Corporate Governance in Pakistan Analysis of Current Challenges and Synopses for Future Reforms

Ibrahim, Ali Adnan

The author is a Senior Associate at Rizvi, Isa, Afridi & Angell, Advocates and Corporate Counsellors, Islamabad

Table of Contents

Introduction......................................................................................................................... 1 Capital Market Reforms in Pakistan ................................................................................... 1 Evolution of Laws and Judicial Precedents ........................................................................ 1 Overview of Pakistans Corporate Governance Regime .................................................... 2 Business EthicsIslamic Considerations....................................................................... 3 Accountability Ordinance ............................................................................................... 4 Current Challenges and Suggested Measures ..................................................................... 6 Minority Shareholders .................................................................................................... 6 Effective Grievance and Redress Mechanism............................................................. 6 Reporting Noncompliance .......................................................................................... 6 Frontline Regulators........................................................................................................ 6
Expansion of Audit CommitteeLegal Expertise ................................................................ 7

Additional Measures ....................................................................................................... 8 Fiduciary Duties ......................................................................................................... 8 Statement of Ethics and Compliance .......................................................................... 8 Audit Committees Terms of Reference....................................................................... 9 Future Challenges ............................................................................................................... 9

Introduction Following the enforcement of the Code of Corporate Governance (the Code) in March 2002, reluctant corporations consider the implementation of the new regime not only expensive to comply with but also practically difficult to implement. While on one hand there is a regulatory pressure to enforce the Code, on the other, there is, among others, an admitted lack of relevant expertise that can assist in the enforcement of the essence of corporate governance in Pakistan. In the present work, recommendations for future indigenous reforms will remain in focus, as against the discussion in respect of the evolving international practices. Such recommendations include: (i) effective grievance and redress mechanism for minority shareholders; (ii) best practices for the frontline regulators; and (iii) expansion of the audit committee to include the legal expertise, etc. Capital Market Reforms in Pakistan With a view to restructuring capital markets so as to make them more attractive for foreign direct investment, Pakistan is in the process of implementing capital market reforms with the assistance of the Asian Development Bank (ADB) and the United Nations Development Program (UNDP). The Securities and Exchange Commission of Pakistan (SECP) is determined to further consolidate and expand such regime. In this regard, substantial revisions of the Code appear to be in the process. Although there has been criticism on the Code that it is not only defective in several areas but also out-dated and has no utility to the stakeholders,1 however, the Code has in many ways achieved the ground-breaking start of a new era of corporate governance, which continues to grow further under SECPs collaboration with UNDP and ADB. It is hoped that the present work contributes to the existing endeavors of corporate reforms in Pakistan. Evolution of Laws and Judicial Precedents Internationally, promotion of corporate governance has been in the public eye2 for over a decade. Concerns about standards of financial reporting,3 effective accountability4 and transparent management and conduct of business by corporations were increasing. Self-observing practices, that is to say, compliances with voluntary codes and disclosure requirements, were encouraged. Adherence to non-binding codes of recognized best practices and listing regulations were advocated to achieve the necessary high standards of corporate behavior. The demand for accountability

Shortcomings in corporate governance code, Khalil Ahmed, September 7 (and 8), 2004, the Business Recorder, Islamabad 2 Report of the Committee on the Financial Aspects of Corporate Governance (the Cadbury Report), by Adrian Cadbury, 1 December 1992, Gee, London, p.8 3 The Cadbury Report, by Adrian Cadbury, 1 December 1992, Gee, London, p.8 4 Cadbury Report, by Adrian Cadbury, 1 December 1992, Gee, London, at 1.1, p.10

Corporate Governance in PakistanAnalysis of Current Challenges and Synopses for Future Reforms

