Director Due Diligence

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Director Due DiligenceCorporate Governance NetworkSeptember 20131

ContentsPagePurpose of the paper3Terminology used in the paper3Introduction – Why undertake due diligence?3Additional matters to consider3Purpose of the annexures4Annexure A – What should the company consider about the potential director?5Annexure B – What should the potential director consider about the company?7Annexure C – JSE Schedule 21 Director’s declaration12Annexure D – Sample confidentiality agreement14The information contained in this paper is published by the Corporate Governance Network and is provided for discussion purposesonly. As such, it is intended to provide the reader or his/her entity with general information of interest. The information is supplied‘as is’ and has not been compiled to meet the reader’s or his/her entity’s individual requirements.It is the reader’s responsibility to satisfy himself or herself that the content meets the individual’s or his/ her entity’s requirements.The information should not be regarded as professional or legal advice or the official opinion of PwC, the Institute of Directors and/or individual members.No action should be taken on the strength of the information without obtaining professional advice. Although the CorporateGovernance Network takes all reasonable steps to ensure the quality and accuracy of the information, accuracy is not guaranteed.The Corporate Governance Network shall not be liable for any damage, loss or liability of any nature incurred directly or indirectly bywhomever and resulting from any cause in connection with the information contained herein.2

Purpose ofthe paperThis paper aims to provide companies with a guide ofwhat to consider before nominating a potential directoronto a board and should not be considered as a checklistin deciding whether to accept a potential candidate or not.From a potential director’s perspective, the paper aimsto guide the individual on what to consider about acompany prior to accepting an appointment.This due diligence allows the prospective director to assessthe risks posed through involvement with the company,its governance procedures, financial management andstrategic aims and objectives. The exercise may reveal themain areas for input requiring the non-executive director’sattention. Alternatively it may provide some idea of justhow much work will be required.Refer to Annexure B for a guideline on what a potentialdirector should consider about a company.By making the right enquiries, asking the rightquestions, and taking care to understandthe replies, the risk of unpleasant surprisescan be reduced and the likelihood of successdramatically increased.Terminology usedAdditional mattersin the paperto considerWhilst the terms “company” and “director” have been usedin this paper, the guidance in the paper can be applied inprinciple to other types of entities and other governanceoffice bearers. However, it is important to note that otherspecific requirements would need to be taken into accountfor different appointments like trustees/councillors, inwhich case the guidance would need to be tailored.IntroductionWhy undertake due diligence?From a company’s perspective, it is important toundertake a due diligence on prospective directors toascertain whether they are suitable for considerationand should be nominated for appointment i.e. whetherthey have the right knowledge, skills and personalattributes to effectively fulfil their legal duties.In doing so, the organisation should be mindful of thefact that it is unlikely that a single individual will fit therequirements perfectly. If the individual has most ofthe skills and attributes required and is not disqualified/ineligible, most other gaps in expectation shouldbe manageable.Refer to Annexure A for a guideline on what a companyshould consider about a potential director.Stakeholder appointed directorsWith regards to stakeholder representation on boards(including board representation of empowermentpartners as well as shareholder representation, wherethe organisation has controlling shareholders), aninherent challenge exists as these individuals areappointed by a third-party.From the organisation’s perspective, there needs to beupfront communication with the relevant third-partyto ensure that the board’s needs are taken into accountwhen the appointment is made.There also needs to be a mechanism whereby anorganisation is able to contest a stakeholder appointeddirector that does not fall within the desired criteriaafter taking into account the questions in Annexure A.From the individual’s perspective, there should be amechanism whereby the nominated individual candecline the appointment after consideration of thequestions in Annexure B.Refer also to the CGN Position Paper –“Representative Directors” for further informationon this subject.From a prospective non-executive director’s perspective,it is imperative that prior to accepting an appointment,he/she should undertake his/her own thoroughexamination of the company to satisfy himself/herselfthat it is a company in which he/she can have faith and inwhich he/she will be well suited to serving.3

