse to information, to exploitation by the greater interest holders in the company. The Code The Code contains some provisions, which provide special protection to minority shareholders and other special interest groups. These are significant as there can be several acts of a company, which can fundamentally alter the rights of the minority shareholders. Rights protection in a divesture of shares scenario The Code provides protection to minority shareholders in a scenario where a company is divesting its shares. Divesture of shares by sponsors/controlling interest: The Code (Clause xxix) provides minority shareholder protection by stating that in the event of a divesture of not less than 75% of the total shareholding of a listed company (with some exceptions), at a price higher than the market value at that time, it shall be desirable and expected of the directors to allow such transfer after it has been ascertained that an offer in writing has been made to the minority shareholders for acquisition of their shares at the same price at which divesture of majority shares was contemplated (where the price is lower, such offer price will be subject to the approval of the SECP). The Ordinance and Related Laws The Ordinance and Related Laws contain several provisions, which provide special protection to minority shareholders and other special interest groups. There can be several acts of a company, which can fundamentally alter the rights of the minority shareholders. Some key protections in such areas under the Ordinance are as follows: Alteration to memorandum/articles of association and minority shareholder rights Alteration to the Memorandum of Association: According to Section 21 of the Ordinance, a company cannot make any alteration (which requires a special resolution passed by three fourths of its members) to its Memorandum of Association without seeking the confirmation of the SECP. SECPs duty to safeguard Minority Rights/Rights of Creditors: According to Section 23 of the Ordinance, while exercising its authority in terms of an alteration under Section 21 of the Ordinance, the SECP is to have regard to the rights and interests of members or any class of members of the company as well as the rights and interests of the creditors and may allow time by adjourning its proceedings to facilitate arrangements for the purchase of the interests of dissident members and may also give such orders/directions as are necessary to carry such arrangements into effect. Alteration to Articles of Association: Section 28 of the Ordinance requires a special resolution passed by three fourths of the members of a company for it to alter any of its articles of association. However, if such alteration affects the substantive rights or liabilities of members or of a class of members then at least three fourths of such members or class of members to be affected need to vote for such alteration for it to take effect. Effect of Alteration in Memorandum/Articles: Section 34 of the Ordinance mandates that no member of a company is bound by such an alteration which requires him to take, or subscribe for more shares than the number he holds or which increases his liability to contribute to the share capital of, or otherwise to pay money to the company unless he agrees in writing to be bound by such alteration.
89
Variation of Minority Shareholder Rights The Judicial Recourse available The following is an important rights protection mechanism in the form of judicial recourse by the minority shareholders. Variation of rights of Shareholders of a class: The Judicial Recourse for Minority Shareholders. Section 108 of the Ordinance provides that while the variation of the rights of shareholders of any class shall be effected only in the manner laid down in Section 28 of the Ordinance (above), ten per cent or more of the class of shareholders who are aggrieved by any such variation of their rights may, within thirty days of the date of the resolution varying their rights, apply to the Court for an order cancelling the resolution. The Court is thus entrusted with the task of ensuring that these shareholders are not the victims of any unfair prejudice or a decision based on not all the relevant information. Access to/rights in Shareholders Meetings Resolution by Minority Shareholders: Section 164(2) of the Ordinance allows members with at least ten percent voting power in the company to give notice of a resolution and such resolution together with the supporting statement, if any, which they propose to be considered at the meeting, shall be forwarded so as to reach the company and the company shall forthwith circulate such resolution to all members. Demand for Polls by Minority Shareholders: Section 167(c) and (d) of the Ordinance require the Chairman to, before or on the declaration of the result of the voting on any resolution on a show of hands, order a poll upon the demand of, inter alia, any member or members present in person or by proxy having at least one-tenth of the total voting power in respect of the resolution as well any member or members present in person or by proxy and holding shares in the company conferring a right to vote on the resolution, being shares on which an aggregate sum has bee paid up which is not less than one-tenth of the total sum paid up on all the shares conferring that right. The following section contains an important protection for minority shareholders in a situation where scheme of transfer of shares is being implemented. Power and Duty of Company to Acquire Shares of Shareholders dissenting from Scheme or Contract for Transfer of Shares between Companies According to Section 289 of the Ordinance, if within 120 days of such an offer by transferee company, it has been approved by holders of at least 9/10th in value of shares whose transfer is involved (other than shares already held at the date of the offer by, or by a nominee for, the transferee company or its subsidiary) the transferee company may at any time, within 60 days after expiry of said 120 days, give notice to any dissenting shareholders of its desire to acquire his shares. After such a notice (unless dissenting shareholders make an application within 30 days of the notice and court thinks it fit to order otherwise) the transferring company will be entitled and bound to acquire these shares on the same terms as the ones on which shares of the approving share-holders are being acquired. Conclusion: The above analysis shows that existing law provides some important mechanism to minority shareholders through recourse to the Courts or the SECP as well as an access to board meetings. A further discussion of these rights has been conducted in Chapter 5.
90
7. Other Shareholder Rights as well as the Rights of the Creditors The Basic Philosophy: So far, this Report has endeavoured to take various thematic components of the Code as the essential reference point in order to gauge whether the existing Pakistani laws promote or hamper the essential purpose of the Code i.e. the promotion of efficiently and ethically functioning companies. However, it is important to note that there are some additional basic shareholders rights, which find mention in international materials on Corporate Governance and shareholders rights. Furthermore, they have also received attention in the existing Pakistani Corporate Governance laws. While a brief discussion of these rights is helpful in getting the complete picture of shareholder protection in Pakistan, they dont quite fit in any of the already stated categories and hence are being listed under this separate category. An important player in the Corporate Governance regime of any country, especially those where the corporate sector is debt driven, is the creditor. The creditors benefit equally along with the shareholders from an efficient and ethically run company, though their interests may clash in certain situations especially the scenarios, which emerge after a company declare bankruptcy or is forced to do so by the concerned authority. Given the fact that the soundness of corporate regulation in a country is gauged also by the level of security and confidence enjoyed by the creditors in a country, that aspect has also been briefly dealt with here. As already discussed earlier, the International Corporate Governance Reports emphasize the accountability of boards to shareholders. The formal relationship between the shareholders and the board of directors is that the shareholders elect the directors, the directors report on their stewardship to the shareholders and the shareholders appoint the auditors to provide an external check on the directors financial statements. Thus the shareholders as owners of the company elect the directors to run the business on their behalf and hold them accountable for its progress. The issue for Corporate Governance is how to strengthen the accountability of boards of directors to shareholders. While we have already discussed various dimensions of this relationship, the following are some additional internationally recognized rights of shareholders. Specific proposals: The following are the specific standards derivable from international reports and which are addressed by the Ordinance and related laws. One Share One Vote Proxy Voting Blocking of Shares before a Meeting Cumulative Voting and Proportional Representation Pre-emptive Rights Control on Further Issuance of Capital Right to call Extraordinary Shareholder Meeting Right to claim Dividends Mandatory Annual General Meeting Specific Creditors Rights
91
7.1
One Share One Vote
International Standard: Ordinary shares carry one vote per share. It is considered desirable to have prohibition on the existence of both multiple-voting and nonvoting ordinary shares. It is also considered desirable if firms are not allowed to set a maximum number of votes per shareholder irrespective of the number of shares owned. The one share-one vote standard is ensured under Pakistani law by the following provisions. These provisions underline the prohibition of the undesirable practices mentioned in the statement of the standard above. Section 160(4) of the Ordinance states that in every company having a share capital, every member shall have votes proportionate to the paid-up value of the shares or other securities carrying voting rights held by him according to the entitlement of the class of such shares or securities, as the case may be. Section 160(5) of the Ordinance states that no member carrying shares or other securities carrying voting rights shall be debarred from casting his vote, nor shall anything contained in the articles have the effect of so debarring him. Section 160(6) of the Ordinance states that for companies limited by guarantee and having no share capital, every member thereof shall have one vote. 7.2 Proxy Voting International Standard: Shareholders should have the right to vote through proxy. It is considered good practice if shareholders are allowed to mail their proxy vote to the firm. The Ordinance and Related Laws as well as the Code do not allow for mailing a proxy vote. The following is a synopsis of the law relating to ordinary and proxy voting. Section 160(7) of the Ordinance says that on a poll, votes may be given either personally or by proxy. There is no provision here for proxy by mail and the proxy has to be through another person. Section 168 of the Ordinance says that any proxy appointed by a member shall have such rights as respects speaking and voting at the meeting as available to a member but a member shall not be entitled to appoint more than one proxy to attend the meeting and a proxy must also be a member unless the articles of the company permit appointment of a non-member as proxy. 7.3 Blocking of Shares Before a Meeting International Standard: It is considered good practice if firms are not allowed to require that shareholders deposit their shares prior to a general shareholders meeting, thus preventing them from selling those shares for a number of days. The Ordinance and Related Laws as well as the Code make no provision for such a practice, neither do they disallow it. 7.4 Cumulative Voting or Proportional Representation International Standard: It is considered good practice if the shareholders are allowed to cast all their votes for one candidate standing for election to the board of directors (cumulative voting) or if a mechanism of proportional representation in the board is allowed by which minority interests may name a proportional number of directors to the board.
