This is the long version of the article that was published in The Business Times on October 27, 2020. It includes more detailed comments about the response of Sabana REIT on October 5 to my earlier post on September 22  titled “Sabana REIT: Independent Overnight?”, regarding the re-designation of a director from non-independent to independent.

By Mak Yuen Teen

On October 14, Chew Yi Hong and I released the Governance Index for Trusts (GIFT) 2020. In assessing the 45 trusts covered, we re-designated 14 independent directors (IDs) in 11 trusts from independent to non-independent due to tenure exceeding nine years or close relationships with the sponsor, controlling unitholder or related companies of the manager. The 14 IDs were out of the 189 ID appointments in the 45 trusts. In addition, another 19 trusts received demerit points for IDs having other relationships, such as lawyers serving as IDs while their firms provided legal services to the trust, the manager or related companies. It is therefore common for IDs of trusts to have relationships other than being a director of the manager/trustee-manager.

Under the regulations for real estate investment trusts (REITs) and business trusts (BTs), the board can deem a director as independent even if the director has relationships specified by these regulations for determining his independence. There are only minor exceptions, such as a director of a REIT manager cannot be deemed by the board to be independent after nine years. Regulations are meant to be prescriptive and clear. Allowing the board to deem a director as independent without any review by the regulators undermines the effectiveness of these regulations.

The IDs whom we have re-designated or applied demerit points for may well be independent in conduct, character and judgement. However, independence is also about perceptions and external stakeholders who are unable to observe the exercise of independent judgement will form their perceptions based on the presence of certain relationships.

Copyright for cartoon belongs to Mak Yuen Teen. Not to be reproduced.

 

For externally-managed trusts which are prevalent in Singapore, all directors, including IDs, are appointed by the shareholders of the manager or trustee-manager and can be removed by them unilaterally. This adds to the challenge of ensuring independence of directors in trusts.

Eagle Hospitality Trust

We saw that recently at Eagle Hospitality Trust (EHT) where ID Carl Gabriel Florian Stubbe was not re-elected by the sponsors, who indirectly own EHT’s manager. Unitholders had no say in Mr Stubbe’s removal and he had strong support from the board. With the dispute between the sponsors and manager, it was not surprising that Mr Stubbe was not re-elected.

Ironically, in an article posted on my website on July 1 based primarily on information disclosed in EHT’s prospectus, I had questioned whether Mr Stubbe was truly independent in the first place. He had joined Jones Lang LaSalle Property Consultants Pte Ltd (JLLPC) in Singapore as a senior executive in May 2019 – the same month when EHT was listed – and JLLPC’s fellow subsidiary in the US was the “independent market research consultant “ which produced a 189-page report that was included in EHT’s prospectus. The fees paid for this work were not disclosed but would undoubtedly have been substantial.

Mr Stubbe had joined EHT as an ID in August 2018. While his employment relationship at JLLPC and the appointment of its fellow subsidiary as the market research consultant were both disclosed in the prospectus, the prospectus was silent as to whether this was considered in determining his independence. He would presumably have been in discussions about joining JLLPC as he was discharging his responsibilities as an ID pre-listing. These responsibilities would include reviewing the prospectus and the market research consultant’s report. Would he be in a position to question the work done by the fellow subsidiary of the company he was about to join as a senior executive?

Sabana REIT

Compliance with the letter of the rules for IDs and the board’s discretion in deeming a director as independent was also in the spotlight recently at the manager of Sabana REIT.

On September 22, I had posted an article on my website questioning the re-designation of Ms Ng Shin Ein from non-independent to independent. The day before, Sabana had issued a belated addendum to its 2019 annual report (released on April 7) to justify the re-designation.

Ms Ng is the Chair of the Nominating and Remuneration Committee (NRC), which among other responsibilities, “determines the independence of Directors”.  In the addendum, Sabana said that Ms Ng recused from the determination of her independence. This does not remove concerns about her independence.

On October 5, Sabana issued a six-page response to my article, giving reasons as to why Ms Ng can be considered independent. The response was just a series of “technical” justifications and falling back on the board’s opinion.

In response to my concern about Ms Ng having received payments from a related corporation of the manager, which is also a wholly-owned subsidiary of the controlling shareholder of the manager – when she sold her 4.5% indirect stake in the manager – Sabana said that these payments had been taken into account in assessing her independence. It then said the REIT regulations allow the board to deem her as independent.

To my comment about the assessment of independence having to go beyond relationships specified in the regulations, listing requirements and the Code, Sabana spelt out some grounds it had considered, then said what is more relevant is that the NRC and board had assessed her as independent.

