Corporate Governance Proposed Changes – How Will it Affect D&O Insurance?

The landscape for Public Companies and their boards is changing fast. The news is flooded with causes for this, whether it is due to the Hayne Royal Commission, Security Class Actions, Globalization or any other factor, corporate governance and directors and officers insurance will not look the same moving forward; boards will need to adjust to what will be considered the “new normal” or they will feel the effects. This can be seen clearly in the Australian Directors and Officers insurance market , with drastic changes to D&O policies and increased premiums charged by insurers over the past 18 months caused by large claim settlements driven by security class actions. Not only this, but we are starting to see regulators reacting to the changing environment, including the ASX looking to amend their Corporate Governance Principles and Recommendations.

Whether you’re on the board of a small junior public company or a large ASX 200, the playing field is changing and you can’t afford to be left behind. We see the challenges that many junior public companies have when they are “grouped” with the large cap companies when it comes to Directors and Officers insurance and the proposed changes to the ASX Corporate Governance is another example of this grouping. However, this is the reality when both large and micro-cap companies are both a listed entity of the same exchange.

We, at KBI, try to add value to our clients by advising them on what we are seeing and how it will impact their companies, boards & executives and more specifically their Directors and Officers insurance. This article is focused on the proposed changes to the ASX Corporate Governance Principles and Recommendations that are due to change in July of 2019. We will drill down on what is proposed, what’s driving the change, recommendations, submissions from external parties and how we feel it may impact Directors & Officers insurance in Australia.

ASX Corporate Governance Principles and Recommendations – Proposed 4th Edition Amendments

The consultation period for the proposed 4th edition of the Corporate Governance Principles and Recommendations closed on 27 July 2018 with 100 submissions received from interested parties. The period for review of the submissions will end in December with the issue of the 4^th edition proposed in Q1 2019 and effective from 1 July 2019. It is contemplated at this stage that ASX listed entities will be required to report against the 4^th edition for their first full financial year ending on or after 30 June 2020.

What has driven the corporate governance changes?

The ASX Corporate Governance Council, in its communique, lists a number of factors which have contributed to the timing of this review. These include:

The changing landscape for listed companies who need to consider the views of a larger stakeholder base to continue to maximise shareholder value and maintain a social license to operate.
That boards of listed companies need real and tangible support to instill and monitor a governance culture within their organization.
The increased “internationalization” of ASX listed companies with operations and/or directors operating outside of Australia and thus falling outside the realm of some of the proposed new whistle blowing and anti-bribery legislation.
Recent governance issues identified in enquiries such as the Hayne Royal Commission and the Senate Economics References Committees, which examined whistle blowing in Australia,foreign bribery and governance concerns raised by ASX during the course of its continuous monitoring.
Similar reviews being undertaken in a number of other jurisdictions, including: Hong Kong, United Kingdom and Singapore.

What are the recommendations in the 4th edition?

The proposed amendments / new recommendations include (amongst others):

The recommendation that a listed company obtain independent advice before entering into any consultancy agreement between the company and a director or senior executive (or a related party) and disclosure of the material terms.
The recommendation that listed companies disclose the process by which they validate their corporate reports to ensure that all market releases are accurate, clear and understandable.
The recommendation that any company with a non-English fluent director have (and disclose) the processes it has in place to ensure that the director understands and can contribute to board meetings.
The recommendation that alongside the need to disclose a code of conduct for directors, senior executives and employees, the board is regularly informed of any material breaches of the code and any other material breaches that call into question the culture of the organization.
The requirement for a periodic review of the skills of existing directors and any need to undertake professional development. This is coupled with enhanced requirements for the induction of new directors.
Requirements that board composition includes directors with skills in new and emerging issues, i.e. cyber security, digital disruption and sustainability.
More fulsome disclosure of corporate governance policies (rather than the release of summaries) to ensure there is no omission of material information.