92
Section 178(5)(b) of the Ordinance says that a a member may give all his votes to a single candidate or divide them between more than one of the candidates in such manner as he may choose. This seems to be allowing cumulative voting. 7.5 Pre-emptive Rights International Standard: It is considered good practice that shareholders are granted the first opportunity to buy new issues of stock, and this right can be waived only by a shareholders vote. The Ordinance provides for this right of the shareholders. 7.6 Control on Further Issuance of Capital International Standard: Some controls are considered desirable. The Pakistani law contains the following relevant provision: Section 86 of the Ordinance states that where directors decide to increase capital by issuance of further shares, such shares are to be issued to each existing member strictly in proportion to his present shareholding, irrespective of class, and such offer to be made by notice, specifying the number of shares to which the member is entitled and stating the time within which the offer is to be accepted, otherwise deemed declined. However, the Federal Government may, on an application made by a public company on the basis of a special resolution passed by it, allow such a company to raise its further capital without issue of right shares. 7.7 Right to Call an Extraordinary Shareholders Meeting International Standard: The minimum percentage of ownership of share capital that entitles a shareholder to call for an extraordinary shareholders meeting is less than or equal to 10%. This right is enshrined in the Ordinance in the following terms: Section 159 of the Ordinance requires the directors of a company to call an extraordinary general meeting of the company to consider any matter which requires the approval of a company in a general meeting and the company is to, on the requisition of members representing at least 1/10th in value of the voting power on the date of the deposit of the requisition, forthwith proceed to call an extraordinary general meeting. The requisitionists, or a majority of them in value, may themselves call a meeting, if the directors do not proceed within twenty-one days from the date of the requisition being so deposited to cause a meeting to be called. Any default entails penalties. 7.8 Right to claim Dividends International Standard: It is good practice for a company to declare a dividend once it reaches the target of a given percentage growth in net income. While the Ordinance does not mandate any such given percentage and a consequential compulsory payment of dividend, it has some other important provisions covering this area, which provide protection to the shareholders. The amount and source of dividends: Section 248 of the Ordinance mandates that no dividend can exceed the amount recommended by the directors and cant be paid out of any profits made through sale or disposal of immovable property or assets of a capital nature (unless such transactions wholly or partly form the business of the company). Section 249 of the Ordinance mandates that dividends can only be paid out of the profits of the Company and Section 250 of the Ordinance says that such dividends can only be paid out to registered shareholders or to their order or to their bankers.
93
Time limit within which to pay announced dividends: Section 251 of the Ordinance requires that when a dividend has been declared, it has to be paid within forty-five days of the declaration, in case of listed company, and within thirty days of declaration, for other companies (unless a listed defense can be invoked). Defaulting chief executive may be imprisoned for up to two years and fines up to a million rupees. 7.9 Mandatory Annual General Meeting International standard: Reports and accounts are presented to shareholders at the Annual General Meeting, when they have the opportunity to comment on them and to put their questions. In particular, the Annual General Meeting gives all shareholders, whatever the size of their shareholding, direct and public access to their boards. Both shareholders and boards of directors should consider how the effectiveness of general meetings could be increased and as a result the accountability of boards to all their shareholders strengthened. The Ordinance contains the following provisions relating to this area: Annual General Meetings: Section 158 of the Ordinance mandates that every company is to hold, in addition to any other meetings, a general meeting, as its annual general meeting, within eighteen months of its incorporation and thereafter once at least in every calendar year within a period of six months following the close of its financial year and not more than fifteen months after the holding of its last preceding annual general meeting. For listed companies, the SECP, and for other companies, the Registrar may for any special reason extend the time within which any annual meeting, not being the first such meeting, shall be held by a period not exceeding ninety days. Extraordinary General Meetings: Section 159 of the Ordinance, as more briefly described above, allows the directors to at any time call such a meeting to consider any matter which requires the approval of the company in a general meeting and on the on the requisition of members representing at least one-tenth of the voting power on the date of the deposit of the requisition, they are required to forthwith proceed to call an extraordinary general meeting. The requisitionists, or a majority of them in value, may themselves call a meeting, if the directors do not proceed within twenty-one days from the date of the requisition being so deposited to cause a meeting to be called. Any default entails penalties. Power of Registrar to call Meetings: Section 170 gives the Registrar the power to call, inter alia, any annual general meeting or extraordinary general meeting, if there has been a default in the holding of any such meetings, either of his own motion or on the application of any director or member of the company and there is a penalty for any default in complying with the Registrars directions. 7.10 Creditors Rights Introduction This section explores the issue of creditors rights and their protection under Pakistani company, insolvency and security laws. For this purpose, five different creditors rights (recognized internationally and examined in the La Porta Report will be evaluated in terms of the Pakistani corporate law regime. The aim is to identify legal rules covering protection of corporate creditors under Pakistani corporate and banking laws to compare them to international standards and legal rules regarding the roles, rights and interests of creditors. From the outset, it is necessary to be clear concerning the nature of effective creditor protection. Effective protection has compensatory and preventive aspects it should allow creditors not merely to obtain compensation when they suffer as a result of unacceptable actions by directors but also
94
should enable them to take reasonable steps to prevent directors from taking such actions10. It is also pertinent to note that the directors owe a duty to the company and to the creditors of the company to ensure that the affairs of the company are properly administered and that its property is not dissipated or exploited for the benefit of directors themselves to the prejudice of creditors. However, it is a fallacy to speak of creditors as a homogenous group and it is important to note the variety of conflicting interests in the body of existing creditors as well as between present and future creditors. Material conflicts of interests between different types of creditor have in fact, complicated the debate as to creditors rights. For example, in the case of a default, senior secured creditors may have a simple interest in getting possession of collateral no matter what happens to the firm, whereas junior unsecured creditors may wish to preserve the firm as a going concern so that they can hope to get some of their money back if the firm turns a profit. It is not clear whether directors owe a duty to creditors generally, to individual creditors, or to a class of creditors. Directors often make difficult decisions as to which pattern of interests is to be favoured by a contemplated course of action whether, for instance, to use remaining assets to pay off preferential creditors or to prejudice these by continuing to trade in the hope of benefiting unsecured creditors. Duties that are effective in the hands of one set of creditors may, accordingly, operate to the detriment of other creditor classes. Nevertheless, creditors interests do merit protection, not because creditors and shareholders have the same relationship to the company, but because, as insolvency approaches, creditors supplant shareholders as the parties most likely to be affected and prejudiced by directorial failings. This Report will further discuss in Chapter 6 why it is important to look at the nature of protection given to creditors rights in countries like Pakistan. Five Internationally Recognised Creditors Rights The following five creditors rights are evaluated in terms of international best practices. 1. Restrictions for going into reorganization It is considered good/best if the reorganisation procedure for companies imposes restrictions, such as creditors consent, in order for companies to file for reorganisation. 2. No automatic stay on secured assets It is considered good/best if the reorganisation procedure does not impose an automatic stay on the assets of the firm on filing the reorganisation petition. It is not considered good if automatic stay prevents secured creditors from gaining possession of their security. 3. Secured creditors first It is considered good/best if secured creditors are ranked first in the distribution of the proceeds that result from the disposition of the assets of a bankrupt firm. It is not considered good if unsecured creditors, such as the government and workers, are given absolute priority. 4. Management does not stay It is considered good/best when an official appointed by the court, or by the creditors, is responsible for the operation of the business during reorganisation. It is also considered good if the
10
.(Eds. Sheikh and Rees, Corporate Governance and Corporate Control 112)
95
