1

PREPARING FOR THE BOARD EXAMINATIONS IN CORPORATE GOVERNANCE AND

CORPORATE SECRETARYSHIP

INTRODUCTION

The King Report on Governance for South Africa 2009 (King III) was released by the Institute of

Directors (IoD) on 1 September 2009 and officially became effective as of 1 March 2010, replacing

the previous King II Code.

The King III Code was developed to provide organisations and, in particular, the board of directors

with guidance on good corporate governance practices, as it is often difficult for directors to properly

determine the best governance practices for their organisations and their stakeholders.

In addition to governance, King III also guides directors in considering the sustainability of its

practices and its operations, the so called “triple bottom line” (social, environmental and economic),

rather than purely financial and profit factors. The King Committee has recognised that there has been

a significant shift internationally towards integration of non-financial issues such as social and

environmental as well as sustainable, moral and ethical business practices within organisations and

has explicitly declared in the Code that these non-financial aspects are inseparable and should now

become the central tenets of good governance for South Africa.

King III provides an extensive list of best practice governance principles, to assist and guide directors

to make the right choices for their organisations. These principles have become an indispensable

guide on Corporate Governance to directors, executives and regulators alike and provide guidance on

various governance related aspects, including:

• Ethical leadership and corporate citizenship

• Boards and directors

• Audit committees

• The governance of risk

• The governance of information technology

• Compliance with laws, rules, codes and standards

• Internal audit

• Governing stakeholder relationships

• Integrated reporting and disclosure

EXAM PREPARATION

The King III code is examinable. In order to help you to prepare for the Board examinations in

Corporate Secretaryship and Corporate Governance, the Institute recommends the following:

1. The King III Code is available from the Institute of Directors – there are strict copyright rules on

this that do not permit the Institute to reproduce or distribute it. The website address is

www.iodsa.co.za. In addition, the IOD provides useful practice notes which can be found on

http://www.iodsa.co.za/?page=Guidancenotes

These are important documents especially for the module in Corporate Governance, but they also

have relevance to the module in Corporate Secretaryship.

SAMPLE QUESTIONS

The following questions are examples of what you might expect in the examination. Please work

through these questions carefully and write out your answers. Guideline answers are provided.

2

QUESTION 1

In a report compiled by the Permanent Subcommittee on Investigations (PSI) entitled “The Role of

the Board of Directors in Enron’s Collapse”; the Board was found to have failed in its duties in the

following areas:

a) Fiduciary failure,

b) High-risk accounting,

c) Inappropriate conflicts of interest,

d) Extensive undisclosed off-the-books activity,

e) Excessive compensation,

f) Lack of independence.

Required:

For each of the items (a) – (f) discuss the guidelines provided in the King III Code that would prevent

these problems from arising.

GUIDE TO THE ANSWER

There are three main issues here: financial (b), (c) and (d), directors’ duties (c) and (f), and

remuneration (e).

Financial issues:

Audit Committees play a vital role in corporate governance as they are responsible for the integrity of

the organisation through oversight of integrated reporting and reviewing of internal financial controls.

King III specifies the duties and responsibilities of the audit committee, over and above integrated

reporting, which has become extensive and now includes internal audit, external audit, risk and

management process, and the finance function which involves IT risks and fraud risks that relate to

financial reporting and internal financial controls. The audit committee should also consist of a blend

of appropriate competence and expertise to discharge their responsibilities.

In terms of the financial issues King III recommends the establishment of an audit committee, as

follows (The King Code on Corporate Governance for South Africa, September, 2009):

All members should be independent non-executive directors.

Audit committees should consist of at least three members.

The audit committee as a whole should have a good understanding of:

integrated reporting, including financial reporting, and sustainability issues

internal financial controls

internal and external audit processes

corporate law and risk management

IT governance as it relates to integrated reporting the governance processes

within the company.

The audit committee should meet as frequently as is necessary, but at least twice a year.

Inadequate audit committee composition can impact on the organisation’s auditing processes and

controls making it difficult to adhere to its statutory responsibilities. This can eventually result in the

organisation failing, due to a lack of discipline and poor regulation.

A weak audit committee can substantially reduce an organisation’s ability to do business ethically and

with transparency. King III stipulates the joint commitment by the board and audit committee to

resolve conflict with regards to the audit committee’s statutory duties in terms of the Companies Act.