Ibrahim, Ali Adnan

and transparency evolved into a comply or explain5 scenario. Stock exchanges leaped to enforce these standards. Recognizing these trends, a legislative milestone in the formative history of corporate governance was achieved in 2002 with the enactment of the Sarbanes-Oxley Act in the US. In Pakistan, on the other hand, SECP took a delegated legislative measure and issued the Code. In preparation of the Code, SECP has, however, benefited from the experience of other jurisdictions.6 In general, all the policies culminating into laws have to pass the test of judicial scrutiny before the legal development in any area is said to have moved forward. Therefore, evolution and development of law remains conditional to the judicial interpretations placed by the Courts on any legislative provision. To note judicial response in Pakistan, the provisions of the Code have so far not invited any significant criticism7 in the past three years. However, recent judicial trend in Pakistan indicated an unprecedented concern in favour of the minority shareholders. Although an elaborate analysis of such trend is not in focus in the present work,8 however, it would be pertinent to mention that the Pakistan Courts have given favourable attention to the minority shareholders and have annulled the majoritys corporate verdict.9 Overview of Pakistans Corporate Governance Regime Before proceeding further, it would be pertinent to have a macro-level glance over the multifaceted corporate governance regime in Pakistan, that is to say, the laws that impact the issues of good governance of a company. Such laws may be categorized as follows: 1. The corporate laws, i.e., the general laws relating to companies and their business;10

Review of the role and effectiveness of non-executive directors, Derek Higgs, (the Higgs Report) January 2003, printed by the Stationery Office, London, para 1.14, p.16. The Report goes on to note that: I do not believe, however, that legislation is the way forward. Instead, this Review builds on the comply or explain approach established by Sir Adrian Cadbury a decade ago. Listed companies have to report on how they apply the Codes principles and to state whether they comply with the detailed provisions and, if not, why not. This approach has worked well. 6 Manual of Corporate Governance, Securities and Exchange Commission of Pakistan, Paragraph 1.2, p.1 7 Except for accepting companys right to continuing with its external auditor, by the Sindh High Court, in contrast to the Code of Corporate Governance (the Code) requiring (in Clause xli) change of auditors after every five years 8 The judicial analysis in this regard is the subject matter of the authors forthcoming work on the issue 9 In general, these matters arise out of objections filed by the minority shareholders against swap-ration determined/worked out in a Scheme of Arrangement for a proposed merger. See generally: In re: Pfizer Laboratories Limited 2003 CLD 1209; Kohinoor Raiwind Mills Limited vs. Kohinoor Gujjar Khan Mills Limited 2002 CLD 1314 10 These laws include: The Companies Profits (Workers Participation) Act, 1968; The Securities and Exchange Ordinance, 1969; The Monopolies and Restrictive Trade Practices (Control and Prevention) Ordinance, 1970; The Workers Welfare Fund Ordinance, 1971; The Companies (Appointment of Legal Advisors) Act, 1974; The Companies Ordinance, 1984; The Securities and Exchange

Corporate Governance in PakistanAnalysis of Current Challenges and Synopses for Future Reforms

Ibrahim, Ali Adnan

2. 3. 4. 5. 6.

The rules and regulations made under the corporate laws;11 The listing regulations and the byelaws of the stock exchanges; A body of general civil laws, i.e., enactments providing remedies for seeking declarations, enforcement of claims and recovery;12 A body of general criminal law, i.e., legislations outlining prosecution and trial for criminal breach of trust, fraud etc.;13 and Special prosecution under the National Accountability Ordinance, 1999 for corporate frauds and misappropriation.14

In view of the above legislative spectrum, a consolidated review of the relevant laws would offer the foundational perspective to understand Pakistans superstructure of corporate governance. Transforming this understanding, along with SECPs vision,15 can truly envision the future of corporate governance in Pakistan as isolated reforms with regard to any one of the above legislative spheres is not likely to ensure the expected results.16 Business EthicsIslamic Considerations SECP has considered corporate governance as a process that seeks to ensure that the business and management of corporate entities is carried on in accordance with the highest prevailing standards of ethics and efficacy upon assumption that it is the best way to safeguard and promote the interests of all corporate stakeholders.17 SECP has further expanded its vision of the process of corporate governance in the following terms:
The process of corporate governance does not exist in isolation but draws upon basic principles and values which are expected to permeate all human dealings, including