debtor does not keep the administration of its property pending the resolution of the reorganisation process. 5. Legal reserve Legal reserve is the minimum percentage of total share capital mandated by corporate law to avoid the dissolution of an existing firm. It is not considered good if there is no such restriction. Pakistani Legal Rules Covering Protection of Corporate Creditors Creditors rights under Pakistani company, banking, insolvency and security laws are analyzed below for the purposes of the Report by comparing them to the above-mentioned five internationally recognized creditors rights. 1. Restrictions for going into Reorganisation Management in some countries can seek protection from creditors unilaterally by filing for reorganization without creditor consent. Such protection is called Chapter 11 in the United States and gives management a great deal of power, since at best creditors can get their money or collateral only with a delay. However, in Pakistan, creditor consent is needed to file for reorganisation, and hence managers cannot so easily escape creditor demands. Part IX (Arbitration, Arrangement and Reconstruction) of the Ordinance imposes restrictions regarding filing for reorganisation. Sections 284 (Power to compromise with creditors and members) and Section 287 (Provisions for facilitating reconstruction and amalgamation of companies) apply to any company liable to be wound up under the Ordinance. Creditors (or a class of creditors) participate in the process of reorganisation of the share capital of the company through a meeting. Section 284: Where such a compromise or arrangement is proposed, the Court may, on application, order a meeting of creditors (or class of creditors) or members (or class of members) to be held in a manner directed by the Court. If 3/4th (representing 3/4th in value) of creditors or members agree to any compromise or arrangement, then it will be binding on all (including company, and liquidator if applicable) if sanctioned by Court. Court will only make such order if satisfied that the applicant has disclosed all material facts to it. Order to be filed with Registrar and Company to annex a copy to every copy of memorandum/constitution issues thereafter. Default will lead to a fine of up to Rs. 500 for each copy in respect of which default made. Section 287: This section relates to the Court sanctioning of a compromise and arrangement under Section 284. List of things, which the Court can do in connection with such a compromise/arrangement (e.g. transfer of undertaking and property/liabilities, allotment of shares/debentures/policies, continuation of legal proceedings, dissolution without winding up, other incidental, provision for dissenters from a compromise, consequential or supplemental matters). This Section further deals with the effect of such an order, notice requirement, penalty for default (up to Rs. 1,000). As is obvious from the above sections, the role of creditors is of paramount importance in any rearrangement or reconstruction of a company. Through the mandatory requirement of consent to be obtained from creditors for any rearrangement or reconstruction, the law provides ample safeguards for the protection of the interests of creditors in Pakistan.
96
2.
No Automatic Stay on Secured Assets
In some countries, the reorganisation procedure imposes an automatic stay on the assets, thereby preventing secured creditors from getting possession of loan collateral. This rule obviously protects managers and unsecured creditors against secured creditors and prevents automatic liquidation. Part IX Arbitration, Arrangements and Reconstruction of the Ordinance does not impose an automatic stay on the assets of the company and hence, secured creditors interests are protected. 3. Secured Creditors First
Under Pakistani corporate laws, secured creditors are assured the right to the assets of the company, which is under liquidation. In fact, secured creditors are ranked first in the distribution of the proceeds that result from the disposition of the assets of a bankrupt firm. However, under Section 405 (Preferential Payments) of the Ordinance and under Section 61 (Priority of debts) of the Provincial Insolvency Act, 1920, certain unsecured creditors such as the government and workers are given priority (after secured creditors) in the distribution of the proceeds that result from the disposition of the assets of a bankrupt firm. Section 405 (1) In a winding up, there shall be paid in priority to all other debts (a) all revenues, taxes, cesses and rates due from the company to the Federal Government or a Provincial Government or to a local authority... (b) all wages or salary of any employee in respect of services rendered to the company... Section 61 (1) In the distribution of the property of the insolvent, there shall be paid in priority to all other debts (a) all debts due to the [Government] or to any local authority; and (b) all salary or wages...of any clerk, servant or labourer in respect of the services rendered to the insolvent... Therefore, except for the above-mentioned unsecured creditors, the interests of secured creditors in the assets of the company are duly protected. 4. Management does not stay In case of reorganisation proceedings of a company, the initiative mostly comes from the existing management itself. Therefore, pending any reorganisation or arrangement, the existing management continues to manage the affairs of the company. However, in case a company is being mismanaged and the creditors feel the need to protect their interests, Pakistani law provides them recourse to the Court wherein they can pray for removal of the existing management. This right of the creditors if exercised properly constitutes a check on the companies. In cases where creditors go for winding up proceedings, the Court has the power to appoint provisional liquidators thereby wresting control of the company from the existing management. Part X Prevention of Oppression and Mismanagement safeguards the stake of creditors rights as to mismanagement of a company. Section 290 of the Ordinance -- Application to Court (Prevention of oppression and mismanagement) Provisions of Section 290 of the Ordinance vests the court with wide and vast powers to take corrective measures by passing appropriate orders in the event that it is shown that
97
the affairs of the Company are being conducted or are likely to be conducted in unlawful or fraudulent manner or in a manner prejudicial to public interest or in a manner oppressive to the members or any of the members or creditors (PLD 2000 Lahore 461). Section 290. Any member(s) holding not less than 20% of issued share capital of company or creditor(s) having an interest not less than 20% of the paid up capital complains, or if the Registrar is of the opinion that the affairs of Company being conducted or likely to be conducted in a manner that is unlawful or fraudulent, or in a manner not provided for in its memorandum, or in a manner oppressive to the member(s)/creditor(s) or in a manner prejudicial to public interest, such person(s) or Registrar may make an application to the Court by petition for an order under this section. The Court on such petition (if it is of the opinion that any of the above is taking place and that to wind up the company would unfairly prejudice the members or creditors), may make such order as it thinks fit to bring an end to the matters complained of (whether for regulating companys conduct in future or for purchase of shares of any members of company by other members of the company or by the company and in case of purchase by company, for the reduction accordingly of the companys capital or otherwise). Company cannot (unless the Court allows) make an addition or further alteration to its memorandum or articles, which is inconsistent with any addition or alteration to its memorandum or articles by the Court under this section (which will be as if duly made by a company resolution). Registration of order is required. Default leads to a fine of up to Rs. 5,000 and a further fine of not more than Rs. 100 for continuing default. 5. Legal Reserve A legal reserve requirement forces firms to maintain a certain level of capital to avoid automatic liquidation. It protects creditors who have few other powers by forcing an automatic liquidation before all the capital is stolen or wasted by the insiders. There is no minimum percentage of total share capital mandated by Pakistani corporate law to avoid the dissolution of a company as a going concern. Conclusion: It can be seen from the above analysis that Pakistani law is quite satisfactory in meeting almost all of the general shareholders rights protection provisions enumerated above as well as some internationally recognized creditors rights. Legal Rules under the Companies Ordinance, 1984 Pertaining to General Creditors Rights PART IV Incorporation of Companies and Matters Incidental Thereto Memorandum of Association Section 21: (Alteration to Memorandum) Changes in memorandum may be made to enable a company to: i. ii. iii. iv. v. Carry on its business more economically, or Attain its main purpose by new or improved means, or Include a business which may conveniently or advantageously be combined with that already stated, or Restrict or abandon any of the objects specified in the memorandum, or Sell or dispose of the whole or any part of the undertaking of the company, or
98
vi.
To amalgamate with any other company or body of persons
Before confirming the above types of alteration(s), the SECP must be satisfied that: either the debt or claim of every creditor who is entitled to object to such alteration and who has objected to it, has been discharged or determined or secured to the satisfaction of the SECP or such creditor has consented to the alteration. Thus, creditors consent, claims, rights and interests are to be considered in making changes in the memorandum of association of the company. Section. 23: (Dissident Members and Creditors Interests) While exercising its authority under Sections 21 and 22 (alteration to memorandum) the SECP shall have regard to the rights and interests of the members or any class of members of the company as well as the rights and interests of creditors and may allow time by adjourning its proceedings to facilitate arrangement(s) for the purchase of the interests of dissident members and may also give such orders/directions as are necessary to carry such arrangement(s) into effect. PART VI Share Capital and Debentures Nature, Numbering and Certificate of Shares Service and Authentication of Documents Section 99: (Objection by Creditors and Settlement of List of Objecting Creditors on Reduction of Capital) Where reduction in capital involves diminution of liability in respect of unpaid share capital or payment to any shareholder of any paid up share capital, creditors may object if certain conditions fulfilled. The Court is to settle list of creditors entitled to object and creditors not on list despite notice are to be excluded. Special Provisions as to Debentures Section 118: (Payment of Certain Debts Out of Assets Subject to Floating Charge in Priority to Claims under the Charge) Where receiver is appointed on behalf of debenture holders of any debentures secured by floating charge or possession is taken by or on behalf of these debenture holders of any property subject to such charge (and if the company is not in course of being wound up at the time) debts under the provisions of Part XI relating to preferential payments in every winding up shall be paid forthwith. Theses are to be recouped out of assets available for general creditors. PART VIII Management and Administration Directors Section 182: (Creditors may Nominate Directors) In addition to directors elected by shareholders, a company may have directors nominated by the companys creditors or other special interests by virtue of contractual arrangements. PART XI Winding Up Winding Up By Court
[
Cases in Which Companies may be Wound Up by Court Section 305: (Circumstances in which Company may be Wound Up by Creditor Approaching the Court): The purpose to seek a winding up by a creditor is invariably to see whatever is left of the
99