JSE listed companiesIn addition to considering the matters raised in theannexures to this paper, a JSE listed company is requiredto submit to the JSE and its sponsor, the relevantdirector’s declaration in respect of each of its appointeddirectors within 14 days of their appointment in the formspecified in Schedule 21 of the JSE Listings Requirements.Refer to Annexure C for the JSE’s Schedule 21 form.ConfidentialityAs the due diligence process involves the sharing ofconfidential information, it is recommended that bothparties (i.e. the company and the prospective director)sign confidentiality/non-disclosure agreements. Thisallows the parties to share information with each otherfor the purpose of the due diligence but restricts accessthereof to/by third parties. Refer to Annexure D for asample agreement that can/should be tailored to suitthe specific circumstances.Purpose of theannexuresThe items covered in the annexures to this paper areintended as consideration or possibly discussion pointswhen undertaking due diligences of this nature – andshould not be viewed as a complete checklist or exhaustivelist of any form. The items are designed to help companiesreach an informed and thoughtful decision beforenominating a prospective director for appointment;and to help prospective directors reach an informed andthoughtful decision before accepting or declining an offerof a board position.The annexures are designed to cover an extensive rangeof possible and potential considerations that can betaken into account. It is not suggested nor intendedthat the considerations set out in the annexures areto function as a tick box checklist which must beexhaustively canvassed. Rather, they should be viewedas a suggested universe of considerations available tocompanies and individuals who should exercise theirown judgement in deciding what specific considerationsset out therein it/him/her views to be appropriate forapplication to any particular situation.In addition to the questions listed in the annexures, thecompany/prospective director should also consider anyother matters that they consider pertinent in coming toa decision.4

Annexure AGovernance contextThe key goal in selecting directors is to build a mix ofskills and experience that achieves a well-rounded teamin fulfilling the board’s duties and responsibilities. King IIIstates in principle 2.18, paragraphs 71 and 72 thatLegal contextSection 68(1) of the Companies Act, 2008 (the Act)requires all directors (including any alternate directors)to be elected by the shareholders of profit companies,or members of non-profit companies that are entitledto exercise voting rights in that election. The onlyexception is directors appointed by persons named inthe Memorandum of Incorporation (MOI), ex-officiodirectors, and where the board fills vacancies on atemporary basis.“Directors should be individuals of integrityand courage, and have the relevantknowledge, skills and experience to bringjudgement to bear on the business ofthe company.” and “every board shouldconsider whether its size, diversity anddemographics make it effective. Diversityapplies to academic qualifications,technical expertise, relevant industryknowledge, experience, nationality, age,race and gender.”A person becomes entitled to serve as a director of acompany when that person has been appointed orelected in accordance with the Act and has delivered tothe company a written consent to serve as its director.Section 69 of the Act sets out certain ineligibility anddisqualification criteria for directors and states that:(2) A person who is ineligible or disqualified, must not(a) be appointed or elected as a director of a company,or consent to being appointed or elected as a director;or(b) act as a director of a company.(3) A company must not knowingly permit an ineligibleor disqualified person to serve or act as a director.In terms of the Act, the election or appointment of aperson as a director is void if, at the time of the electionor appointment, that person is ineligible or disqualified.CompanyThe nominations committee (or if none exists, the board),should determine the nominees who will be put forwardto the shareholders for election. This should be basedon the assessments of the proposed candidates (CV’s,background checks and interviews) as well as the needsof the board (as covered in the questions below).It is also important, that in putting forward the nomineesto the shareholders, that the board inform theshareholders of the process that has been followed andthe criteria that has been considered in getting to thosedecisions.Due diligencePotentialDirectorA1 Legal and governance#Questions to considerReasonSourceTo ensure complianceA1.1Is the candidate allowed to serve as a directorin terms of the Companies Act and/orMemorandum of incorporation ineligibility/disqualification criteria?Inspection of CV background checksand enquiry at interviewA1.2Does the candidate understand his/her role asa non-executive director?To ascertain whetherexpectations will be metInspection of CV and enquiry atinterviewA1.3Are there any potential/actual conflictsof interest between the candidate andthe company?To ascertain independenceInspection of CV background checksand enquiry at interviewA1.4Has the candidate consented to act as adirector of the company?To ascertain willingnessto serveEnquiryA1.5Would you consider the candidate to beindependent (if this is a requirement forthe position)?To ascertain independenceInspection of CV and enquiryat interview5

