Note: This is one of two commentaries on the most recent developments and questions that shareholders should ask at the Singapore Post’s AGM this Thursday. Versions of these will be published in Business Times and this is published on my website now with their agreement given that the AGM is just two days away.

A number of investors have asked me if I am attending. Unfortunately, I am in New York this week for an important meeting that was planned since late last year. While I hope that shareholders would ask questions, I also hope that they will be measured and support the efforts of the new Board to take the company forward.

______________________________

By Mak Yuen Teen

On June 16, Singapore Post (SingPost) released a code of business conduct and ethics for directors (the Code), and new policies governing directors’ conflicts of interest (COI policy) and board renewal and tenure. This was followed by the release of the notice of its 2016 AGM and its latest annual report on June 22.

The recent initiatives are excellent. However, there are questions that shareholders should consider asking the company and its auditor at the coming AGM.

New Policies

While most companies have a code of conduct or ethics, they are generally targeted at employees and usually do not specifically address issues that are relevant to directors. Further, as non-executive directors are not employees, such codes are not directly applicable to them.

Having a separate code of conduct for directors – and this is common practice in global companies and is even practised by some not-for-profit organisations here – helps the board to set the right tone starting from the top. Some directors may feel that a code of conduct is not relevant because their duties and responsibilities are already covered by laws, regulations, listing rules, corporate governance codes and articles of association. However, as the SingPost’s Code shows, there are important areas that are not explicitly addressed by these sources. Further, having a code and having directors sign an annual confirmation that they have read, understood and will comply with it – as employees often have to do – reinforces how directors are expected to conduct themselves.

SingPost’s Code now makes it clear that to avoid conflicts of interest, directors must recuse themselves from participating in any discussion and decision on the matter, which goes beyond minimum legal requirements of disclosure and abstention. The COI policy further clarifies that abstention from voting and recusals from discussions apply “at all levels within the SingPost Group, including, but not limited to, the Company’s subsidiaries and any committees and sub-committees that are involved in the proposed transaction”.

It also states that “in severe situations, Directors should consider whether it might be appropriate to resign from the Board. This is particularly relevant where the conflict of interest is a material one that will continue over a prolonged period or where it results in the appearance of serious impropriety on the part of the Company or the Director.” This is an important point. The necessary measures to address conflicts of interest vary with the severity and persistence of the conflict. Disclosing, abstaining and even recusing may not be sufficient. As a conflict becomes severe or ongoing, disposing of the personal interests that cause the conflict or resigning from the company may be necessary.

Some guidelines in the Code are not directly related to specific concerns raised in the SingPost saga but are good practices nonetheless. One is that directors “should consult the Chairman of the Board and the Chairman of the Nominations and Corporate Governance Committee prior to accepting any appointments to the board of directors or advisory board of any public or privately held company or any other principal commitments”. This is useful for considering potential conflicts of interest before a director accepts another appointment. It also allows the Nominating Committee to re-assess the independence and commitments of directors timely and to plan for board changes, if necessary, should the director accept the other appointment.

The Code also requires directors to provide advance notice prior to dealing in the shares of the company. In “Tighten insider trading restrictions” (BT, Nov 1, 2010), I had advocated that SGX-listed companies adopt such a policy and mentioned that Singtel already has it in place.

Directors are often potentially in possession of material non-public information, beyond the “blackout periods” prior to financial results announcements when trading is generally already prohibited. Companies have regular management reporting of results, usually monthly, and expected results for the quarter, half-year or full year would usually be known to directors and key officers well before the blackout periods. Fixed blackout periods also do not address the existence of material price-sensitive information at other times, such as around major acquisitions.

In SingPost’s case, it had made more than 20 acquisitions between 2011 and 2015, spending more than half a billion dollars. While there is no allegation of any insider trading by SingPost directors, they would have been in possession of material non-public information relating to acquisitions on many occasions during this period prior to their announcements.

As for Singpost’s new board renewal and tenure policy, directors are now expected to serve for only two terms, and no more than six years. It allows a director to serve up to nine years if necessary “to accommodate phasing, giving due regard to critical skill sets needed.” The policy also sets out a sound nomination process that encompasses the development of a Board Composition Matrix of skill sets and capabilities, and considering a director’s fit with this Matrix; the Annual Board Effectiveness Review; the contribution and performance of the Director; and the Director’s compliance with the Board’s Code of Business Conduct and Ethics.

SingPost’s board tenure limit has immediate implications for some of the existing directors. One of the three independent directors retiring by rotation and standing for re-election at this July’s AGM, Zulkifli Baharudin, has already served more than six years, having being appointed on 11 November 2009. As he is the Chairman of the re-constituted Nominations and Corporate Governance Committee tasked with helping rebuild the board and recruit the new CEO, it is understandable that he will be an “exception” to the six-year tenure policy. Another independent director, Professor Low Teck Seng, who was appointed on October 8, 2010, is not due for re-election at the coming AGM but would reach six years of service this year. It is likely that he will not seek re-election when his current term is up, given that SingPost would presumably not want too many exceptions to its policy.