assets, and that the assets may not further diminish before an actual recovery is affected. Ground for winding up of company arises only when it is unable to pay its debts and the creditors are of the view that if the matter is left any further, then either their security will diminish or the amount due to them will further be reduced. (2002 CLD 614). Powers of Court Hearing Application Section 320: (Court to have Regard to Wishes of Creditors or Contributories) The Court shall have such regard, as to all matters relating to a winding up, as proved to it by any sufficient evidence. Official Liquidators Section 331: (Committee of Inspection in Compulsory Winding Up) When winding up order is made, liquidator has to summon separate meetings of creditors and contributories to determine whether or not an application to the Court for appointment of Committee of inspection to act with liquidator is to be made, and to determine members of such Committee. The Court then has to make any order and appointment to give effect to such determinations (and to decide differences, if any exist in the determinations of the creditors and the contributories). Section 352: (Power to Order Public Examination of Promoters, Directors) When an order is made by the Court for winding up of company, and the official liquidator has made a report that in his opinion, fraud or other actionable irregularity has been committed by any person in promotion/formation of company or by any director or officer in relation to company since its formation, the Court may after consideration of the report, direct such person to attend Court and publicly examine him. Official liquidator to take part in such examination. Any creditor or contributory may also take part in order to safeguard their interests. This is also a reflection of creditors say in management issues. Declaration of Solvency Provisions Applicable to Members Voluntary Winding Up Section 365: (Power to fill vacancy in office of liquidator) Creditors role in filling vacancy in office of liquidator is that if a vacancy occurs by death, resignation or otherwise, the company in general meeting may fill the vacancy subject to any arrangement with its creditor. Section 368: (Duty of Liquidator to Call Creditors Meeting in Case of Insolvency) Insolvency here means the company not being able to pay its debts in full within 12 months from the commencement of the winding up, or that 12 months have expired without the debts having been paid in full. It is the liquidators duty to protect creditors rights by summoning a meeting of creditors if he is of the opinion that the company will not be able to pay its debts in full. In such a case, it is the creditors right to appoint their own liquidator unless otherwise directed by the Court. Section 370: (Final Meeting and Dissolution) Subsection (6) of this section protects the interests of creditors and members through the Registrar. If on his scrutiny the Registrar considers that the affairs of the company or the liquidation proceedings have been conducted in a manner prejudicial to its interests or the interests of its creditors and members or that any actionable irregularity has been committed, he may take action with the provisions of this Ordinance.
100
Provisions Applicable to Creditors Voluntary Winding Up Section 375: (Appointment of Liquidator) Creditors appointment of liquidator supersedes companys appointment. If the creditors and company nominate different persons, the person nominated by the creditors shall be the liquidator. However, final decision rests with the Court. Section 376: (Appointment of Committee of inspection) It is the creditors option if they think fit to appoint not more than five members to the Committee of inspection. The company may also appoint not more than five members to the Committee. However, it is the right of the creditors to remove any person so appointed by the company. The final authority in this case also rests with the Court. Section 378: (Directors Powers to Cease on Appointment of Liquidator) Subject to the sanctions of the Committee of inspection or the creditors (in a general meeting) directors powers may not cease on appointment of liquidator (an exception to the rule). Section 381: (Duty of Liquidator to Call Meetings of Company and of Creditors at the End of Every Year) In the event of the winding up continuing for more than one year, it is the liquidators duty to summon a general meeting of the company and a meeting of creditors, and to disclose all necessary information regarding the conduct of winding up during the preceding year. Provisions Applicable to Every Voluntary Winding Up Section 385: (Distribution of Property of Company) The section provides that the property of the company, on its winding up, shall be applied in the pari passu satisfaction of its liabilities and be distributed among the members according to their rights and interests in the company. The shareholders may decide on a scheme of liquidation whereby the debts and liabilities of the company are to be paid and the balance distributed. When a company commences voluntary liquidation, the remedy of a creditor is only to take what he can take under the scheme of liquidation and nothing more. However, this section does not bar execution proceedings against a company gone into voluntary liquidation and a liquidator/a dissatisfied creditor may move the Court. Section 393: (Costs of Voluntary Winding Up) Costs of voluntary winding up are payable out of the assets of the company in priority to all other claims subject to the rights of secured creditors. Section 394: (Saving for Right of Creditors and Contributories) Voluntary winding up is no bar to the right of any creditor and contributory to have a company wound up by the Court. Winding Up Subject to Supervision of Court Section 398: (Court may have Regard to Wishes of Creditors and Contributories) The Court may have regard to wishes of creditors and contributories as proved to the Court by any sufficient evidence in all matters relating to the winding up subject to supervision of Court. Provisions Applicable to Every Mode of Winding Up
[
Proof and Ranking of Claims, Etc. Section 403: (Debts of All Descriptions to be Proved) In every winding up (subject, in the case of insolvent companies, to the application in accordance with the provisions of this Ordinance (Section 404) or the law of insolvency) all debts payable on the contingency, and all claims against the company, present or future, certain or contingent, ascertained or sounding only in damages, shall be
101
admissible to proof against the company once a just estimate has been made of the value of such debts or claims. Section 404: (Application of Insolvency Rules in Winding Up of Insolvent Companies) With regard to the respective rights of secured and unsecured creditors, the same rules shall prevail as are in force for the time being under the law of insolvency with respect to the estates of persons adjudged insolvent. Supplementary Provisions as to Winding Up
[
Section 421: (Liquidator to Exercise Certain Powers Subject to Sanction) When a company is being wound up, a liquidator may exercise his powers: i) to pay any class of creditors in full; ii) make any compromise or arrangement with creditors whereby the company may be rendered liable; iii) compromise any calls and liabilities to calls, debts etc. and take any security for the discharge of any such calls, debt etc. and give a complete discharge in respect thereof. Any creditor or contributory may apply to the Court with respect to any exercise or proposed exercise of any of theses powers. Section 422: (Meetings to Ascertain Wishes of Creditors or Contributories) This section is applicable in all winding up proceedings. It provides that as far as creditors rights are concerned regard shall be had to the value of each creditors debt when ascertaining the wishes of creditors. In order, therefore, to determine the wishes of the creditors, it will not suffice to merely allow each creditor one vote. The amount due to each creditor will also have to be taken into consideration (PLD 1952 Lahore 465). Creditors Rights under the Banking Laws of the Country In view of the huge bad debt portfolio of the banking sector, the recovery laws have undergone massive changes in the last few years in Pakistan. Most of these changes have been aimed at providing for summary and effective recovery of outstanding dues owed to banks. The most recent recovery law promulgated for recovery of outstanding dues is the Recovery of Finances Ordinance. The said law not only aims at providing summary proceedings for recovery but for the first time has introduced the concept of sale by banks of mortgaged property without intervention of the Court. Thus, the Recovery of Finances Ordinance was promulgated with the object to safeguard the interests of creditors/financial institutions. The Ordinance prescribes a summary procedure to facilitate swift recovery of defaulted loans. Sections 10 and 11 (Procedure in Banking Suits) Leave to Defend, filed by the defendant in a case, shall clearly state facts and figures relating to the amount due and not disputed by the party in order to enable the Banking Court to determine such amount and pass an interim decree in favour of the creditor to that extent. If any substantial question of law or fact requiring adducing of evidence do not arise from the leave to defend and reply thereto then the banking court shall not grant such leave and the suit shall be decreed in favour of the creditor. Section 15 (Sale of Mortgaged Property) In case of a default by a customer/debtor the financial institution/creditor, after giving three statutory demand notices, becomes vested with all the powers of a mortgagor relating to such property. After expiry of the third demand notice, the creditor/financial institution may, without the
102
intervention of any court, sell the mortgaged property by public auction and appropriate the proceedings towards total outstanding of the debtor. Section 16 (Attachment Before Judgment/Appointment of Receivers) In order to prevent the mortgaged property from being alienated or prejudiced in any manner, the Court may pass appropriate orders against the debtor/creditor or any other person so concerned with such mortgaged property. These include orders for attachment of properties, appointment of receivers, and hand over possession of properties to the creditors/financial institutions. The section further allows the financial institutions/creditors to recover from the debtor any pledged moveable property or any property obtained through finance lease without intervention of the Court, if a provision to this effect is made in the agreement between the parties. Section 23 (Restriction on Transfer of Assets) After publication of summons for debtor/customer under this Ordinance, such debtor/customer cannot alienate any of its properties without prior written permission of the Court until the final decision of the suit.
103
CHAPTER 4. POWERS OF THE REGISTRAR AND THE SECP UNDER THE ORDINANCE FOR THE PROTECTION OF SHAREHOLDERS RIGHTS AND THE ROLE PLAYED BY THE COURTS
Levels of Shareholder Protection
A holistic picture of the Corporate Governance regime in Pakistan and the role to be played by the Code in it is only possible if one appreciates the various levels of shareholder rights protection under it. It might be useful to conceive of such protection at three separate levels in the following manner. The Tracheotomy of Shareholder/Creditor Rights protection in Pakistan It would be useful to compartmentalize the protection of the rights of the shareholders and creditors under Pakistani law under the following three heads: (1) Statutory Rights and Best Practice Guidelines: These are rights, which are already enshrined in the Ordinance and related laws and hence there are in-built protections in the laws themselves. For example the various rights and protections, which can be invoked by shareholders holding at least 10% of the value of the total shareholding can be put in this category because these are established rights which can be invoked whenever the requisite number of shareholders get together and decide to invoke them. To this list can be added the additional protections introduced by the Code and the Insider Trading Guidelines, which are of increasing importance. Protection through the Regulatory Agencies: The SECP and the Registrar have special powers, which they can use on application of a shareholder or creditor or on their own initiative, to ensure that companies are not doing anything which can lead to fraudulent or negligent behaviour, resulting in the rights violation of the shareholders and creditors. Protection through the Courts: The Ordinance and related laws have special provisions, which provide shareholders and creditors with recourse to the courts under special circumstances. Over the years, the courts have made some significant contributions to the existing statutory protection for the rights of shareholders and creditors, by way of a further enhancement of and broadening of these rights.
(2)
(3)
The Role of the Registrar and the SECP