3

Thus a weak audit committee may not have the necessary influence to manage board conflicts to

provide the financial independence required.

Remuneration issues:

Scrutiny of executive pay is now greater than ever as a result of the economic downturn combined

with public anger over the role played by excessive levels of remuneration in the collapse of the

financial markets. Globally, there is a focus on the need for robust governance processes around

executive remuneration coupled with the requirement for transparency.

These themes are echoed in King III and three general principles in respect of the remuneration of

directors and senior executives are set out:

Companies should remunerate directors and executives fairly and responsibly

Companies should disclose the remuneration of each individual director and certain senior

executives

Shareholders should approve the company’s remuneration policy.

King III recommends the following (The King Report on Corporate Governance for South Africa,

September, 2009):

Companies must adopt remuneration policies that create value for the company over the long

term.

Short-term and long-term performance-related awards must be fair and achievable.

The remuneration committee should assist the board in setting and administering remuneration

policies.

Annual bonuses should clearly relate to performance against annual objectives consistent with

long-term value for shareholders; and should be reviewed regularly to ensure that they remain

appropriate.

Participation in share options or share incentive schemes should be restricted to employees and

executive directors. The chairman and other non-executive directors should not receive share

options or other incentive awards geared to share price or corporate performance.

Vesting of rights, whether settled in cash or shares, should be based on performance conditions

measured over a period appropriate to the strategic objectives of the company. This should be not

less than three years.

Where performance conditions are not met, they should not be re-tested in subsequent periods.

Regular annual grants of awards is desirable.

There should be no re-pricing or surrender and re-grant of share options which are ‘underwater’.

There should be no automatic waiving of performance conditions on a change of control, a capital

reconstruction or termination of employment. It may be appropriate to pro-rate the benefit both

for time and performance

On termination of employment, where early vesting is deemed to be appropriate, vesting should

be dependent upon the extent to which performance conditions have been met over the period, as

well as the time served.

Full disclosure of remuneration paid to each executive director and non-executive director must

be made. Details should be provided of base pay, bonuses, share-based payments, granting of

options or rights, restraint payments and all other benefits. Disclosure of the maximum and

expected potential dilution that may result from incentive awards granted in the current year is

also required. In addition, this information must also be disclosed for the three most highly-paid

employees who are not directors in the company.

The company’s annual remuneration report must explain the remuneration policies followed

throughout the company and explain the strategic objectives that the policies seek to achieve. The

remuneration report must also explain the company’s policy on base pay and the use of

appropriate benchmarks.

4

On an annual basis, the company’s remuneration policy should be tabled to shareholders for a

non-binding advisory vote at the annual general meeting. This vote enables shareholders to

express their views on the remuneration policies adopted and on their implementation.

The implementation of King III principles ensures that remuneration committees are progressively

more informed and equipped to make strategic decisions on remuneration. Furthermore, remuneration

policies will become more aligned with a company’s strategy, reviewed regularly and linked to the

executive’s contribution to company performance and shareholders will be invited to participate in

discussion of remuneration of executives.

Director’s duties:

King III (The King Report on Corporate Governance for South Africa, September 2009), explicitly

proclaims that the Board of Directors is responsible for upholding the principles and practices that

ensure good corporate governance. King III requires boards to have an appropriate balance of skills,

experience and expertise to fulfil its mandate successfully. The code declares the Board is integral to

the success of corporate governance and directors should always act in the best interests of the

company. This is in fact a legal requirement in terms of the Companies Act which codifies the duties

and responsibilities of directors – fiduciary duty, the duty of care and skill and the exercise of good

business judgement.

Increased regulation and legal liability hold the board personally responsible for failed decisions, lack

of insight and due diligence in exercising its b duties. Directors are now, more than ever, held

accountable by their stakeholders for implementing sound governance measures and sustainable

business practices as provisioned in the new Companies Act and King III Code.

In terms of independence of directors, the following guidance is provided by King III (The King Code

on Corporate Governance for South Africa, September 2009).

The chairman of the board should be an independent non-executive director and should not be the

CEO.