Commission of Pakistan Act, 1997; and The Listed Companies (Substantial Acquisition of Voting Shares and Takeovers) Ordinance, 2002 11 These rules and regulations include: The Companies Profits (Workers Participation) Rules, 1971; The Investment Companies and Investment Advisers Rules, 1971; The Companies (Appointment of Trustees) Rules, 1973; The Companies (Appointment of Legal Advisers) Rules, 1975; The Monopoly Control Authority (Net worth of Stocks and Shares) Rules, 1977; The Companies (General Provisions and Forms) Rules, 1985; The Companies (Registration Offices) Regulations, 1986; The Companies (Invitation and Acceptance of Deposits) Rules, 1987; The Companies (Management by Administrator) Rules, 1993; The Asset Management Companies Rules, 1995; The Credit Rating Companies Rules, 1995; The Monopoly Control Authority (Supply of Information) Rules, 1995; The Monopoly Control Authority (Value of Assets) Rules, 1995; The Venture Capital Companies and Fund managers Rules, 1995; The Companies (Issue of Capital) Rules, 1996; The Employees Provident Fund (Investment in Listed Securities) Rules, 1996; The Monopoly Control Authority (Computation of Market Shares) Rules, 1996; The Companies (Issue of Capital) Rules, 1997; The Companies (Audit of Cost Accounts) Rules, 1998; The Companies (Asset Backed Securitization) Rules, 1999; The Companies (Buy-back of Shares) Rules, 1999; The Companies (Rehabilitation of Sick Industrial Unites) Rules, 1999; and The Companies Share Capital (Variation in Rights and Privileges) Rules, 2000 12 These laws include: The Specific Relief Act, 1877; The Code of Civil Procedure, 1908; The Limitation Act, 1908 13 Including the Pakistan Penal Code, 1860 and the Code of Criminal Procedure, 1898 14 A discussion in this respect is set out below 15 Manual of Corporate Governance, Securities and Exchange Commission of Pakistan (Manual of Corporate Governance), Paragraph 2.2, p.3 16 Manual of Corporate Governance, Paragraph 2.1, pp.12-16 17 Manual of Corporate Governance, Paragraph 2.1, p.3

Corporate Governance in PakistanAnalysis of Current Challenges and Synopses for Future Reforms

Ibrahim, Ali Adnan

business dealings principles such as utmost good faith, trust, competency, professionalism, transparency and accountability, and the list can go on. Corporate governance builds upon these basic assumptions and demands from human dealings and adopts and refines them to the complex web of relationships and interests which make up a corporation.18

In terms of SECPs aforesaid vision, recourse to ethical dimensions of business practices appears inevitable for the future of corporate governance in Pakistan. In the Pakistani context, the ethical consideration emanate predominantly from Islamic law,19 particularly due to the constitutional mandate for legislation to be in accordance with Islam.20 Recognizing the significance of Islamic business ethics for the corporate governance in Pakistan, SECP has adequately premised the Islamic law position in respect of fiduciary duties.21 In this respect, we also notice current international trends promoting the ethical CEO.22 In view of the aforesaid and to predict the expected contours of the corporate governance in Pakistan, it appears that the future initiatives of reforms would like to achieve a higher level of transparency through more responsible financial and business ethics by, among others, identifying a refined business behavior based upon the Islamic law. In this regard, pursued endeavors and their vigilant implementation are likely to ensure economical compliance with the available best practices. Accountability Ordinance The National Accountability Ordinance, 1999 (the Ordinance of 1999) was introduced to, among other reasons, eradicate corruption and corrupt practices in Pakistan.23 Upon promulgation, the Ordinance of 1999 was initially pressed into service to prosecute the holders of public office against misappropriation of public money. While retaining the focus on preservation of the public money, the Ordinance of 1999 has been amended from time to time not only for legislative improvements but also for expansion of its scope.
18 19