Financial statements

SingPost’s latest financial statements show an improvement in key ratios, revenues, operating profit, net profit and dividends. However, underlying profit, leverage, operating cash flows and free cash flows have all worsened, some quite considerably.

Goodwill and other intangible assets arising from SingPost’s acquisitions are an area of interest because of the significant premia paid for many of its major acquisitions. Note 22 in its latest annual report shows a summary comparison of various intangible assets between the (restated) 2015 and 2016 financial statements, with the total increasing from $316.6 million to $583.2 million. The main increases are for goodwill on acquisitions, which increased from $267 million to $494 million, and customer relationships, which increased from just under a million to $40.5 million. One acquisition – of the U.S.-based e-commerce company, TradeGlobal – had a purchase consideration of $236 million, and accounted for $169 million of the goodwill and $43 million of the customer relationships in the 2016 financial statements.

A new intangible asset in the 2016 financial statements is “Trademarked brands” at $42 million. A closer examination of the notes suggests that this is largely due to the re-allocation of part of the purchase price from goodwill for the Couriers Please acquisition, which took place in December 2014. This is permitted under accounting standards.

Note 22(a) relating to goodwill on acquisitions shows comparative average cash flow growth rates, terminal growth rates and discount rates for SingPost’s acquisitions. These parameters are critical in determining value-in-use for impairment testing of goodwill. For all six of the acquisitions where they are provided, there are decreases in the average cash flow growth rate, and in five of these cases, the decreases are substantial – General Storage (13% to 3%), Famous Holdings (6.6% to 1.9%), Couriers Please (10% to 8.6%), F.S. MacKenzie (8.5% to 2.2%), Famous Pacific (Shipping) NZ (11% to 2.1%) and The Store House (10% to 1%). When SingPost first published it annual report, I had mentioned this point to the media.

The fact that the large declines in the assumed average cash flow growth rates did not result in impairment suggests that the prior value in use estimates were very high and well above the carrying values of the “cash-generating units” (acquired companies). Perhaps we should congratulate the directors and management who made those acquisition decisions for such large value-in-use buffers that a collapse in cash flow growth rates does not result in impairment. However, as these cash flow estimates have to be based on management-approved budgets, it raises questions about the accuracy of the projections supporting the acquisitions. If there are questions about the accuracy of the assumed cash flow growth rates, there could also be questions about the accuracy of the discount rates, which are equally critical in estimating value-in-use. The discount rates for three of the six acquisitions were reduced, while those for the other three remained unchanged.

In terms of the three “big ticket” intangible assets of goodwill, customer relationships and trademarked brands, it would be useful to understand if inputs of independent third parties were used in determining their values. I would also be interested to know from the external auditors about audit procedures relating to acquisitions and the intangibles related to them.

With a newly constituted Board in place, and proper policies and procedures for evaluating and approving acquisitions, which may include post-acquisition reviews, perhaps shareholders can expect a thorough review of all the major acquisitions.

Non-audit fees and services

The latest annual report shows that the percentage of non-audit fees to audit fees, at 75 per cent, has once again exceeded the 50 per cent threshold that the Code of Professional Conduct and Ethics for Public Accountants (CPCE) deems as high for public company clients. (Note that SingPost discloses non-audit fees as a percentage of total audit and non-audit fees, which is a lower percentage of 42.9 percent.) The special audit fees are likely to at least partly explain the increase in non-audit fees. As stated in my commentary with Chew Yi Hong (“SingPost saga: Untenable for PwC to stay on as special auditor, BT, Jan 28), the threshold was exceeded in four of the five years between 2011 and 2015. The CPCE requires that in such situations, certain safeguards must be considered and applied as necessary. A relevant question for the external auditor is which of the specified safeguards in the CPCE were applied. Shareholders should also ask about the nature of the non-audit services provided by PwC, something that is not disclosed by SingPost because it is not required.

Since PwC is seeking re-appointment as auditor at the coming AGM, it is important for shareholders to receive sufficient comfort about their independence and the conduct of the audit. It is not just in SingPost’s case that shareholders should ask questions about the audit and auditor. As external auditors report to shareholders and are appointed by them, shareholders can play a stronger role in holding auditors accountable and enhancing audit quality. Relying solely on the audit committee may not be sufficient, because independent directors on the audit committee may not be truly independent or sufficiently competent.

In conclusion, I am heartened by the board composition changes and other recent initiatives of SingPost. However, some questions remain.

The writer is an associate professor of accounting at the NUS Business School where he teaches corporate governance and ethics. He is a shareholder of Singapore Post but is unable to attend the coming AGM due to a prior overseas commitment.