To avoid conflicts of interest, a non-executive director should

i. not have been employed by the company or the group of which it currently forms part, in any

executive capacity for the preceding three financial years;

ii. not be a member of the immediate family of an individual who is, or has been in any of the

past three financial years, employed by the company or the group in an executive capacity;

iii. not be a professional advisor to the company or the group other than in a director capacity;

iv. be free from any business or other relationship which could be seen to materially interfere

with the individual’s capacity to act in an independent manner;

v. not be a significant supplier to, or customer of the company or group; and

vi. have no significant contractual relationship with the company or group.

vii. not be a direct or indirect interest in the company (including any parent or subsidiary in a

consolidated group with the company) which is either material to the director or to the

company. A holding of five percent or more is considered material; and

viii. not receive remuneration contingent upon the performance of the company.

QUESTION 2

Regal Treasury Private Bank Limited – a failure of corporate governance (Extracted from

Levenstein Case: Report of the Commissioner, Adv JF Myburgh SC, in terms of s69A (11) of the

Banks Act, 94 of 1990, 15 November 2001).

5

The problem defined

In this case, Jeffrey Levenstein (who was eventually sentenced in 2009 to 15 years in jail for fraud)

was found “not a fit and proper person to be an executive director, CEO and chairman of Regal

Holdings and the bank in that:

• he did not exercise the utmost good faith and integrity in his dealings with and on behalf of the

bank;

• he did not exercise reasonable skill and care;

• he did not always act in the best interests of the bank, depositors and shareholders;

• he permitted a conflict of interest to arise between his interests and those of the bank, its

depositors and shareholders;

• his management of the bank was incompetent and amateurish;

• he acted dishonestly and fraudulently;

• he confused corporate governance with thuggery in that he promptly fired any executive director

or got rid of any non-executive director who dared to question his decisions, at times even

threatening to kill them.

In summary he lacked three of the qualities of a director required of a bank in terms of s1A(a) of the

Banks Act, namely, probity, competence and soundness of judgment. He ran the bank with little

sophistication. He had no idea of the concept of corporate governance and, even if he did have, he was

indifferent to it. Levenstein carried on the business of the bank and Regal Holdings in a reckless

manner.”

Required:

Using the King III code as a guideline, and the case outlined above as an example of what NOT to do,

discuss the following:

(a) the separation of the CEO and Chairman’s roles. (5)

(b) the concept of “non-executive” and “independent” directors. (5)

(c) the need for compliance with laws, rules, codes and standards. (5)

(d) the consequences of non-compliance in terms of the Companies Act, 1973. (5)

(20 marks)

GUIDE TO THE ANSWER

(a) King III mandates the separation of the roles of Chairman and CEO. The Chairman should

preferably be an independent, non-executive director.

A board's ability to exercise independent judgment of company management is weakened if one

person fills both the positions of Chief Executive Officer and Chair of the board of directors. The

board will be more effective in carrying out its critical roles in appointing, monitoring and, if

necessary, replacing the CEO, if different individuals hold the positions of CEO and Chair.

Separating the roles assists in establishing an appropriate balance of power between management

and directors, increases accountability and helps ensure that the board serves to represent the

interests of shareholders, not management.

Where the two roles are combined King III advocates the appointment of a lead, independent,

non-executive director.

(b) A non-executive director is an individual not involved in the day-to-day management and not a

full-time salaried employee of the company or of its subsidiaries. A person who is not in the full-

time employment of the holding company or its subsidiaries, other than the company concerned,

would also be considered to be a non-executive director unless such individual by his/her conduct

6

or executive authority could be construed to be directing the day-to-day management of the

company and its subsidiaries.

An independent director is one who is a non-executive director, does not represent the interests of

any shareholder, is not employed in the company or its subsidiaries in any way and has no

contractual interests in the company or group.

(c) Legal and statutory compliance is an important element in good corporate governance. In addition

compliance also considers non-statutory and non-binding rules, codes or standards and

consequently, as with laws, failure to meet these recognised rules, codes or standards of

governance may render an organisation, board or individual director liable at law. King III

emphasises the importance of compliance with all applicable laws and non-binding standards,

codes and rules in achieving the appropriate standards of conduct for the business. It also ensures

that the board is responsible for oversight of the company’s compliance. Regulatory compliance

should be seen to be a natural extension of governance duties by organisations.

King III sets out the following guidelines: (The King Code on Corporate Governance for South

Africa, September, 2009)

It is necessary to comply with the applicable laws and regulations.