The Registrar and the SECP play an increasingly important regulatory role in the Pakistani Corporate Governance environment. The following is an overview of some of their more important powers under the Ordinance in the context of the protection of the rights of shareholders and creditors. The Role of the Registrar The Registrar has important and significant powers to require companies to divulge information, if he thinks it is important for any reason for him have access to such information while looking into a matter. This serves as an important weapon against a company not coming clean with information.
104
Power of Registrar to call for information or explanation Section 261 of the Ordinance provides that if the Registrar thinks that any information, explanation or document is necessary, (1) he may in writing call for it (within a specified time frame not less than 14 days). (2) If no information furnished within specified time or inadequate information provided, the Registrar may through a written order call for production of any books or papers which he considers necessary and it will be the duty of the company and such persons to provide the same within the specified time frame. If still a default, then apart from financial penalty and the penalty that every defaulting officer punishable with imprisonment for up to one year, the Authority trying the offence may, on the Registrars application make an order, directing the Company to produce such books or papers as in its opinion may reasonably be required by Registrar. (3) If still no information, explanation, book or paper furnished, as required by the Registrar or such a submission shows an unsatisfactory state of affairs or does not disclose a full and fair statement of the matter, the Registrar may report in writing the circumstances to the SECP. An extension of the above power of the Registrar is the power to take even more direct attention and seize documents from the company under certain scenarios. Seizure of documents by Registrar Section 262 of the Ordinance provides that where the Registrar has reasonable grounds to believe that books or papers of or relating to any company or any chief executive or officer of such company or any associate of such person, may be destroyed, mutilated, altered, falsified or secreted, then after obtaining permission from magistrate of the first class or Court, he can search and seize such books and papers. Related powers are also discussed. Seized documents are to be returned, however, within thirty days after seizure unless SECP gives another thirty-day grace period. The Criminal Procedure Code is to be followed during searches. The SECP has wide-ranging investigative powers into the affairs of a company, which are as follows: Investigation of affairs of company on application by members or report by Registrar Section 263 of the Ordinance provides that SECP inspectors may investigate on; (a) in case of company with share capital, on application of members holding no less than 1/10th of total voting power; (b) in case of company with no share capital, on application of no less than 1/10th of persons on companys register as members; and (c) in case of any company, on receipt of a report under Section 231(5) of the Ordinance (a report by an officer of SECP when inspecting accounts under this section) or the Registrars report under Section 261(6) of the Ordinance. SECP has further powers to initiate investigations into the affairs of a company under the following scenarios, either due to a board resolution requesting such an investigation or a court order directing one or under certain special circumstances. Companies Amendment Ordinance introduces a new Section 78 A to the Ordinance which gives a person, who transfers any shares or debentures, a right to appeal to the SECP against a refusal by a company to register a transfer or transmission. Investigation of Companys Affairs in Other Cases Section 265 of the Ordinance says that the SECP may appoint inspectors for investigation if: (a) the company, by a resolution in general meeting or, (b) the court, by order declares that the affairs of the company ought to be investigated. SECP may also investigate (after giving Company show cause notice) if in the opinion of SECP certain circumstances exist which suggest that (i) business being conducted with intent to defraud or unlawful purpose; (ii) framers of company guilty of fraud,
105
misfeasance, breach of trust, misconduct towards company or any of its members or have been carrying unauthorized business; (iii) affairs of company so conducted so as to deprive members of reasonable return; (iv) members not given all information which they might reasonably expect; (v) any shares of company allotted for inadequate consideration; (vi) affairs of company not being managed in accordance with sound business principles or prudent commercial practices. Inspector to be a Court for Certain Purposes This declaration is provided by Section 266 of the Ordinance and applies to an inspector under Sections 263 and 265 of the Ordinance. Every proceeding before such inspector will be a judicial proceeding. Non-compliance or contravention with any orders, directions or requirement of the Inspector will have the same consequences, liabilities and penalties as provided for such in the civil and criminal procedures. Duty of Officers, etc., to Assist Inspector Section 268 of the Ordinance states that it is the duty of officers etc., to assist the inspector and any default in this regard is punishable with imprisonment and fine. Inspectors Report Section 269 says that inspectors may, and if so directed by SECP, make interim reports and on conclusion of investigation, a final report. SECP will forward a copy to the company and may, on request, give a copy to a member of the company or other body corporate or anyone interested in affairs of the company or whose interest as creditor of company or other body corporate appear to SECP to be affected. Also copies are to be forwarded to the Court, Registrar, and shareholders under given situations. SECPs Power of Prosecution Section 270 of the Ordinance allows SECP (on the basis of a report under Section 269 of the Ordinance) to prosecute that any person whose affairs have been investigated under Section 267 of the Ordinance and who has been guilty of an offence for which he is criminally liable, and it shall be duty of all officers, employees, agents of company and body corporate (other than the accused) to give all reasonable assistance in this process. Power of SECP to Initiate Action against Management Section 271 says that if the SECP is of the opinion that (on the basis of a report under Section 269 of the Ordinance) that: (i) (ii) (iii) (iv) (v) (vi) (vii) the business of the company is being conducted with intent to defraud or unlawful purpose; framers of company guilty of fraud, misfeasance, breach of trust, misconduct towards company or any of its members or have been carrying unauthorized business; affairs of company so conducted so as to deprive members of reasonable return; members not given all information, which they might reasonably expect; any shares of company allotted for inadequate consideration; affairs of company not being managed in accordance with sound business principles or prudent commercial practices; or the financial position of the company is such as to endanger its solvency,
then SECP may apply to court, which may order
106
removal from office of director, officer, managing agent or chief executive (not unless court specifies a lower period, disqualified for five years from holding such a position), that director should carry out specified changes in management or accounting policies, call meeting of members to consider specified matters and take appropriate remedial action, or (direct) to annul any existing contract, which is to detriment of company or members, or to benefit of any officer or director.
Sections 273 and 274 of the Ordinance state that no compensation is to be paid for annulment or modification of contract and no right of compensation for loss of office. SECPs Powers to Initiate Proceedings for Recovery of Damages or Property Under Section 278 of the Ordinance, the SECP may, if from a report under Section 269, it appears to it that in the public interest, proceedings should be brought by company or body corporate (whose affairs are being investigated) for recovery of damages (in respect of fraud, misfeasance, breach of trust or other misconduct) or any property, which has been misapplied or wrongfully retained, bring proceedings in the name of such entity (which will indemnify SECP for any costs and expenses). SECPs powers of Imposition of restrictions on shares and debentures and prohibition of transfer of shares and debentures in certain cases (also applies to debentures) Section 279 of the Ordinance states that, where it appears to the SECP that in connection with any investigation, it is important for fact finding about shares to impose certain specified restrictions, the SECP may impose such restrictions for not more than a year. The SECP is to provide an opportunity for showing cause before imposing any such restriction. Detailed list of restrictions are specified under the section. The SECP can also block for up to a year, a change in directors of a company through an already completed transfer of shares or a future transfer of shares, if the SECP thinks that such change is prejudicial to public interest. The SECP can also rescind any of its orders. Otherwise, relief against such an order lies in court (which will first hear the SECP). Default is punishable with imprisonment or fine or both. Powers of SECP under the SE Ordinance and the SECP Act SECP draws its basic powers of registering and regulating stock exchanges as well as regulating issuers under the SE Ordinance. The SE Ordinance is significant for its detailed treatment under Section 15-A of prohibited insider trading and under Section 17 of prohibited fraudulent acts, which it defines in great detail. If further provides the procedure for enquiries, the penalties and appeals pertaining to the same. SECPs Power to Issue Prohibitory Orders Section 20 of the SE Ordinance allows the SECP to issue prohibitory orders for preventing, through any commission or omission, a contravention of any provision of the SE Ordinance or any rules made thereunder.
107
Power of Federal Government to Conduct Enquiries Section 21 gives the Federal Government the power, suo moto or on an application, to appoint any person to inquire into (i) the affairs of any stock exchange, or (ii) the dealing/trading being conducted by any broker, member, director or officer of a stock exchange. The SECP Act dwells in greater detail on the structure, functioning and powers of the SECP. Some of the significant stated powers of the SECP under Section 20 of the SECP Act include, inter alia: (1) prohibiting fraudulent and unfair trade practices relating to the securities market; (2) conducting investigations in respect of matters relating to the SECP Act and the SE Ordinance and in particular for the purpose of investigating insider trading in securities and prosecuting offenders; (3) regulating substantial acquisition of shares and the merger and take-over of companies; (4) considering and suggesting reforms of the law relating to companies and bodies corporate, securities markets, including changes to the constitution, rules and regulations of companies and bodies corporate, Stock Exchanges or clearing houses; (5) promoting investors education and training of intermediaries of securities market; and (6) encouraging organized development of the capital market and the corporate sector in Pakistan. Even a cursory glance at the above reveals the wide ambit of powers, which the SECP enjoys and the many hats that it wears. It acts as a developer and educator as well as a regulator with wide investigative powers. The regulatory power of the SECP, especially in the acquisition, take-over and merger area has been effectively used recently for the protection of the interest of minority shareholders and creditors.
[
Adjudicative Powers
Section 22 of the SECP Act also gives the SECP adjudicative powers to adjudicate upon the rights of any person whose application on any matter it is required to consider in the exercise of any power or function under the SECP Act and some very important case law has emerged from this process over the last couple of years which has clarified the rights and duties of various components of the corporate sector in Pakistan. Power to conduct suo moto investigations Section 29 of the SECP Act empowers the SECP to conduct investigations in respect of any matter that is an offence under the SECP Act. Powers of the Courts vis--vis the Protection of Shareholders Rights (Some recent case law) The primary power of the courts to intervene to prevent oppression of shareholders and mismanagement of the affairs of the country is through Section 290 of the Ordinance. Power of Court to declare a general meeting invalid Companies Amendment Ordinance introduces a new version of a now repealed Section 161(8) of the Ordinance, as Section 160(A) to the Ordinance, which enumerates circumstances in which proceedings of a general meeting may be declared invalid. This can be done by a Court on the petition of members having not less than ten percent of the voting power of the company who
108
point out a material defect or omission in the notice or irregularity in the proceedings of the meeting which prevented members from effectively using their rights. Application to Court (Prevention of oppression and mismanagement)
[
According to Section 290 of the Ordinance, if any member/members holding not less than 20% of issued share capital of a company or creditor/creditors having an interest not less than 20% of the paid up capital, complain(s), or the Registrar is of the opinion, that the affairs of the company are being conducted or are likely to be conducted in a manner, that is unlawful or fraudulent, or in a manner not provided for in its memorandum, or in a manner oppressive to the members/creditors/ or any of the members/creditors or in a manner prejudicial to the public interest, such person(s) or Registrar may make an application to the Court by petition for an order under this Section. The Court, on such petition (if it is of the opinion that any of the above is taking place and that to wind up the company would unfairly prejudice the members of creditors), may make such order as it thinks fit to bring an end to the matters complained of (whether an order for regulating the companys conduct in future or for the purchase of shares of any members of the company by other members of the company or by the company and in case of purchase by company, for the reduction accordingly of the companys capital or otherwise). The company cannot (unless Court allows) make an addition or further alteration to its memorandum or articles, which is inconsistent with any addition or alteration to its memorandum or articles by the Court under this section (which will be as if duly made by a company resolution). Section 291 of the Ordinance lays out further specific powers of the Court in connection with the exercise of its general powers under Section 290 of the Ordinance. The courts have been active in recent years for the development of jurisprudence in the various important areas of Corporate Governance. Some illustrative instances are as follows: (i) Duty of Auditors.11 The High Court observed that the Auditors are the ultimate watchdogs of the shareholders interests. According to the set practice, the Auditors are required to give a report, which is either clean or qualified. By issuing a clean report, the Auditors certifies that the financial statement reflects a true and fair view of the companys affair and a qualified report subjects such opinion to some observation of irregularity or inconsistency. The High Court highlighted and denounced the practice adopted by the managements of some large companies, which are dependant on public confidence, frenziedly trying to secure a clean audit report from their auditors. The High Court pointed out that since the auditors are recommended (and virtually appointed) by the board of directors, some of them are made to condescend to the managements demand and declared that it caused a devastating effect if the auditors put a seal of approval on the misleading accounts of a company. Role of the SECP as regards disclosures to shareholders12. The High Court has emphasized in a 2002 case, that the SECP should consider the advisability of issuing instructions for guidance of companies to ensure that shareholders attending general body meetings with the object of considering special business receive full disclosure of facts necessary for making an informed decision.
(ii)
11 12
Institute of Chartered Accountants of Pakistan v. Messers Hyderali Bhimji & Co. 2002 CLD 1207. Kohinoor Raiwind Mills Limited v. Kohinoor Gujar Khan. 2002 CLD 1314.
109
Furthermore, that the SECP should also consider issuing guidelines for determining the fair value of shares by companies. (iii) Minority Shareholder protection.13 In the above stated case, the High Court made another very significant addition to minority shareholder rights protection by underlining the fundamental importance and duty of the courts to the protection of minority shareholder rights. It was observed by the High Court, that the court is not a bystander obliged to grant approval to all schemes of arrangements approved by special majority of shareholders specified in Section 284 of the Ordinance (dealing with a compromise of the company with its creditors and members). The court can review the proposed scheme and decline approval, even though scheme approved by requisite majority, in a situation where the majority shareholders of a company had voted in a manner coercive or oppressive to the minority or where the majority shareholders had not voted in the interest of shareholders as a class. The High Court further observed that wherever the Court reaches the conclusion that a scheme is unfair and conscionable, and to which material objections have been raised by any shareholder either in a general meeting or before the court, it would become a duty of the court not to approve the scheme. The fact that the objecting shareholder constitutes a small minority in proportion to the majority will be wholly irrelevant in such circumstances. Elaborating further on the Section 284 provision, it said that Section 284 of the Ordinance which required the sanction of the Court to any scheme of arrangement is meant for the protection of the rights of powerless small minorities who can be outvoted at general meetings and cannot, therefore, adequately safeguard their interests on the strength of their voting rights alone. It is, therefore, open to these minorities to show to the Court that the proposed scheme of arrangement is unfair, unreasonable and prejudicial to their interest, or to the interests of the shareholders generally. The above three examples are all from the year 2002 and indicative of the growing role of the judiciary in elaborating upon and further enhancing the protections for shareholders and creditors under the law.
13
Ibid.
110
CHAPTER 5. CONCLUSIONS AND RECOMMENDATIONS

