Due diligence and liability for

non-executive board members

(incl. audit committees)

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Cyril Soeri M.A. RA CISA

20-21 July 2012, St. Lucia , 6th AGM and Conference of the

Caribbean Association of Audit Committee Members Inc. (CAACM)

Content

Due diligence for non-executive board members

Risks and liability for non-executive board members

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Due diligence

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“An objective test for those who want to become a non-executive board member or to continue their current role as a non-executive board member. It is also a test for self-evaluating the performance of a non-executive board member (self-assessment).” CAACM

Recruiting for prospective non-executive board members (1)

What makes an exceptional Non-Executive Director? In order to effectively recruit non-executive board (including audit committee) members the Whitehead Mann Group plc (www.wmann.com) performed a research on “What makes an exceptional Non-Executive Director’.

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Positive characteristics Negative characteristics

Experience 57% Joining in or nodding 44%

Not egocentric 55% Negative-sceptical / no added value 21%

Positive critical and independent as advisor 44% Acting as a CEO or frustrated manager 19%

Dedicated and prepared 36% Do not think matters through or is 'not up to the job' 13%

Strongly communicative 33% Egocentric 13%

Analytical with a good judgement 31% Micro manager and ask too much details 12%

Visionary and creative 28% Unprepared 10%

Contactual skills 27% More 'sender' than 'receiver' 8%

Selfconfidence 22% Dare not to share own opinion 8%

Open for feedback 20% Divides the group and is dogmatic 8%

Source: Whitehead Mann Group plc (www.wmann.com):

Recruiting for prospective non-executive board members (2)

Profiling the required composition of the Board of Directors The context of the organization are also a basic principle for profiling the entire Board of Directors, considering:

The nature of the industry;

The maturity phase of the company, its structure and governance model;

Strategic intentions, opportunities and risks;

The legal status of the company;

Stakeholders and their influence on the company.

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Recruiting for prospective non-executive board members (3)

Individual profiling The profile of the entire Board of directors is the basis for the individual profile per member, seeking for specific expertise and experience.

Recruiting & selection from a Board’s perspective A careful recruiting and selection process is an effort which benefits qualitative sound composition and good performing board. This process requires specific attention in the preparation as well as in the execution phase (information file, the interview).

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Recruiting for prospective non-executive board members (4)

Perspective of the candidate

Also the candidate should ask oneself whether he/she is the most fit for the job and able to meet the high expectations.

A critical self reflection on personal characteristics is appropriate (spirit and independence, critical analytical judgement, teamplayer or solo performer).

After these considerations, the next phase is the first acquaintance (depending on the content of the information file) and the second or closing interview.

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Evaluation of the performance from non-executive board members (1)

How to confront a fellow member with his/her behavior:

Feedback on specific subject or specified behaviour;

Points addressed are based on direct observation;

Focus on how activities can be (further) improved;

The panel chairman should monitor above points tightly.

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Evaluation of the performance from non-executive board members (2)

How to react on feedback:

The feedback regards the performance of the Non-Executive Director and is not personal.

Gain more in-depth knowledge.

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Evaluation methods (1)

Involvement of an independent process coach;

Collective evaluation of the audit committee: Key subjects (a.o.) include:

Successful matters and less successful matters and areas of improvements;

Balance between distance and involvement; and supervision and advise;

Compilation of the Supervisory board in accordance with the company needs (strategy, maturity phase and challenges).

Subjects relating communication and synergy between Board members;

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Evaluation methods (2)

Individual evaluation - Key subjects could include:

Knowledge and insight of the culture, history, core competences, key success factors and strategic market position of the company;

Knowledge of the industry and own specialty;

Presence and preparation at meetings;

Contribution in good professional judgement and decision making.

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Evaluation methods (3)

Evaluation of the chairman of the board - Key subjects could (a.o.) include:

Good preparation, list the agenda items, good apportionment of meeting time;

Summaries of discussions and formulation of clear conclusions and decisions;

Oversee implementation of decisions;

Contribute in an open and fraternal atmosphere which stimulates members to share their views.

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Risks and liability

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Content

One Tier versus Two Tier model

Managing risk

‘Stormy weather’

Liability for non-executive board members

Insurance

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One Tier versus Two Tier Model

1. The formal differences and similarities;

2. Differences in Practice?

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Managing risks (1)

1. Identifying risks;

2. Determining the probability of the risks;

3. Evaluating the possible financial damage;

4. Countermeasures.

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Managing risks (2)

Focus points for the Board of Directors and Audit committees:

Sufficient knowledge / insight of the company;

Discuss the outcome of the risks;

Sufficient knowledge of system of internal controls.

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Managing risks (3)

Focus points for the Board members and audit committees (continued):

Discuss procedurs from internal and external auditors;

Discuss changes in the risk profile of the systems of internal controls;

In case of doubt, investigate specific aspects.

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“Stormy weather” (1)

Alertness at the following pitfalls (to be continued 1):

Problems are being trivialized;

Overconfidence;

Financial figures are too good or exactly according to the budget;

Emphasizing external factors;

Board of Directors are not informed completely, late or incorrect;

Executive Directors are responding defensively or repeatedly surprised;

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‘Stormy weather’ (2)

Alertness at the following pitfalls (continued 2):

Postpone meeting with the chairman of the board of Directors;

Apparent tensions between the C-level Officers (non-verbal, body language);

Signals from the labor union for a meeting with the Board;

High labor turnover from the second level management;

Rumors in the press, networks or lobbies;

Irrational priorities of time spending at the C-level Officers;

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‘‘Stormy weather’’ (3)

Alertness at the following pitfalls (continued 3):

Disfunctional behaviour of the CEO:

Status symbols;

Court behaviour;

Too much or shortage of vacation;

Popular public appearance;

Moody (quickly irritated or seemingly cheerful);

Conspicuous expenditure behaviour;

Excessive consumption of alcohol;

Divorce or extramarital relations.

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‘‘Stormy weather’’(4)

How to avoid pitfalls:

1. Be alert and signal conspicuous cases at the Chairman of the Board;

2. Discuss at least twice per year in the Board meeting the performance of each C-level Officer;

3. In case of doubt, determine whether the performance of CEO is above or below the standard;

4. Be very sceptic on defensive behaviour of the CEO when his performance is being evaluated.

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Liability of Non-executive directors (1)

Personal liability of directors;

Loyal and acting with due care;

Personal commitment and high level of culpability;

Mismanagement and unseemly supervision.

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Liability of Non-executive directors(2)

Possibilities for a Non-Executive Director to mitigate the risk of liability:

Adopt an independent attitude;

Adequately informed;

Critical towards management;

Eyes and ears open for feedback;

Dare to address dysfunctional behaviour of other board members;

Try not to sit on the chair of the CEO;

Resign if conditions of previous points cannot be met.

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Liability of Non-executive directors(3)

• Assessment of the moment of conduct;

• Recording of decision making;

• Board members in an executive role.

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Liability of Non-executive directors(4)

The following situation could lead to a higher liability risk for Non-Executive Directors:

The Board of Directors are aware of mismanagement, but do not intervene;

Misleading view of the financial situation in the financial statements;

Unseemly supervision which is an important cause of bankruptcy;

Poor accounting practices. 28

Insurance

Protection against said risks can be provided by:

Directors’ Liability insurance;

Indemnification.

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Q&A

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E: Cyril.soeri@tah.sr / T: 597 7190047