Manual of Corporate Governance, Paragraph 2.2, p.3 Also on account of being a country with majority Muslim population 20 In this regard, please see the relevant portion of Article 2-A (read with the Annex) and Article 227 of the Constitution of the Islamic Republic of Pakistan 1973: Article 2-A (read with the Annex, the Objective Resolution): Wherein the principles of democracy, freedom, equality, tolerance and social justice as enunciated by Islam shall be fully observed; Wherein the Muslims shall be enabled to order their lives in the individual and collective spheres in accordance with the teachings and requirements of Islam as set out in the Holy Quran and the Sunnah Article 227(1): All existing laws shall be brought in conformity with the Injunctions of Islam as laid down in the Holy Quran and Sunnah, in this Part referred to as the Injunctions of Islam, and no law shall be enacted which is repugnant to such Injunctions Manual of Corporate Governance, pp.37-38 Principles of Corporate Governance, A White Paper from THE BUSINESS ROUNDTABLE, May 2002, p.2. The relevant portion of Chapter II reads as follows: The selection, compensation, and evaluation of a well qualified and ethical CEO is the single most important function of the board. The board also appoints or approves other members of the senior management team. 23 The Preamble of the National Accountability Ordinance, 1999
22 21

Corporate Governance in PakistanAnalysis of Current Challenges and Synopses for Future Reforms

Ibrahim, Ali Adnan

Section 9 of the Ordinance of 1999 defines the offense of corruption and corrupt practices, which definition includes the following:
[A] holder of public office, or any other person, is said to commit or to have committed the offense of corruption and corruption practices: [] if he dishonestly or fraudulently misappropriates or otherwise converts for his own use, or for the use of any other person, any property entrusted to him, or under his control, or willfully allows any other person so to do.24

The Ordinance of 1999 defines the expression person, as used in Section 9, to include:
[I]n the case of a company or a body corporate, the sponsors, Chairman, Chief Executive, Managing Director, elected Directors by whatever name called, and guarantors of the company or body corporate or any one exercising direction or control of the affairs of such company or a body corporate and in the case of any firm, partnership or sole proprietorship, the partners, proprietor or any person having any interest in the said firm, partnership or proprietorship concern or direction or control thereof.

The above definition of person, as revised by way of amendments, extends the scope of corruption and corrupt practices to corporate frauds and misappropriations. Accordingly, for corporate frauds and misappropriations, a special prosecution under the Ordinance of 1999 is attracted before the Accountability Courts, established pursuant to the Ordinance of 1999. Upon successful prosecution for the offense of corruption and corrupt practices, the delinquent corporate management may face rigorous imprisonment which may extend to fourteen years in addition to the payment of a fine and the confiscation of the property misappropriated or obtained through corruption and corrupt practices.25 The Ordinance of 1999 expressly provides that the imposition of fine as a punishment shall in no case be less than the gain derived by the accused by the commission of the offence.26 The Ordinance of 1999 is the first-ever legislation in Pakistan that has treated a holder of a public office at par with the corporate management for the purposes of prosecution under the Ordinance of 1999. However, the Supreme Court of Pakistan has already considered an office of the public company to be a public office and, therefore, entertained constitutional petitions for the issuance of the writ of quowarranto.27 Accordingly, the above jurisprudential expansion needs to be carefully reviewed keeping in view all the repercussions for the growing capital market in Pakistan.

Section 9(a)(iii) of the National Accountability Ordinance, 1999 Section 10 of the National Accountability Ordinance, 1999 26 Section 11 of the National Accountability Ordinance, 1999 27 See generally: Salahuddin vs. Frontier Sugar Mills & Distillery Limited PLD 1975 Supreme Court p. 244
25

24

Corporate Governance in PakistanAnalysis of Current Challenges and Synopses for Future Reforms