A2 Knowledge, experience and personal attributes#Questions to considerReasonSource1A2.1How will the candidate fit within the boardculture and dynamics?To consider suitability ofpersonal attributesConsideration at interviewA2.2Does the candidate satisfy and transformation/diversity considerations for the board?To consider transformationtargetsInspection of CVA2.3How will the candidate make a positivecontribution to the board’s knowledge andskills? Ie does the individual fill the right gap?To consider adequacy ofknowledgeInspection of CV orconsideration at interviewA2.4Does the individual demonstrate the necessaryknowledge (industry, business, finance,strategy, risk, legal, governance)?To consider adequacy ofknowledgeInspection of CV orconsideration at interviewA2.5What is the extent of the candidate’sexperience in directorship roles?To consider adequacy ofdirectorship experienceInspection of CV andenquiry at interviewTo consider suitability ofpersonal attributesConsideration at interviewA2.6Does the candidate portray the desiredpersonal characteristics, including integrity,honesty, curiosity, courage, teamwork,communication skills, instinct, activecontributor?A2.7Does the candidate portray a genuine interestin the organisation and its business?To consider commitmentConsideration at interview1In addition to the specific sources listed in this table, one would usually also look to informal networks (talking to people/contacts who may know theindividual) to ascertain suitability to the position.A3 Other considerations#A3.1A3.2A3.3A3.4A3.56Questions to considerReasonSourceCould association with the candidate result ina risk to the company?To assess reputational riskthrough association withan individualInspection of CV and enquiry ininterviewBased on his/her other commitments, doesthe candidate have the time to make the levelof commitment required to be an effectivedirector on the board?To consider ability todedicate sufficient timeand effort to dutiesInspection of CV and enquiry ininterviewWhat strategic relationships/alliances does thecandidate have that would be of value to thecompany?To consider potentialopportunities throughassociation with anindividualInspection of CV and enquiry ininterviewWhat is the potential candidate’s fee/salaryexpectation and can that be met by thecompany?To consider affordabilityEnquiry in interviewHas the company (or its agent) checked theauthenticity of the candidate’s qualifications?To provide assurance thatthe candidate has theappropriate qualificationsInspection of certificates andconfirmation with issuing body

Annexure BLegal and governance contextIn terms of the Companies Act, 2008, a person becomesentitled to serve as a director of a company when thatperson has been appointed or elected in accordancewith the Act and has delivered to the company a writtenconsent to serve as its director.In considering whether to consent to serve on a board, thereare a number of critical matters that a potential directorshould take into account, as covered in Section 1 below.During this consideration or subsequent to being appointedas a director, there are further informative matters thata director would consider in order to familiarise himself/herself with the company, as covered in Section 2 below.Potential DirectorDue diligenceCompanySection 1 – Critical matters to consider#Sub-sectionA1.1RiskWhat are the main risks thecompany faces, and how arethese risks managed?To consider how mature the riskmanagement process isInspection of risk register andrisk management planA1.2RiskDoes the company havesound and effective systems ofinternal controls?To consider how mature theinternal control system isInspection of internal auditreports and/or enquiryIs any material litigationpresently being undertakenor threatened, either by thecompany or against it?To consider how this impactsthe future viability of thecompany and whether youwant to be associated with thecompany.Inspection of prior integratedreport and/or enquiryWhat are the key issues facingthe board?To ascertain whether you wantto become involved with thisboardInspection of board appraisalreport (if any) or enquiryTo consider the risk involvedwith accepting the appointmentReview of board charterand enquiryA1.3RiskA1.4RiskQuestions to considerReasonSourceA1.5RiskAre you aware of the potentiallegal liabilities as a director?Which of those are coveredby D&O insurance? Whatis the company’s policy onindemnifying directors? Arethere any outstanding/pendingclaims that may result indirectors’ liability?A1.6FinancialWhat is the company’s currentfinancial position and what hasits financial track record beenover the past three years?To ascertain the financialviability of the companyInspection of prior annual/integrated reportsFinancialIs the company a goingconcern? Is there any reasonto suspect or believe thatthe company is insolvent orheading that way?To ascertain the financialviability of the companyInspection of prior annualfinancial statements, goingconcern assessments andfinancial forecastsA1.77