Some summaries of submissions lodged in response to the proposed changes

The Australian Institute of Company Directors submissions highlight proposed corporate governance amendments in other jurisdictions, such as the United Kingdom and Singapore. This indicates a move away from a compliance “box ticking” exercise to the adoption of a corporate governance practice that will support the long-term growth and success of the business. https://www.asx.com.au/documents/regulation/Australian-Institute-of-Company-Directors.pdf

The Governance Institute of Australia expressed concerns about the increase in the level of prescription in some of the new recommendations and commentary, as well as the adoption date for the recommendations. They prefer the option of “early adopters” for companies in a position to do so, but require the first companies to report against the 4^th edition to be those with December 2019 balance dates. https://www.asx.com.au/documents/regulation/governance-institute-of-australia.pdf

King & Wood Mallesons noted that the proposed new recommendation relating to directors who are not fluent in the language of the listed company’s meetings might be better dealt with through other methods; for example: the listing conditions which apply to non-Australian domiciled entities on application for admission. They also highlight concerns that the recommendation requiring directors to “have regard” to the interests of other stakeholders (not simply shareholders) is inconsistent with the requirements of Australian Company law, which requires directors to focus on the interests of the Company’s shareholders as a whole. https://www.asx.com.au/documents/regulation/king-wood-mallesons.pdf

Herbert Smith Freehills submissions highlighted the need to understand the extent of the process of “validation” of corporate reports – whether this contemplates a process as involved as the validation process required for a company when completing its prospectus document, or a simple internal review process with key management. https://www.asx.com.au/documents/regulation/herbert-smith-freehills.pdf

How do these changes in corporate governance relate to Directors and Officers Insurance?

The proposed changes raise some interesting considerations for listed entities when considering their Directors and Officers Insurance:

Some “red flag” concerns for insurers could be alleviated to some extent by companies ensuring they adopt the appropriate processes. For example, companies with operations or board members predominantly based outside of Australia would benefit from adopting appropriate processes for non-English fluent directors. This can include induction processes to ensure they are familiarised with their legal duties and responsibilities under key Australian legislation.
Disclosure of full policies, especially the continuous disclosure policy, prevents the possibility of an inadvertent omission of material information when summarising these documents and enhances the quality of publicly available information.
Will the increase in disclosure requirements increase the chances for errors and omissions, and consequently an increase in the possibility of security class action law suits? The plaintiff law firms have targeted these oversights in the past and the changes could make it more difficult for boards to manage.
Insurers will continue to refer to a company‘s corporate governance statement alongside other publicly available company information when considering the company’s insurance risk profile. As new recommendations are implemented, insurers will consider how their policies respond and any changes they might need to put in place.
As the corporate governance principles evolve to include emerging issues such as cyber security and digital disruption, companies will need to examine their insurance policies closely to ensure they have the capability to respond to potential claims. If they don’t, companies will need to consider if they should be purchasing a standalone insurance policy to deal with these issues.

Ultimately, any changes which improve the quality and depth of disclosure by listed companies are positive for all stakeholders. Directors considering board positions can review and take some comfort in circumstances where a company’s prevailing corporate governance structure measures favourably against recommendations.

A link to the relevant consultation papers, ASX roadshow presentation and submissions can be found here: https://www.asx.com.au/regulation/corporate-governance-council/review-and-submissions.htm

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About KBI

KBI is a boutique insurance brokerage with a focus on Directors’ & Officers’ insurance. Our team has placed Directors’ and Officers’ Liability Insurance for over 300 public companies in Australia, Asia, North America and Europe including the ASX, TSX/TSX-V, SGX, Nasdaq, NYSE and LSE/AIM. Our team consists of senior brokers, lawyers and past ASX listing advisors. We add value to the process by helping our clients make an informed decision during the purchasing and claims process. We also continue to provide updates to our clients, so they are properly informed on the ever-changing landscape of Directors & Officers insurance.

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By Dawn James

Dawn James is an Account Manager at KBI with a focus on Directors and Officers insurance.