Adherence to applicable rules and standards should be considered.

It is necessary for individual directors to be aware of relevant laws and standards.

Compliance with laws and regulations is a responsibility of the Board.

Effective compliance processes and frameworks should be implemented.

Risk management should include compliance as part of its function.

(d) Non-compliance with the Companies Act, 2008, leads to the following consequences:

PENALTIES

Section Compliance Penalty

S216 Any person convicted of an offence in

terms of this Act:

(a) Contravention of S213(1) or

214(1)

(b) In any other case

A fine or imprisonment not exceeding 10

years or both

A fine or imprisonment for a period not

exceeding 12 months, or both

S218 Civil actions:

(1) Subject to any provision in this Act

specifically declaring void an

agreement, resolution or provision of

an agreement, Memorandum of

Incorporation, or rules of company,

all actions that fall outside of these

categories are only void or voidable if

the Court declares it.

(2) Any person who contravenes any

provision of this Act is liable to any

other person for any loss or damage

suffered by that person as a result of

that contravention.

(3) The provisions of this section do not

affect the right to any remedy that a

person may otherwise have.

S75 Disclose any interest in a contract The non-disclosure of personal financial

interests and any breach of statutory or

common law fiduciary duties may amount

to fraud

S76 Breach of fiduciary duties Depends on the case

S77 Liability of directors and prescribed

officers relating to a breach of fiduciary

duty, bound the company without proper

authorisation, authorised false or

misleading financial statements,

Joint and several liability to recover any

loss, damages or costs provided that such

action commences within three years after

the act or omission

7

contravened financial assistance

provision, contravened distribution

provisions

S78 (3) A company is prohibited from directly or

indirectly paying any fine that may be

imposed on a director of the company or

of a related company who has been

convicted of an offence unless the

conviction was based on strict liability.

S213 Breach of confidence

S214 False statements, reckless conduct and

non-compliance

S11 Criteria for names of companies:

(2)

(a) must not pass themselves off or

“coat-tailing” on the reputations

and goodwill of another

(b) must not be misleading that

falsely implies a non-existent

association

(c) prohibit hateful or offensive

names that fall outside the scope

of the constitutional protection of

freedom of expression such as

propaganda for war, incitement to

violence, advocate hatred based

on race, ethnicity, gender or

religion, or incitement to cause

harm.

S22 Reckless trading The Commission may issue a compliance

notice to the company requiring it to cease

carrying on its business or trading, as the

case may be

S28 A company must keep accurate and

complete accounting records in one of the

official languages

The Commission may issue a compliance

notice

Note: other examples will also be accepted.

The court convicting any company, director, officer or person for failure to perform any act required

to be performed by it or by him or under this Act, may, in addition to any penalty which the court

imposes, order such company, director, officer or person to perform such act within such period as the

court may fix.

8

QUESTION 3

Regal Treasury Private Bank Limited – a failure of corporate governance continued. (Extracted

from Levenstein Case: Report of the Commissioner, Adv JF Myburgh SC, in terms of s69A (11) of

the Banks Act, 94 of 1990, 15 November 2001)

The problem identified

“The respects in which the audit committee operated in breach of the Banks Act, the Companies Act,

and the King Code of Governance were the following:-

While Levenstein was chairman of the bank of Regal Holdings, he was a member of the audit

committee.

The auditors were not invited to all audit committee meetings.

The audit committee did not consider, let alone approve, the interim financial results of 31 August

1999.

The audit committee did not consider, let alone approve, the results of 16 May 2000.

The audit committee did not review the fundamental and related transactions.

The audit committee did not revise a transaction in terms of which Regal Bank paid a related

company R60m for its Regal shares.

The audit committee did not review the transactions in terms of which Regal Bank financed the

acquisition of Regal Holdings shares by the trusts and related parties.

From August 2000, the CFO was not invited to attend audit committee meetings.”

Required

You have been called in to help the company resolve these problems. Write a detailed memorandum

to the new Board in which you explain the crucial role an audit committee has in effective corporate

governance and what the King III Code recommends regarding the composition of the audit

committee. You are also required to make a recommendation to the company in this regard.

