Companies must follow a set of practices and rules to ensure that their efforts are cohesive and take the organizations closer to their goals. Corporate governance is the guiding principles that control and direct an organization in the best way possible. The Board of Directors is responsible for the governance of their respective companies, and they must ensure that the company’s operations adhere to the four pillars of corporate governance – accountability, transparency, ethical conduct, and risk management.
Let’s dive deep into the corporate governance responsibilities of board members from a compliance perspective.
But before that, a quick peek into the legislations that govern corporate governance in general, and the role of board members in particular.
Corporate Governance in the U.S.
In the United States, there are four sources of corporate governance law and regulation, and they are:
- State corporate laws, particularly Delaware, where over half of all publicly traded companies in the U.S. are registered.
- The 1933 Securities Act and the 1934 Securities Exchange Act, and the guidelines of the Security and Exchange Commission (SEC) under these Acts.
- The stock exchange listing rules of NYSE and NASDAQ.
- Federal statutes like the Sarbanes-Oxley Act (SOX) and the Dodd-Frank Act.
Here’s a brief look into each of these sources.
Sarbanes-Oxley Act (SOX)
This act came into force as a response to corporate scandals. SOX aims to enhance corporate accountability by imposing stringent requirements on financial reporting and internal controls. Section 302 of SOX requires senior management to certify the accuracy of financial statements, while Section 404 mandates an annual assessment of internal controls over financial reporting.
Dodd-Frank Act
The Dodd-Frank Act addresses financial stability and consumer protection. It includes provisions to enhance the oversight responsibilities of board members, particularly in areas like executive compensation and financial transparency. Specifically, it requires additional disclosure in corporate proxies and more regulations in non-binding shareholder votes. The idea behind this Act is to prevent another economic crisis like the 2008-2010 financial crash, which is largely perceived to be due to corporate misgovernance.
This act also established the Consumer Financial Protection Bureau (CFPB) to oversee consumer protection in the financial sector.
State Laws
The Delaware General Corporation Law (DGCL) and the Model Business Corporation Act (MBCA) are two primary legal frameworks that outline the fiduciary duties of directors, procedures for corporate actions, and shareholder rights. These laws provide the foundation for corporate governance practices in many U.S. companies.
Stock Exchange Requirements
The New York Stock Exchange (NYSE) and NASDAQ impose additional governance standards on listed companies. These include requirements for independent directors, audit committees, and codes of conduct.
NYSE listing standards require listed companies to have a majority of independent directors, establish audit, compensation, and nominating committees composed entirely of independent directors, and adopt corporate governance guidelines. These rules aim to enhance board accountability and ensure effective oversight of management.
NASDAQ also requires listed companies to have a majority of independent directors and establish audit, compensation, and nominating committees. NASDAQ’s rules emphasize the importance of director independence and the role of the audit committee in overseeing financial reporting and internal controls.
Thus, these are the key laws that impact corporate governance in the U.S. Let’s see the international laws for corporate governance.
International Laws on Corporate Governance
United Kingdom
The UK Corporate Governance Code applies to companies listed on the London Stock Exchange. It promotes board effectiveness, accountability, and relations with shareholders. The Financial Reporting Council (FRC) enforces this code and compliance is based on a “comply or explain” approach.
European Union
The European Union has developed comprehensive corporate governance frameworks, like the Shareholder Rights Directive II (SRD II) and the upcoming Corporate Sustainability Reporting Directive (CSRD). These directives aim to enhance shareholder engagement and promote transparency in ESG (Environmental, Social, and Governance) reporting.
Australia
In Australia, the ASX Corporate Governance Council’s Principles and Recommendations guide listed companies. These principles focus on board structure, risk management, and corporate reporting, and companies must disclose their compliance on an “if not, why not” basis.
Canada
The Canadian Securities Administrators (CSA) provide corporate governance guidelines emphasizing board independence, audit committee roles, and risk management. These guidelines aim to ensure that Canadian companies adhere to high standards of corporate governance.
As you can see, there are similar areas of focus across all these laws and regulations, with all of them emphasizing financial reporting and transparency, compensation, and board composition.
To adhere to these laws, the Board of Directors has to perform multiple duties and responsibilities for compliance.
Duties and Responsibilities of Board Members
Based on the above laws, we will list down the duties and responsibilities of board members.
Fiduciary Duties
Fiduciary means trust and the Board of Directors has the responsibility to maintain the trust of all stakeholders and act on their behalf and for their well-being. These duties must adhere to the legal laws and best practices in corporate governance.
Broadly speaking, the fiduciary duties can be:
- Duty of Care
- Duty of Loyalty
Duty of Care
The duty of care means directors must always be on top of the company’s operations, financial health, and regulatory compliance. They should review all relevant materials, seek expert advice, and actively participate in board meetings. The Delaware General Corporation Law (DGCL) in the United States and the Model Business Corporation Act (MBCA) provide specific guidelines for how directors should fulfill these duties.
Duty of Loyalty
The duty of loyalty requires directors to prioritize the company’s interests over their own. This involves avoiding conflicts of interest and disclosing any potential conflicts to the board. The Securities Exchange Act of 1934 stresses the importance of transparency and honesty in disclosing material information that could impact the company or its shareholders.
Risk Management
Directors must ensure the company has a robust risk management framework. The Sarbanes-Oxley Act (SOX) emphasizes the importance of internal controls and risk management practices, particularly in financial reporting. Boards must regularly review the company’s risk management policies and ensure they are adequate to address potential risks.
Effective internal controls are essential for ensuring accurate financial reporting and compliance. SOX requires companies to establish and maintain adequate internal controls, and board members, especially those on audit committees, are responsible for overseeing these controls. This includes reviewing reports from internal and external auditors and ensuring that any deficiencies are promptly addressed.
Boards must ensure that the company has a comprehensive compliance program that includes policies, procedures, and training designed to prevent and detect violations of laws and regulations. Moreover, the Principles of Federal Prosecution of Business Organizations in the Justice Manual checks for this compliance while conducting investigations in a corporation. To prevent fines and other legal proceedings, the Board has to ensure compliance with the prevailing laws.
Strategic Guidance
Board members are responsible for providing strategic guidance while ensuring that the company’s strategic objectives align with regulatory requirements and ethical standards. Directors must balance short-term performance with long-term sustainability. This involves setting strategic goals that comply with relevant regulations and ethical standards. For example, the Environmental Protection Agency (EPA) regulations must be considered when making long-term plans involving environmental impact.
Similarly, effective allocation of resources requires compliance with financial regulations and reporting standards. The Dodd-Frank Wall Street Reform and Consumer Protection Act emphasizes transparency and accountability in financial transactions, and board members must ensure that resource allocation decisions adhere to these principles.
Ethical Standards
The Board of Directors must comply with ethical behavior laws. It is responsible for promoting a culture of ethics and integrity in the organization. Board members should adopt and enforce a code of conduct that sets clear expectations for behavior within the company. The code should address issues like conflicts of interest, fair dealing, and compliance with the law. Ethical guidelines from organizations like the Institute of Internal Auditors (IIA) and the Ethics & Compliance Initiative (ECI) can provide valuable frameworks for developing and implementing these standards.
Thus, these are the duties and responsibilities of board members in corporate governance.
Wrapping Up
Board members have an important role in ensuring that the company adheres to the prevailing laws and regulations. It must navigate a complex legal and regulatory environment and stay informed and proactive in addressing evolving trends and challenges. With a strong commitment to compliance, the Board has the power to create a culture of compliance, resulting in improved trust with stakeholders and a reputation for integrity and transparency.