Independent Directors – How Independent?

The need to have Independent Directors on the Boards of Companies has in recent years changed from being desirable to mandatory. Most codes of corporate governance now insist on one or two of the Non-executive Directors on the Board, being independent. Indeed, the Nigerian Code of Corporate Governance 2018 recommends that the majority of Non-executive Directors (NEDS) should be independent.

The recently signed Companies and Allied Matters Act (CAMA) further codifies this requirement and makes it mandatory for public companies to have at least three Independent directors. This requirement becomes effective from the date of gazetting the Act.

You may then wonder why it is desirable for NEDS to be independent. Perhaps an understanding of who an Independent Director is will be helpful at this point.

Simply put, an Independent Director is a Director who does not have a material or pecuniary relationship with the Company or related persons, except sitting allowance, reimbursable and director fees.

According to the Central Bank of Nigeria (CBN) Circular on Guidelines for The Appointment of Independent Directors:

‘an Independent Director is a member of the Board of Directors who has no direct material relationship with the bank or any of its officers, major shareholders, subsidiaries and affiliates; a relationship which may impair the director’s ability to make independent judgments or compromise the director’s objectivity in line with Corporate Governance best practices.’

The Nigerian Code of Corporate Governance (NCCG) 2018 provides that:

‘An Independent Non-executive Director (INED) should represent a strong independent voice on the Board, be independent in character and judgment and accordingly be free from such relationships or circumstances with the Company, its management, or substantial shareholders as may, or appear to, impair his ability to make independent judgment.’

In the United States, the NASDAQ and New York Stock Exchange (NYSE) standards for Independent Directors are similar. Both require that “a majority of the board of directors of a listed company be ‘independent,’

The NYSE states that:

“no director qualifies as ‘independent’ unless the board of directors affirmatively determines that the director has ‘no material relationship’ with the listed company, either directly or as a partner, shareholder or officer of an organization that has a relationship with the company.”

Whilst the requirement for Independent Directors in Nigeria is not as stringent as that of the United States where Independent Directors ‘must’ (as against ‘ recommended’ in the NCCG 2018) be a ‘majority’, most codes of corporate governance, require that two or at least, one Independent Director must sit on the Board of a public company.

As may be gleaned from the foregoing, the generally accepted rationale for appointing Independent Directors to the Board is to have a Director who does not have a material pecuniary relationship or transactions with the company, its promoters, its management or its subsidiaries, that may affect his/ her independence of judgment.

The need to have Independent

Directors on the Board developed out of the need to have independent minded business managers who are able to exercise sound judgement independent of any affiliation or personal interests in the Company.

However, a pertinent issue arises from the current selection process of Independent Directors which may influence and impact their independence of thought and judgement. The question of the selection process of the Independent Directors is often overlooked but critical in the determination of the Director’s independence.

A review of the current selection process for most companies reveal that the Chairman of the Board, initiates the appointment of proposed Independent Directors. In rare instances, another member of the Board makes the nomination and subsequently considered by the Board. Barring any exceptional reason, such nominations pass the usual selection hurdles, if any, and the nominee becomes the Board designated ‘Independent Director’. Perfect process? Not exactly. Embedded in the above described process is a beneficiarybenefactor relationship. If the intendment of the NCCG 2018 was for a Director to be appointed without relationships which ‘may, or appear to, impair his ability to make independent judgment’, then the process needs to be reviewed as having a benefactor relationship with the Chairman, or any other nominating director, will have, or at least appear to, impair his ability to make independent judgment.’

How then can this process be improved upon?

It is considered opinion that the NCCG and the newly enacted CAMA be amended to recommend to Boards that the best practice should be for the Independent Director selection process be chaperoned by an independent consultant. These consultants, which have, in recent times been building up an independent director database may thereafter recommend a list of Independent Directors from which candidates may be selected for the Board’s consideration. The Institute of Directors (IOD) or other consulting firms with an Independent Director database should be encouraged to become involved in the process as they may prove a useful partner in this regard.

An alternative to the foregoing is for sectoral regulators to develop a list of candidates who have good standing in the society, demonstrated expertise in the industry and who may have been vetted by the regulator. A list of these individuals may then be provided to requesting companies intending to make such appointment.