How independent are independent board directors?

A good friend, Atty. Bienvenido Medel, who has been in the private legal practice most of his life but has recently taken interest in investment and the stock market, took issue—in the process, engaging me in an animated discussion—of the role of independent directors in companies.

Independent directors are elected on the basis of their vital capability or expertise to infuse and generate fresh ideas for the growth of the company as well as qualification and stature to effectively protect stockholders’ interests by forestalling fraudulent practices.

More importantly, the election of independent directors is part of the government’s policy to promote corporate governance reforms to raise investors’ confidence, develop the capital market and sustain high growth in the corporate sector and the economy.

Despite this requirement, however, the corporate world has been fraught with stories of business failures and bankruptcies that debunked the importance and relevant role of independent directors in the ultimate protection of stockholders’ interests.

There is no denying that these corporate failures have been the result of a breakdown in the observance of good business practices and the ineffectiveness of elected independent directors to hinder management excesses or dishonesty, thus, begging the question as to “how independent are independent directors” in the discharge of their duties and responsibilities.

An independent director, otherwise known as an “outside director,” according to Section 17.2 of the Securities Regulation Code “is a person who, apart from his fees and shareholdings, is independent of management and free from any business or other relationship which could, or could reasonably be perceived to, materially interfere with his exercise of independent judgment in carrying out his responsibilities as a director in any corporation.”

As prescribed, the board of a corporation must be composed of at least five but not more than 15 members, 20 percent of which shall be constituted by independent directors, and “in no case, less than two.” This rule was made “in order that no director or small group of directors can dominate the decision-making process” of the company.

SEC Memorandum Circular No. 9, series of 2011, allowed no limit as to the number of companies where a person may be elected, except when a person is an independent director of a business conglomerate, he may be elected to only five companies of such conglomerate.

In the same circular, the term of an independent director was expanded to five consecutive years. After this period, he or she shall become ineligible for election unless he or she first undergoes a “cooling off” period of two years.

After the mandatory two-year cooling-off period, the person can be reelected in the same company to serve another five consecutive years.

However, after serving for 10 years, the person is “perpetually barred from serving as an independent director for such corporation, without prejudice to his being elected as such in other companies outside of the business conglomerate.”

The reason behind the term limit is that after serving that long, it is deemed that his or her objectivity and loyalty could have already been compromised.

Lastly, the aim of the perpetual ban is to force corporations to appoint new persons who can introduce fresh and innovative ideas to the company.

Bottom line spin

Despite the strong provisions, there are still doubts to their effectivity.

The case of Enron and Worldcom, two of the worst financial scandals in the US, reportedly stemmed from the failure of its board “to check the use of irregular accounting procedures bordering on fraud.” These companies appeared to have representations from elected “independent directors.”
Nevertheless, the independent directors’ effectivity is muffled by their very predicament as to who gets them elected. Beholden by management, they didn’t become that “independent” as independent directors after all.