The following are the conclusions, which can be drawn from this Report along with the recommendations, which are being suggested for the effective implementation of the Code: (1) The review and analysis of the UK Corporate Governance Reports conducted in Chapter 3 gives some very useful insights into the process through which the contemporary consensus on the substantive content of the Combined Code was reached in UK. Some useful conclusions, which, can be drawn from this process for our purposes are contained in the following paragraphs. Chapter 3 mentions the extensive institutional and market support extended to the committees, which authored the UK Corporate Governance Reports (indeed this was also the case in other jurisdictions including India where the Confederacy of Indian Industries played a cardinal role in shaping Indias code of best business practices). This support came not only through a sponsorship of these reports by, inter alia, the London Stock Exchange, the accountancy profession and the UK business sector and extensive institutional and market input and feedback on these reports but also through the fact that the members of these committees came primarily from some of the leading business houses in the UK. This essentially meant that these committees gained tremendously from the invaluable input of its members, which represented diverse interests and many relevant perspectives such as those of the financial and industrial sector, the stock exchange, the accountancy profession, the pension and the insurance sectors. Thus, such a membership brought a wealth of diverse, practical experience to the committees and this was not abstract theorization but a direct insight into the problems confronting the corporate sector in the UK. The fact that the committees represented such diverse groups also meant that there was a much greater chance of their joint recommendations gaining market acceptability, which is exactly what transpired in UK. The additional fact that it took various reports and codes for UK to discover the right balance also shows that identifying the right mix of best practice guidelines is an on-going process and requires consistent market feedback. In view of this, one of the broad recommendations of this Report is that the Code would have a much better chance of implementation if a process of constant evaluation of its contents and implementation, with the flexibility of making some changes in view of persuasive market feedback by relevant institutions and business sectors, is entrenched in the workings of the SECP. More specific recommendations under this broad recommendation are discussed in the following paragraphs. (3) One recurrent slogan of the Combined Code is that Corporate Governance is not just about regulation but a contributor to business prosperity. This is a point made time and again in the Combined Code and is in many ways a point of departure from the Cadbury Code, which the UK market found to be at times over-regulatory and in some ways impeding the flexibility required by companies to pursue their essential and primary goal of making profits. The Combined Code is saying that its regulatory dimension should not cause anyone to lose sight of the business prosperity dimension of the entire exercise. The Cadbury Evaluation 2002 also mentions several contemporary studies which give very
(2)
111
encouraging statistics showing a correlation between implementation of best practices of Corporate Governance and greater profitability for companies which undertook such an implementation. At the same time the Combined Code is saying that business prosperity does not come merely from effective regulation but a whole host of other important factors such as people, teamwork, leadership, enterprise, experience and skills. In other words, an overall development of the capital markets and the quality of people functioning in it make companies better run and more profitable and that dimension should not be lost sight of. Given that the primary aim of introducing more stringent Corporate Governance through the Code is an overall development of Pakistani capital markets so that companies have much better access to capital, this objective of the Code should be highlighted in order to better contextualize it. It is, therefore, a recommendation of this Report that the access to capital nexus of Corporate Governance needs to be highlighted and brought to the attention of the corporate sector in Pakistan by the SECP to win over more adherents. Mere emphasis on the goals of accountability and transparency may not win as many converts as an emphasis on accountability and transparency, which also illustrates the incentive of resultant development of capital markets and access to capital in a convincing manner. At the same time a holistic approach needs to be adopted, focusing on all relevant factors pertaining to the capital markets and the corporate sector in order to develop more informed and sophisticated cadres of people for running companies. This point is further elaborated upon below where the Report discusses various models of capital markets. (4) The Hampel Committee, while preparing its report, also looked at the German and US systems of Corporate Governance and decided not to directly incorporate a system of accepted best practices in those systems. This is because the Hampel Committee concluded that no single recipe of success applies to every jurisdiction. Corporate structures and governance arrangements vary widely from country to country. They are a product of the local economic and social environment. The Code seems to be very much influenced by certain foreign codes including the Combined Code and while many of the essential provisions of governance may be the same in codes around the world, a case can be made for indigenization of the Code given the Pakistani social and economic environment. It is, therefore, one of the recommendations of this Report that two steps be taken by the SECP. (a) There needs to be a regular and extensive review of compliance across the spectrum of listed companies in Pakistan to see whether the Code is actually addressing real issues and what problems, if any, are emerging and recurring. It may emerge from such a review that some problems are recurring due to a lack of information/training of corporate managers in certain areas and hence the review would help flag the areas which may require corporate education programs with specific emphasis on those areas, which the SECP may then consider offering. A syllabus may thus be developed for courses, which the SECP may consider offering through its Institute of Corporate Governance discussed in 6.13 below. On the other hand, it may emerge from such a review that other problems are emerging not due to lack of information/training but simply because a particular requirement of the Code imposes too big an expense on a small listed company in the short-term, which is otherwise making a genuine effort to comply. There may then be a case for conceiving a hierarchy of the provisions of the Code and considering whether a longer timeframe should be extended for compliance with some comparatively less significant provisions of the Code and an immediate and strict compliance timeframe for the most important provisions. It should be noted that some filtering is inevitable. Which is to say that there are some more or less opaque listed companies for whom any Corporate Governance would be an anathema and
112
they will de-list in any case. This Report, however, is primarily concerned about the many others, which will be making a genuine effort to comply but may be hard pressed by the short-run procedural costs of compliance of certain provisions of the Code. A staggering of such costs through the extension of a flexible time period for compliance will ensure that these willing compliers remain in the fold of listed companies for their gain as well as the collective gain of the market. In sum, it may well turn out that some of the provisions of the Code require either an amendment or a more flexible compliance timeframe in view of such real market feedback and such a review would help identify different reasons for noncompliance, which in turn would necessitate different kinds of remedies. It is important that the listed companies be required to give detailed reasons for non-compliance, if any, so that compliance record keeping does not become mere box-ticking and the SECP has sufficient qualitative feedback to gauge the problems being faced by companies in the market. The current provisions of the Code (Clauses xlv to xlvii) do not require such a level of detailed feedback and hence a review of the nature discussed above, may not be possible on the basis of such feedback. (5) An exhaustive evaluation of the corporate profile of the Pakistani listed companies needs to be conducted to gauge their corporate makeup. The UK has highly developed corporate markets, which is not the case in Pakistan. While the development of capital markets in Pakistan is one of the primary aims of an effective Code, the Code also takes shape from the level of development of the capital markets in Pakistan. In other words the level of development of a capital market determines the nature of the code most suitable for that market. A highly sophisticated Code imposed on an unsophisticated market may not do the trick. While this Report is not suggesting that there is necessarily an unbreachable divergence between the Code and the capital markets in Pakistan, any comment on the effectiveness of the Code is incomplete and lacking context, unless conducted against the backdrop of a very clear evaluation of the Pakistani capital markets and their unique features. Once again, an important area to look at is the costs imposed by the Code on small, struggling listed companies which essentially want to comply and the risk of them getting tempted to de-list. This point will be further elaborated upon below. The Combined Code emphasizes the recommendatory nature of its provisions. The Hampel Report finds that good Corporate Governance is not just a matter of prescribing particular corporate structures and complying with a number of hard and fast rules. It rather favours an enumeration of broad principles and then requires all concerned to apply these broad principles flexibly and with common sense to the varying circumstances of individual companies. While this Report agrees that rigidity is undesirable and a level of flexibility in the implementation of the Code is necessary in order to tackle varying situations and to carry everyone forward, it does not agree that the prescription of focusing on broad principles instead of hard and fast rules will work in Pakistan. The reason for this is that sophisticated capital markets have several mechanisms for imposing discipline on recalcitrant companies. These control mechanisms stem from large and liquid financial markets, which empower stakeholders by providing them with viable exit options by reducing risk through investment portfolio diversification, already strong shareholder rights, effective take-over mechanisms and greater shareholder awareness and sophistication. If a company chooses not to be transparent or in compliance with good business practices, shareholders can easily invest elsewhere and thus send a strong signal to the company from which they are disinvesting. Furthermore, the boards of directors in these companies function better as they represent varying and diverse interests and there is no owner-manager monopoly over operations. In