(20 marks)

GUIDE TO THE ANSWER

Memorandum

To: The Board

From: The Company Secretary

Date: xxxx

Re: The role, work and composition of the audit committee

(a) The crucial role of the audit committee

King III shifts towards risk-centric internal auditing as it is able to address strategic, operational,

financial and sustainability issues. A risk-based approach allows internal audit to determine whether

controls are indeed effective in managing the risks that arise from the company’s strategic direction.

King III requires internal audit to provide assurance on internal controls and risk management. This

will allow internal audit to deliver value to the business and contribute to effective corporate

governance.

Internal Audit, as advocated by King III, places greater emphasis and aims to provide better assurance

on internal controls and risk management. Lack of proper internal auditing procedures can negatively

impact the transparency, accountability and effective management of the organisation and expose it to

greater risks. Inadequate risk management procedures and internal controls can easily be detected

through precise internal auditing. However, as we have seen, weak internal auditing procedures can

9

allow fraudulent activities, financial discrepancies, non-compliance and unsustainable practices to

arise. Inconsistent internal auditing procedures may invite inefficiencies and possibly overlook

pertinent strategic and business risks making it more difficult to manage and mitigate risks and

establish proper responses. Weak audit procedures can result in the audit coverage failing to

adequately cover the full breadth of the organisation’s risk profile and leaving key areas unprotected.

Failure of internal audit to address key strategic, business and compliance risk areas can ultimately

lead to weak overall corporate governance and business inefficiencies.

(b) The composition of the audit committee

King III provide the following guidance on the role and composition of an audit committee. (The

King Code on Corporate Governance for South Africa, September 2009)

The Need for and Role of Internal

Audit

A risk based and effective internal audit should be required by

the Board.

The Role of Internal Audit It is necessary for internal audit to provide the Board with a

written assessment of the system of internal control,

performance and risk management. Internal audit should assist

the Audit Committee.

Internal Audit’s Approach and Plan A risk based approach is necessary for internal audit planning.

Internal Audit’s Status in the

Company

It is necessary for internal audit to be strategically placed.

Through the CEO, internal audit should have a direct

relationship with:

Audit Committee;

Corporate Governance Committee;

Risk Committee.

The internal audit function should be properly staffed.

The following recommendations are made in this regard (King III Practice Notes, 2009a):

The audit committee should consist of at least three members, all of whom should be independent

non-executive directors.

The audit committee should meet as frequently as is necessary, but at least twice a year.

The audit committee as a whole should have a good understanding of:

o integrated reporting, including financial reporting, and sustainability issues

o internal financial controls

o internal and external audit processes

o corporate law and risk management

o IT governance as it relates to integrated reporting the governance processes within the

company.

I trust that this has provided the Board with the necessary information.

Sincerely

Company Secretary

10

QUESTION 4

The remuneration committee of the Board was determined in both the King II as well as the King III

Code to be one of the most important committees of the Board. It is recommended that all companies,

both large and small, public and private, have a remuneration committee.

Required:

(a) Discuss the roles and responsibilities of the remuneration committee of a Board of Directors.

(b) Draft a remuneration policy in which you deal with each of the following elements:

• Fixed remuneration

• Variable pay

• Pensions and insurance schemes

• Severance pay arrangements

• Other benefits.

The policy should also address how the risk issues surrounding remuneration will be addressed.

GUIDE TO THE ANSWER

(a) (i) The Role of the remuneration Committee (King III Practice Notes, 2009b.)

The Committee has an independent role, operating as an overseer and a maker of recommendations to

the board for its consideration and final approval.

The Committee does not assume the functions of management, which remain the responsibility of the

executive directors, officers and other members of senior management.

The role of the Committee is to assist the board to ensure that:

• the Company remunerates directors and executives fairly and responsibly; and

• the disclosure of director and remuneration is accurate, complete and transparent.

(a) (ii) Responsibilities (King III Practice Notes, 2009b.)