Ibrahim, Ali Adnan

Current Challenges and Suggested Measures Minority Shareholders Effective Grievance and Redress Mechanism The Companies Ordinance, 1984 and the Code do not recognize minority shareholders with a shareholding below 10%. The minimum threshold for seeking remedy from the Court against mismanagement and oppression requires initiation of the complaint by no less than 20% of the shareholders.28 Shareholders representing 10% can apply to SECP for appointment of inspector for investigation in to the affairs of the company.29 No effective redress is available to shareholders representing less than the 10% of the shareholding (the minority shareholders) upon being aggrieved. The minority shareholders are left with the sole civil remedy to sue for the tortious loss in accordance with the general laws for enforcement of a claim. There is a visible increase for bringing such actions especially in the wake of increasing shareholders activism. In routine, such claims seek interim and permanent injunctive relief against the management. Pending final adjudication of the matter, interim relief is invariably granted, resulting in the hindrance of a companys business.30 To channelise shareholders activism in a direction that provides the minority shareholders with an effective remedy with no or minimal hindrance to the companys business, an internal grievance and redress mechanism should be considered for listed companies. In this regard, SECP may formulate a list of maintainable grievances with a direction to listed companies to establish a grievance and redress committee consisting of executive and independent directors. The minority shareholders may have an appellate remedy before the relevant frontline regulator, and thereafter to SECP. This will essentially entail expansion of quasi-judicial functions of the stock exchanges and SECP. Reporting Noncompliance In order to make the reporting and disclosures more reliable, SECP should encourage the minority shareholders to report any noncompliance with the applicable laws directly to the Audit Committee, with a copy to the relevant stock exchange. Frontline Regulators We recently experienced an unprecedented surge of investment in the public stocks. Unfortunately, it was followed by a sudden market crash. Huge market losses triggered a public debate on a more active role for the frontline regulators. The best practices set out in the Code are expected to ensure a self-sustaining mechanism that provides financial transparency to, mainly, safeguard the investments.
28 29

Section 290 of the Companies Ordinance, 1984 Section 263 of the Companies Ordinance, 1984 30 Actions of this nature are ordinarily adjudicated in 4-6 years at the Court of first instance. This duration increases in case of interlocutory appeals

Corporate Governance in PakistanAnalysis of Current Challenges and Synopses for Future Reforms

Ibrahim, Ali Adnan

A better-governed stock exchange would, thus, ensure safer investment opportunities. Accordingly, SECP should consider introducing appropriate guidelines for the stock exchanges so as to ensure their better governance, or applicability of the Code thereto.
Expansion of Audit CommitteeLegal Expertise

Introduction of internal and external audit mechanism can be considered as one of the most prominent achievements in the evolution and development of global corporate governance initiatives. The SECP has benefited from and enriched the Code with the international experience in this regard.31 In general, the main function of the internal audit committee is to assist the board of directors whereas the external audit committee addresses the concerns of the shareholders at large. In both respects, it is only the financial and accounting expertise that is being made available to a company. The concern that the business and affairs of a company should be run and managed in accordance with the applicable laws cannot be adequately addressed either by the internal or external auditors due to unavailability of professional legal expertise with them. The Code requires not only compliance with the Code and the Companies Ordinance, 1984 but also requires certification in relation thereto.32 Although, the existing provisions in the Code do not require a companys certification for compliance with other applicable laws, however, a proper certification as to the compliance with the Companies Ordinance, 1984 and the Code can only be done on the basis of professional legal advice. Additionally, a deficiency in the Code for requiring compliance with law, and its certification, should be made good. Although such compliance would expand the corporate governance regime but, for all intents and purposes, would be in consonance with the purposes for which the issuance of the Code was considered appropriate.33 Such certification will lead to the companys (somewhat partial) adherence to the Corporate Social Responsibility (CSR). Accordingly, the Code may become instrumental in introducing CSR for the listed companies, and thereby making them more attractive for local and international investments. In addition, the compliance with law certification would, inter alia, help to discourage the transaction between the associated companies. In order for the Code to achieve the above, SECP should consider expanding the scope of internal and external audit to include the legal expertise for evaluating the
31 32

Manual of Corporate Governance, Paragraph 1.2, p.1 Clauses (xxv) and (xlv) of the Code, which read as follows: Clause (xxv): The Company Secretary of a listed company shall furnish a Secretarial Compliance Certificate, in the prescribed form, as part of the annual return filed with the Registrar of Companies to certify that the secretarial and corporate requirements of the Companies Ordinance, 1984 have been duly complied with Clause (xlv): All listed companies shall publish and circulate a statement along with their annual reports to set out the status of their compliance with the best practices of corporate governance set out above 33 The preamble of the Code reads for the purpose of establishing a frame work of good corporate governance whereby a listed company is managed in compliance with best practices

Corporate Governance in PakistanAnalysis of Current Challenges and Synopses for Future Reforms

Ibrahim, Ali Adnan

companys business and the affairs with the legal perspective. In this respect, the following initiatives may be taken: 1. One of the independent non-executive directors may be a professional lawyer. In this regard, the companies may consider retaining services of their legal advisors appointed pursuant to the Companies (Appointment of Legal Advisors) Act, 1974 and may alternatively, be deemed to be a member of the board; One of the non-executive directors on the audit committee34 should be the professional lawyer/legal advisor; With the assistance of the professional lawyer/legal advisor, the audit committee should certify companys compliance with the applicable laws; and Upon availability of the legal expertise, the Audit Committee should be empowered to entertain (and decide) the grievances lodged by the minority shareholders, as discussed above.