113
(6)
such a context, a hardnosed emphasis on compliance with strict rules may be unnecessary and too restrictive. However, in less sophisticated capital markets like Pakistan, these market checks do not exist as yet. Owner-managers tightly control companies and there is little disclosure and transparency14. This stranglehold can only be broken through promotion of adherence to specific provisions of a code rather than advocating allegiance to some broad principles so that companies become more effective and transparent and attract investment from various quarters, thus diversifying and strengthening the capital markets. This Report, therefore, favours the overall emphasis of the Code on clearly defined and specific rules but with some flexibility to address individual company concerns. However, the substantive content of these rules may need to be altered for local problems and concerns, in view of what has been said in 6.4 above. (7) This then takes one to the question as to whether there is a case for giving statutory protection to all the provisions of the Code by bringing about requisite amendments to the Companies Ordinance. This Report does not recommend such a step as: (a) it can be seen from 6.11 below that the provisions of the Code do not create any great conflict with existing laws and mesh in well with existing provisions; (b) the existing laws already provide some additional useful mechanisms for shareholder rights protection through the institutions of the Registrar, the SECP and the Courts (which have been discussed at length in Chapter 5) and thus along with the existing mode of implementation of the Code, through the stock exchanges, create an extensive regime of Corporate Governance; (c) some of the more important provisions of the Code have recently been given statutory cover; and (d) most importantly a degree of flexibility needs to be retained in the applicability and implementation of the Code. In other words the Code should remain a code and not become a statute. The current mode allows for the SECP to factor in the individual situations and constraints of different listed companies and extend leeway in deserving situations. A statutory entrenchment of the provisions of the Code will diminish this flexibility. Also, as has been suggested earlier, the Code needs to be an evolving and organic document and especially so in the Pakistani context where the capital markets may see some significant changes necessitating a revisiting of the provisions of the Code as well. For example, it will be seen in 6.10 below that the provisions in the Code regarding NEDs are currently being undermined by a particular accountability law of the country and may require some amendment. Furthermore, there seems to be a legislative trend currently en vogue which is generally extending the ambit of accountability of company directors. If this trend continues, very few people may be willing to act as NEDS, and this would then force a reconsideration of the role of the NEDs in the regulatory mechanism being visualized by the Code. It is now pertinent to come to the substantive comparative analysis of the Code with the Combined Code in Chapter 3. This Report finds, that barring the areas of Directors Remuneration and Institutional Shareholders, the Code echoes most of the provisions of the Combined Code. This may, at one level, be regarded as desirable and satisfactory as the Combined Code contains a comprehensive treatment of Corporate Governance based on a rigorous and widely participatory exercise conducted in a legal jurisdiction which has many similarities to our own. At the same time, it denotes a lack of adequate local flavour in the
(8)
14 The Corporate Governance Regime of Pakistan: A Country Report -- Dr. Faisal Bari, Dr. Ali Cheema & Osama Siddique (Lahore University of Management Sciences 2002).
114
Code, which should naturally emanate from local ground realities. For example, the Code is silent about Creditors Rights, discussed in 6.9 below, which play a very important role in the Pakistani corporate environment. Hence once again the observations made in 6.4 and 6.5 above become relevant. The few provisions of the Combined Code, which do not find a corresponding counterpart in the Code, have been listed in the conclusions section of Chapter 3. Any definitive judgment as to whether they should find their way into the Code is also dependent on the results of the surveys and studies recommended in 6.4 above. It may well turn out that their imposition, along with some already existing disclosure and other provisions of the Code are too onerous for the smaller listed companies in Pakistan genuinely making an effort to be compliant with the Code. The fact that the code in UK is organic and constantly evolving is shown by the fact that the areas of Directors remuneration and Institutional Shareholders were not addressed in the Cadbury Report and only came under the purview of later committees due to tremendous growing interest in and concern about these areas in the years after the Cadbury Report came out. A more detailed analysis of the capital markets in Pakistan will divulge more precise solutions but this Report does not consider Directors remuneration to be an area requiring immediate attention in Pakistan. The area of Institutional Shareholders however may become important in a developing capital market, and this is a point discussed further below in 6.9. (9) A useful method of categorizing corporate governance structures is by looking at them as an: (a) Equity-Market Based System (EMS), a (b) Bank-Led System (BLS); or a (c) FamilyBased System (FBS). An EMS is typified by the US/UK capital markets where the share of control-oriented finance is low, financial markets are large and liquid, share of listed firms is large, investment portfolios are diverse and there are strong shareholder and creditors rights. The Combined Code has to be looked at in this context and its provisions reflect its market realities. In an EMS, the dominant conflict is between the shareholders and the management and the Combined Code takes that as its essential focal point and area of regulation. In an EMS there is a separation of ownership and control and dispersed ownership weakens owners ability to monitor management. The boards of directors play a cardinal role in such a scenario and hostile takeovers, insolvency protections and liquid capital markets impose checks on companies. The Pakistani corporate governance structure on the other hand has features of both a BLS and an FBS. While it is not a typical BLS like Germany or Japan, it has some BLS features such as less liquid financial markets than the EMS, a high share of control-oriented finance, relatively strong creditors rights (at least on paper, the implementation is not as strong) and weak shareholder rights. However, it tallies most closely with the features of an FBS with a high share of family-control oriented finance along with an important stake of the banking and financial institutions, relatively small and less liquid financial markets with poor disclosure and a vulnerability to insider trading and other forms of abuse, very rare instances of hostile takeovers, a small share of listed firms and relatively weak implementation of shareholder and creditor rights15. Therefore, in an FBS, unlike in an EMS like the UK, the tussle is not quite between shareholders and the management but between owner/managers, minority shareholders and creditors. Once again these differences between the capital markets and ownership and control structures in the UK and Pakistan underscore the necessity of the steps recommended to the SECP in 6.4 above. Effective Corporate Governance thus becomes even more paramount in an FBS and
15 Coping with Agency Issues with Corporate Governance Dr. Faisal Bari & Dr. Ali Cheema. (Economics Department-Lahore University of Management Sciences-2003).
115
its nature and contents have to be tailored more closely to the special issues and features of an FBS. In this regard it becomes evident that there needs to be an evaluation of Creditors Rights, an area which is currently not reflected in the Code and which is discussed at some length in Chapter 4 of the Report. Since capital markets are not well developed in Pakistan as yet, the importance of the debt market becomes more nuanced. (10) It is now important to see in greater detail why Creditors Rights are important to look at in the Pakistani context. An evaluation of the existing laws pertaining to creditors shows that they are mostly allowed to step in to protect their rights when it is already too late i.e. post declaration of insolvency by a company. While creditors will definitely benefit from the emphasis on disclosure in the Code as they will have access to more and better quality information in order to safeguard their rights and even otherwise companies are expected to function better as such due to the provisions of the Code which also benefits the creditors, there is a case for them to have a greater say in the board rooms or at least have a supervisory presence in that context. In other words, a greater institutional role for the Creditors in the Corporate Governance structure in Pakistan needs to be visualized to bring about their active involvement in the corporate boardrooms as engaged stakeholders. The Code introduces the concept of NEDs but firstly the relevant provisions pertaining to NEDs only consider the representation of equity interests and secondly even these provisions are currently not mandatory. This Report, therefore, recommends that given the significance of creditors in the Pakistani context, Creditors Rights be focused upon and protected through the Code. This is especially important, as Institutional Investors, which provide an additional check on boards in the UK, are as yet an underdeveloped phenomenon in Pakistan. It is also important at this juncture to be cognizant of some recent developments in Pakistani law, which may have an adverse impact on the functioning of the NEDs, as visualized by the Code. The National Accountability Bureau Ordinance, 1999 (the NAB Ordinance) is a recent law, which furnishes a new regime of anti-corruption and accountability measures, including, inter