Debate on governance proposal

Canada’s governance regime follows the rules-based approach used in the U.S., which relies on so-called “bright line tests” for assessing independence (along with guidance). However, the CSA is looking at moving toward a more principles-based model that would rely largely on guidance rather than on hard-and-fast rules for determining independence. (The latter is the approach used in the U.K. and Australia.)

The rationale for regulators to contemplate this change stems from certain issuers’ complaints that the CSA’s existing approach prevents otherwise qualified candidates from serving as independent directors and limits the pool of potential corporate directors needlessly.

Companies that are held by a single major shareholder or controlled by a family in particular are opposed to the current approach in Canada. They say it penalizes them unfairly relative to more widely held companies.

In a submission to the CSA consultation on behalf of a group of Toronto Stock Exchange-listed issuers with controlling shareholders, Bay Street law firm Osler Hoskin & Harcourt LLP notes that these companies believe the current approach to director independence is “flawed, inconsistent with practices in all other jurisdictions other than the U.S. and fails to consider the unique role of controlling shareholders in Canadian capital markets compared with the U.S.”

Yet, the pressure for the CSA to change the rules on this matter has received resistance from institutional investors, proxy advisory firms and corporate governance experts. These groups question the claim that the current approach to determining independence is restricting the pool of qualified directors dramatically.

The submission from the Ca- nadian Coalition for Good Governance (CCGG), a Toronto-based shareholder advocacy group, states that the CCGG is “unaware of any evidence to support the view that too few individuals are available to serve as directors.”

Although some issuers may believe the rules on director independence are too restrictive, the opposite often is true from the investor’s point of view, the CCGG’s submission states.

Historically, the concept of board independence has been applied too broadly, the CCGG’s submission adds, allowing boards to count directors as independent despite the fact “relationships exist that might reasonably be expected to interfere with the exercise of independent judgment.”

The submission from Institutional Shareholder Services Canada Corp. (ISS Canada), a Toronto-based proxy advisory firm, also challenges the idea that family-controlled firms should be given special consideration in assessing director independence.

ISS Canada’s submission states that the dual-class shares and unequal voting rights at these firms represent potential conflicts of interest that could harm the interests of minority shareholders.

“The ability to elect independent directors who are charged with protecting the interests of all shareholders is particularly important in a controlled company scenario,” ISS Canada’s submission states.

Moreover, the CCGG’s submission warns that changing the rules to accommodate issuers that claim the existing approach to independence is too restrictive would run counter to the CSA’s efforts in improving the representation of women on corporate boards.

Revising the rules to allow directors that currently fail the CSA’s independence tests “would be working at cross-purposes with the CSA’s initiative on another front to expand the pool of qualified candidates by including more women,” the CCGG’s submission adds.

Submissions from several institutional investors contend that companies simply aren’t doing enough to find qualified, independent directors – as demonstrated by the lack of female directors in Canada. According to the CSA’s latest data, just 14% of corporate directors in Canada are female, and 39% of companies still don’t have a single female director.

To some, this situation points to the failure of the existing director recruitment process. The submission from Toronto-based NEI Investments states: “We question whether all companies are making sufficient efforts at present to expand the reach of their director recruitment efforts, noting that many boards have yet to recruit their first female director.”

NEI’s submission argues against easing the independence criteria, which, it warns, “could undermine the valuable work securities regulators have undertaken in recent years on [corporate] board diversity by allowing or encouraging public companies to retreat into traditional networks of contacts in recruiting directors.”

Similarly, the submission from Victoria-based British Columbia Investment Management Corp. (bcIMC), suggests that the failure to find qualified, independent directors lies with companies’ efforts in identifying directors: “The only limitation on the pool of available individuals is the limitation caused by the recruitment and selection process itself.”

The bcIMC’s submission contends that the director recruiting process “should cast the widest possible net when searching for potential director candidates and embrace diversity.” This, the submission adds, would negate any perceived limitations on the pool of qualified directors and ultimately results in highly qualified, effective boards of directors.

Although the submission from the Institute of Corporate Directors, a Toronto-based trade association for corporate directors, acknowledges that the CSA’s current approach may mean that some capable people are excluded from possible corporate board posts, that submission also backs up the assertion that there is an adequate supply of qualified directors in Canada: “Senior directors we consulted explained that [the CSA rules] take pressure off directors when determining member independence.”

Rather than relaxing the criteria for independence, NEI’s submission recommends that issuers work harder to identify the capable candidates they’re overlooking: “We believe the priority should be expanding the pool of [corporate] directors with new, diverse candidates who contribute expertise in new areas.”

The submission from the Canadian Foundation for the Advancement of Investor Rights, a Toronto-based investor advocacy group, recommends that corporate boards of issuers listed on the TSX Venture Exchange (TSXV) be required to be composed of a majority of independent directors: “This would increase the governance standard for venture issuers, which would be appropriate, given that retail investors are exposed to higher-risk investments [when investing in TSXV-listed companies].”