2. 3.

4.

Additional Measures Fiduciary Duties The code requires the directors to carry out their fiduciary duties with a sense of objective judgment and independence in the best interests of the company.35 However, the expression fiduciary duties is not defined in the Code. SECP may consider listing out the fiduciary duties to make this provision more certain and, thus, effectively enforceable. In this regard, SECP may include the list of fiduciary duties from the Manual of Corporate Governance,36 which SECP does not consider to be a legal document.37 Statement of Ethics and Compliance As has been suggested earlier by an expert,38 the non-compliance should be strictly followed in the process of a comply or explain principle. Accordingly, the companies should be strictly required to ensure compliance with their Statement of Ethics and Business Practices,39 in addition to the existence of such statement. In this regard, SECP should provide a general specimen setting out the minimum contents for Statement of Ethics and Business Practices and, additionally, require the companies to expand their own Statement on the basis thereof.

34 35

Constituted under Clause (xxxiii) of the Code Clause (vii) of the Code 36 Manual of Corporate Governance, pp. 32-38 37 Manual of Corporate Governance, p.1. The Manual expressly states, on its first page, that the Manual is for reference only and does not constitute any legal requirement on companies, their officers, directors of auditors. This manual may be used for guidance and compliance must be ensured with the provisions of applicable laws and regulations. 38 Short comings in corporate governance code, Khalil Ahmed, September 7 (and 8), 2004, the Business Recorder, Islamabad 39 Issued under Clause (viii) of the Code

Corporate Governance in PakistanAnalysis of Current Challenges and Synopses for Future Reforms

Ibrahim, Ali Adnan

Audit Committees Terms of Reference In addition to the above, the Audit Committees Terms of Reference should expressly provide for review of the companys outsourcing policy, so as to ensure that the company is getting the best available services at the most competitive rates. Future Challenges The most profound challenge that the corporate governance regime is likely to face is the vindication of penal liability for non-compliance of mandatory disclosure and certification requirements by senior executives against the constitutional touchstone of self-incrimination. The contemporary drive to integrate ethical codes of corporate governance into legislative instruments incorporating punitive sanction, the best example of which is the Sarbanes-Oxley Act, though are hailed as a quantum leap in structuring a transparent governance regime, if examined in the rich constitutional tradition of upholding civil liberties, may appear hollow in the corpus. Concerns like uplifting of standards of financial reporting and accountability40 to boost the business growth are supplemented today by considerations of curbing money laundering and white-collar crimes. It may not, perhaps, be farfetched to expect a paradigm shift enabling detection of flow of funds, particularly to eliminate financing of terrorism. Expansion of the scope of corporate governance regimes appears inevitable, thus, creating an unprecedented jurisprudential challenge to extant constitutional notions. The above and several other aspects require in-depth examination and analysis, including: what would be the repercussions of over-institutionalising internal corporate structures (by forming committees and sub-committees)? Would externalisation of the board result in cost overruns and otherwise cause greater administrative and organizational expense and what alternatives may be recommended to minimize such costs without compromising due effectiveness, transparency and similar underlying considerations? Would good faith presumption in favour of the management be reversed? Would corporate jurisprudence evolve other ethically tested modes of corporate conduct, including a new corporate vehicle in place of the existing structure of a corporate entity? With the incorporation of the Pakistan Institute of Corporate Governance and SECPs continued strive to reforming the capital market in Pakistan, we hope to have a more effective response to the challenges highlighted above, and to those that would follow.

_________

40

The Cadbury Report, by Adrian Cadbury, 1 December 1992, Gee, London, p.8