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 October 2010. In order to help you to prepare for the Board
examinations in Corporate Secretaryship and Corporate Governance in October 2010, 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.

• You can download the King Code on Corporate Governance for South Africa from:
http://www.iodsa.co.za/products_reports.asp?CatID=150
• You can view the King Report on Corporate Governance for South Africa online on
http://www.iodsa.co.za/products_reports.asp?CatID=150
• You can download the practice notes: http://www.iodsa.co.za/books.asp?CatID=277

These are crucial documents especially for the module in Corporate Governance, but they also
have relevance to the module in Corporate Secretaryship.

1 
 
2. Download the following documents from the Internet which are very helpful in assisting you to
understand the application and implications of the King III Code:

• The latest edition of Steering Point, and the Executive Guide to King III which address
issues around King III and the related legislative requirements. These documents can be
downloaded from http://www.pwc.com/ZA/en/publications/steering-point.jhtml
• The King III Scorecard: Alexander Forbes. This document can be found on
https://extranet.alexanderforbes.com/kingiii/login/login.html – click on the link that says
“Click here to view our King III brochure”. Pages 1 – 18 of this document are relevant for
your studies.

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.

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.

2 
 
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:
ƒ integrated reporting, including financial reporting, and sustainability issues
ƒ internal financial controls
ƒ internal and external audit processes
ƒ corporate law and risk management
ƒ 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. 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.

3 
 
• 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.
• 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

4 
 
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).

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;

5 
 
• 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 or executive authority could be construed to be directing the
day-to-day management of the company and its subsidiaries.

6 
 
 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, 1973, leads to the following consequences:

Section 441 sets out the penalties applicable to various offences (ranging from nominal
fines to a maximum penalty monetary fine plus 10 Years imprisonment), for example:

Section Compliance Penalty

440F Prohibition of insider trading a fine or to imprisonment for a
period not exceeding 10 years or
to both such fine and such
imprisonment
132 Forgery, impersonation and unlawful fine or imprisonment for a period
engravings not exceeding 10 years or to both
such fine and such imprisonment
440FF A widely held company which issues a a fine not exceeding R1 000 000
1 financial report that fails to comply with
a financial reporting standard, and every
director of the company who has signed
or was party to the preparation or
approval of the financial report, shall be
guilty of an offence.

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

7 
 
 Penalty which the court imposes, order such company, director, officer or person to
perform such act within such period as the Court may fix.

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

8 
 
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 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
The Role of Internal Audit
Internal Audit’s Approach and
Plan
Internal Audit’s Status in the
Company
A risk based and effective internal audit should be
required by the Board.
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.
A risk based approach is necessary for internal audit
planning.
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
9 
 
 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

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.

10 
 
(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;
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.

11 
 
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.

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.

12 
 
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

13