Section 1 – Critical matters to consider (continued.)#Sub-sectionQuestions to considerA1.8FinancialHas the company achievedunqualified audits over for theprevious years?To ascertain the quality of thecompany’s financial function.Inspection of prior signedfinancial statementsA1.9FinancialHave previous audit reportsrevealed any issues/concernsabout the company?To ascertain any major concernsabout the companyInspection of prior signedfinancial statementsTo consider the personalfinancial impact of theappointmentReview of board charterenquiry considerationFinancialAre non-executive directors paid?If so, how much, how often,on what basis? Have youconsidered your possibleannual tax burden given thatyour current earnings need tobe combined with your newearnings?BoardcompositionTo gain an understanding of thecurrent board and consider howwell you would fill the gapsInspection of integrated report /website or enquiryA1.11What is the currentcomposition of the board?Who are the executives andnon-executives? What is theirbackground and how long havethey served?A1.12BoardcompositionIs there a range of skills on theboard and are those skills andexperiences aligned to thecompany’s strategic objectives?To gain an understanding of thecurrent board and consider howwell you would fill the gapsInspection of board appraisalreport and enquiryA1.13BoardcompositionIs the board compositionsuitably diverse to stimulateindependent challenge andthought?To gain an understanding of thecurrent board and consider howwell you would fill the gapsInspection of board appraisalreport and enquiryA1.14How has the board compositionchanged over the last few years?If there was a resignation, whatwas the reason (resignation/retirement/removal)?To consider the company’srelationship with its directors.EnquiryBoardcompositionA1.15Is there a suitably qualifiedcompany secretary supportingthe board? Is there adequateinternal support of the nonexecutives?To gain an understanding ofhow sufficiently the board issupportedInspection of board charterBoardcompositionA1.16BoardcompositionWhat is the CEO’s relationshipwith the board? What is her/his performance reviewmechanism?To ensure healthy tensions existbetween the board and theexecutiveInspection of board appraisalreport and enquiryBoardcompositionTo ascertain access toinformation for non-executivesEnquiry and inspection ofboard charterA1.17Are non-executives kept up todate of significant happeningsbetween board meetings?What are the internal protocolsfor non-executive directors toobtain access to information?A1.18BoardcompositionWhich board committees havebeen established and which wouldyou be required to serve on?To gain an understanding ofhow the board operates aswell as the expectations of apotential directorInspection of board charterand enquiryA1.19BoardmeetingsWhere and how often are boardmeetings held? How long doesa typical board meeting last?To consider whether you wouldbe able to make this timecommitmentInspection of board charterand enquiryA1.20BoardmeetingsDoes the board hold an annualstrategy session?To consider whether you wouldbe able to make this timecommitmentEnquiryA1.108ReasonSource

Section 1 – Critical matters to consider (continued.)#Sub-sectionQuestions to considerReasonSourceA1.21DesireIs there anything about thenature and extent of thecompany’s business activitiesthat would cause you concernboth in terms of risk and anypersonal ethical considerations?To identify the reputationalrisk of associating with thecompany.ConsiderationA1.22DesireIf the company is not performingparticularly well is there potentialto turn it around?To ascertain whether you havethe time, desire and capabilityto make a positive impact.ConsiderationDesireTo consider whether theappointment would makesense from a career progressionperspectiveConsiderationA1.23Is this a good career move? Willyou grow in terms of experienceand/or ability as a result ofjoining the board?A1.24SuitabilityAre you being brought onto theboard to bolster an existing group,or to bring something new?To ascertain expectations andwhether you are able to fulfilthose expectationsInspection of Nomco minutes,previous board appraisal reportand enquirySuitabilityTo ascertain whether youare able to make t

what to consider before nominating a potential director onto a board and should not be considered as a checklist in deciding whether to accept a potential candidate or not. From a potential director’s perspective, the paper aims to guide the individual on what to consider about a company prior to accepting an appointment. Terminology used in the paper Whilst the terms “company” and .

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