alia, the area of wilful default. According to the NAB Ordinance, a person is said to commit Wilful default if he does not pay, or continues not to pay, or return or repay the amount to any bank, financial institution, cooperative society, or a Government department or a statutory body or an authority established or controlled by a Government on the date that it became due as per agreement containing the obligation to pay, return or repay or according to the laws, rules, regulations, instructions, issued or notified by the State Bank of Pakistan, or the bank, financial institution, cooperative society, Government Department, statutory body or an authority established or controlled by a government, as the case may be, and a thirty day notice has been given to the defaulter. For purposes of this Section and the rest of the NAB Ordinance, a Person .includes in the case of a corporate body, the sponsors, Chairman, Chief Executive, Managing director, elected directors, by whatever name called, and the guarantors of the company or any one exercising direction or control of the affairs of such corporate body. This definition of Person seems to be wide enough to encompass the NEDS proposed by the Code. This means that anyone would be highly reluctant to act as an NED and hence an amendment to this law to preclude NEDS from the ambit of the above definition would be necessary or else the proposal in the Code regarding NEDs will receive a huge setback. Furthermore, as mentioned above, there seems to be a legislative trend currently en vogue, which is generally extending the ambit of accountability of company directors. If this trend continues, very few
(11)
116
people may be willing to act as NEDS, and this would then force a reconsideration of the role of the NEDs in the regulatory mechanism being visualized by the Code. (12) Having conducted a substantive evaluation of the Code and made certain evaluations, the Report then looks at the Code in the context of the existing corporate laws in Pakistan. Apart from the Code, twenty-one important laws are looked at in detail, which include broad regulatory laws such as the Companies Ordinance and the SECP related laws as well as specific statutory regimes for setting up certain banks and other institutions of national significance. What emerges is that there are comparatively very few areas of conflict, which require any amendment to the relevant laws. These are in the areas of tenure of office of directors; frequency of meetings of board of directors and appointment of external auditors and these have been highlighted in Chapter 4. On the other hand the Code breaks new ground in areas such as role of NEDs and officers of the company such as the Company Secretary and the CFO, the quantity and quality of information, which needs to be presented before boards of directors to take better decisions, audit committees and role of internal auditors. These are essentially areas, which have not been addressed in existing laws and hence there is no question of a conflict. Then, there are areas such as the structure and responsibilities of the board of directors, powers and duties of executive directors, role of external auditors and disclosure requirements, which have been addressed at times quite adequately by existing laws but which are augmented and well-supplemented by the new provisions in the Code. The overall picture, which emerges is that of harmony rather than conflict. The most significant dimensions of the Code are (a) the further formalization and bolstering of the functioning of the board of directors; (b) the emphasis on sound internal control for more informed and efficient directorial decision-making; and (c) the strengthening of the audit function by the addition of the audit committee and internal audit dimensions. These three areas of reform should have a direct and potent bearing on the efficient and transparent functioning of companies in Pakistan. Furthermore, the new amendments, which have been recently introduced to the Companies Ordinance further entrench and bolster some of the important provisions of the Code. Given the above recommendations, this Report supports any efforts towards a wellequipped permanent Research Cell at the SECP to monitor compliance, market feedback and significant financial and legal developments in Pakistan. This Report also supports the SECPs plan to set up an Institute for Corporate Governance, which should not only provide training programs and orientation courses for directors and other office holders of companies but also provide fora for open debate on relevant current issues and legal reforms. There is also a case for a Compliance Rating System to be set up by the SECP for giving incentive to more compliant companies in the form of some market rating or accreditation. One drawback, however, which should be noted with such an approach, could be that while the already well governed and compliant companies may benefit from this, the smaller, cashstrapped companies which are finding it hard to comply may not get any rating and that in itself may further defeat any possibility on their part to attract investment from the market. Given the fact that some government-owned organizations and other entities currently fall outside the ambit of the Code, due to exemptions which have been extended to them by the government, the reputation of the SECP as a regulator extending a uniform, across-theboard application of the Code may suffer in the eyes of those required to comply with the
(13)
(14)
(15)
(16)
117
Code. Therefore, there needs to be an open and clearly-laid out process of who gets an exemption and for what reason. This also becomes important, in the context of the SECP potentially extending a more flexible compliance timeline to some companies due to their individual circumstances, as recommended earlier in the Report. In other words, exemptions should follow from transparent and clearly defined rules and criteria and not pure discretion.
118
LIST OF REFERENCES
UK Corporate Governance Reports: Report of the Committee on the Financial Aspects of Corporate Governance headed by Sir Adrian Cadbury: The Code of Best Practice (Cadbury Code) 1 December 1992. Directors Remuneration: Report of a Study Group chaired by Sir Richard Greenbury (Greenbury Committee Report) 17 July 1995. Committee on Corporate Governance: Final Report (Hampel Committee Report) 28 January 1998. Review of the Role and Effectiveness of Non-Executive Directors by a Committee headed by Derek Higgs (Higgs Review) --20 January 2003. The UK Code: The Combined Code Principles of Good Governance and Code of Best Practice -Derived by the Committee on Corporate Governance from the Committees Final Report and from the Cadbury and Greenbury Reports June 1998 Guidance on the Combined Code The Report of the Turnbull Committee: Internal Control Guidance for Directors on the Combined Code (Report of the Turnbull Committee). September 1999. The Cadbury Evaluation 2002: Cadbury, Sir Adrian. Corporate Governance and Chairmanship: A Personal View. London: Oxford University Press 2002. La Porta Report: Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer Harvard University. Robert W. Vishny University of Chicago. The Journal of Political Economy, Volume 106, Issue 6 (Dec., 1998). The Code: Securities and Exchange Commission of Pakistans Code of Corporate Governance March 28, 2002.
119
Laws Reviewed that were in the Terms of Reference: (a) Ordinance and Related Laws Companies Ordinance, 1984 Companies (Amendment) Ordinance, 2002 Companies (Second Amendment) Ordinance, 2002 Companies (General Provisions and Forms) Rules, 1985 Securities and Exchange Ordinance, 1969 Securities and Exchange Rules, 1971 Securities and Exchange Commission of Pakistan Act, 1997
(b) Other Laws Pakistan National Shipping Corporation Ordinance, 1979 The Pakistan International Airlines Corporation Act, 1956 Pakistan Telecommunication (Re-organization) Act, 1996 The Bank of Punjab Act, 1989 Chartered Accountants Ordinance, 1961 National Bank of Pakistan Ordinance, 1949 The Modaraba Companies and Modaraba (Floatation and Control) Ordinance, 1980 Banking Companies Ordinance, 1962 Insurance Ordinance, 2000
Laws Reviewed that were not in the Terms of Reference Financial Institutions (Recovery of Finances) Ordinance, 2001 Securities and Exchange Commission of Pakistans Listed Companies (Prohibition of Insiders Trading) Guidelines, 2002 Modaraba Companies and Modaraba Rules, 1981 Provincial Insolvency Act, 1920 The National Accountability Bureau Ordinance, 1999
Other Reports: The Corporate Governance Regime of Pakistan: A Country Report -- Dr. Faisal Bari, Dr. Ali Cheema & Osama Siddique (Lahore University of Management Sciences 2002).
120
Coping with Agency Issues with Corporate Governance Dr. Faisal Bari & Dr. Ali Cheema. (Economics Department-Lahore University of Management Sciences-2003).
Circulars: Institute of Chartered Accountants of Pakistan (ICAP) Circulars Securities and Exchange Commission of Pakistan (SECP) Circulars State Bank of Pakistan (SBP) Circulars References in the Creditors Rights Section (7.10) Eds. Sheikh, Dr Saleem and Rees, Professor William, Corporate Governance and Corporate Control. London: Cavendish Publishing Limited 1995. Finch, Vanessa. Creditor Interests and Directors Obligations. P.111 141, Chapter 4 of Corporate Governance and Corporate Control. London: Cavendish Publishing Limited 1995.
References:
Case Laws: Pakistan WAPDA v. Kot Addu Power Co. Limited (PLD 2000 Lahore 461). Rizvi and Rizvi, Advocates v. Wak Orient Power and Light Limited (2002 CLD 614). Abdus Salam v. Mian Muhammad Sharif (PLD 1952 Lahore 465). Institute of Chartered Accountants of Pakistan v. Messers Hyderali Bhimji & Co. (2002 CLD 1207). Kohinoor Raiwind Mills Limited v. Kohinoor Gujar Khan (2002 CLD 1314).
121

Harmonizing Code

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Harmonizing Code

Uploaded by

Copyright:

Available Formats

Report of the Research Study on

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

104 111 119

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

10. 11. 12. 13.

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

37. 38. 39. 40.

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

44. 45. 46. 47.

53. 54. 55. 56.

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

2.2 The UK Code and the Pakistani Code: A Comparative Analysis

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

B.3.2 B.3.3 B.3.4

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

1. The Structure and Responsibilities of the Board of Directors

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Role of the Chairman

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

The Decision Making Process of the Board of Directors

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan

Harmonizing Code of Corporate Governance with other Laws/Regulations in Pakistan