The Committee must perform all the functions necessary to fulfil its role as stated above and

including the following:

i. Oversee the setting and administering of remuneration at all levels in the company;

ii. Oversee the establishment of a remuneration policy that will promote the achievement of

strategic objectives and encourage individual performance;

iii. Ensure that the remuneration policy is put to a non-binding advisory vote at the general

meeting of shareholders once every year;

iv. Review the outcomes of the implementation of the remuneration policy for whether the set

objectives are being achieved;

v. Ensure that the mix of fixed and variable pay, in cash, shares and other elements, meets the

company’s needs and strategic objectives;

vi. Satisfy itself as to the accuracy of recorded performance measures that govern the vesting of

incentives.

vii. Ensure that all benefits, including retirement benefits and other financial arrangements, are

justified and correctly valued;

viii. Consider the results of the evaluation of the performance of the CEO and other executive

directors, both as a directors and as executives in determining remuneration;

11

ix. Select an appropriate comparative group when comparing remuneration levels;

x. Regularly review incentive schemes to ensure continued contribution to shareholder value and

that these are administered in terms of the rules;

xi. Consider the appropriateness of early vesting of share-based schemes at the end of

employment;

xii. Advise on the remuneration of non-executive directors;

xiii. Oversee the preparation and recommending to the board the remuneration report, to be

included in the integrated report, for whether it: -

o is accurate, complete and transparent;

o provides a clear explanation of how the remuneration policy has been implemented; and

o provides sufficient forward-looking information for the shareholders to pass a special

resolution in this regard.

(b) Remuneration policy

The Company’s Remuneration Policy

Fixed remuneration

Fixed remuneration consists of base salary and a long-term incentive.

Base salary

The base salary shall be competitive in the markets in which the company operates and shall reflect

the individual's responsibility and performance. The evaluation of performance is based on fulfilment

of certain pre-defined goals; refer to "Variable pay" below. The base salary is normally reviewed once

a year.

Long-term incentive (LTI)

The Company will carry on the established long-term incentive system for a limited number of senior

managers, including the members of the corporate executive committee.

The LTI system is a fixed, monetary compensation calculated in per cent of the participant's base

salary; ranging from 20 to 30% depending on the participant's position. The participant is obliged to

buy the Company’s shares in the market for the fixed LTI amount (after tax deduction) every year and

to hold the shares for a lock-in period of three years.

The LTI and the annual variable pay system constitute a remuneration concept that focuses on both

short-term and long-term goals and results. The LTI contributes to strengthening the common

interests between the top management and the shareholders of the Company.

Variable pay

The intention is to continue the company's variable pay concept in 2010. Based on performance, the

chief executive officer is entitled to annual variable pay with a maximum potential of 50% of the

fixed remuneration. The executive directors have an equivalent variable pay scheme with a maximum

potential of 40%.

In order to obtain an improved distribution of the annual variable pay, and to underpin a drive towards

an even stronger performance, it has been decided to adjust the pay out level for performance at target

level from 67 per cent to 50 per cent of the maximum potential.

12

Remuneration policy’s effect on risk

The remuneration concept is an integrated part of our performance management system. An

overarching principle is that there should be a close link between performance and remuneration.

Individual salary and annual variable pay reviews shall be based on the performance evaluation in our

performance management system. However, participation in the LTI scheme and the size of the

annual LTI element are not directly based on performance but linked to the executive's position level.

Performance evaluation is a holistic evaluation combining measurement and assessment of

performance against both delivery and behaviour goals. Hence, sound judgement and hindsight

information are applied before final conclusions are drawn. For instance, measured KPI results are

reviewed in relation to their strategic contribution, sustainability and significant changes in

assumptions.

This balanced scorecard approach, with goals defined in both the delivery and behaviour dimension,

and a holistic performance evaluation, should significantly reduce the risk that our remuneration

policies are likely to have a material adverse effect.

In the performance contracts of the chief executive officer and chief financial officer, one of several

targets is related to the company's relative total shareholder return (TSR). The amount of the annual

variable pay is decided on the basis of an overall assessment of the achieving of various targets,

including but not limited to the company's relative TSR.

Statement regarding remuneration

The board's statement regarding all remuneration of the corporate executive committee, as well as

information about all remuneration paid to each member of the executive committee, is presented in

the company financial statements.

References

The King Report on Corporate Governance for South Africa, The Institute of Directors in Southern

Africa, September 2009

The King Code on Corporate Governance for South Africa, The Institute of Directors in Southern

Africa, September 2009.

King III Practice Notes, 2009a: Internal Audit Charter

King III Practice Notes, 2009b: Remuneration Committee Terms of Reference

Companies Act, 2008 and Companies Regulations 2011