On my point that the payments to Ms Ng created a deemed business relationship under the Practice Guidance 2 (PG2) of the Code, it said that Practice Guidance is only voluntary (a point which I had acknowledged in my article). It added that PG2 only mentions payments to a director “received from the company or any of its subsidiaries”. Payments to the owners of the manager are not technically caught, the response said, because PG2 only mentions payments to the manager itself or its subsidiaries. This is clearly form over substance. It went on to again reiterate that the NRC and board had assessed her to be independent.

In response to my statement that the amounts paid to Ms Ng should be disclosed for full transparency, it said that since they were not payments from the manager or its subsidiaries, the provision and related footnote I cited are “not strictly applicable”. Therefore, the strict letter of the Code prevailed.

I had also noted that there was no meaningful break between Ms Ng’s business relationship ending, her joining the board as a NED, and her subsequent re-designation as an ID. Sabana said the business relationship had been taken into account by the NRC and board in the re-designation.

I also said that Ms Ng’s interest was more aligned with the manager than unitholders because she had an indirect 4.5% stake in the manager, and a negligible stake in the REIT. The response was that there is no requirement for Ms Ng to have a stake in the REIT to qualify as an ID, a known fact. It added that she had divested her entire stake in the manager by the time she was re-designated. However, the response does not address the perception that she may be or feel obliged to support the current controlling shareholder of the manager especially as there were no details about the sale price and how it was determined, which I had raised.

In response to my comment that Ms Ng’s relationship with the manager goes back to 2010, and that she had resigned in May 2017 and rejoined the board in August 2019, it said that the board comprised only of IDs and that all, except one, had been newly appointed after Ms Ng’s resignation. It also said that it appointed her back as a NED because of “her experience and her understanding of the business strategy and operations of Sabana REIT” and re-designated her after observing that she was exercising independent judgement. This does not address my questions about the search process that was undertaken and why she was specifically selected. Was she appointed with a view to supporting a certain strategy, which would raise questions about her independence?

The concern about IDs is arguably even worse for listed companies for which most of the rules relating to director independence are in the Code of Corporate Governance which is based on “comply or explain”.  With certain relationships now moved to the listing rules, observance with the letter in certain areas would undoubtedly improve, but spirit would likely remain lacking.

Family relationships

Take the case of family relationships. The listing rules (and previously the Code) say that a director who has  an “immediate family member” whose remuneration is determined by the remuneration committee is not independent. At Asian Micro in 2018, the nephew of the executive chairman and controlling shareholder was re-designated from non-independent to independent, with the concurrence of the continuing sponsor. It is absurd that a nephew can transform from non-independent to independent. I am sure there are other companies with family members such as in-laws, nephews, nieces and cousins acting as independent directors because they are not considered “immediate family members” under the rules, as I have come across such cases from time to time.

Employment relationships

Then we have companies like China Sunsine, CWX Global and Hyflux, where employees or executive directors morphed into non-executive directors and then into independent directors after “cooling off” periods for employment relationships. If someone had never left the company after being an employee, I do not see how he or she can be perceived as independent. Relying on the “cooling off” period  to justify a director as independent only makes sense to me if that person has left the company and returned after a cooling off period –  and arguably only if the management and controlling shareholder have substantially changed.

Long tenure

We also have many companies navigating around the guidelines on tenure. Take the case of Santak Holdings. Two independent directors who have served on the board for 19 years are on the nominating committee (NC), including one who is NC chairman, with the group managing director being the third NC member. The company said that the NC had undertaken a rigorous review and considered the recommendations in the 2018 Code in determining that the two long-serving  directors are still independent.  Part of the justification was that they “are valuable to the Group in terms of their experience and knowledge in finance, understanding of the precision components business and the markets notwithstanding their long tenure”. The company also said “the Board considers continuity and stability of the Board important”. However, the company has been making losses for the past seven years (excluding discontinued operations). I guess it is possible that without the long-serving directors, it could have been worse.

In this case, each of the two long-serving director would presumably have taken turns recusing, while the other long-serving director and the group MD “rigorously review” if the recusing ID is independent. The latter would then “rigorously review” the ID who had just “rigorously reviewed” him. Presumably,  both IDs will later “rigorously review” the performance and remuneration of the group MD too.

It gets worse because according to Santak’s annual reports, a firm in which the “independent” chairman has a substantial financial interest in, had been providing advisory and consultancy services ranging from $88,000 to $199,240 per year from FY2006 to FY2017 – a total of nearly $1.5 million over a 12-year period. He is also one of the two long-serving IDs on the NC – so he was deemed independent despite long tenure and having a long and substantial business relationship with the company.

Other countries

Other countries have taken different approaches for director independence. Countries like Hong Kong, Malaysia and US include all or most of the criteria for determining independence in the listing rules, while also requiring the NC/board to assess independence. This means that any deviation from the criteria is a deviation from the listing requirements.

In HK, the listing rules say that the exchange will take into account the factors relating to independence included in these rules when assessing the independence of directors, and state that independence is more likely to be questioned by the exchange if a director is caught by any of those factors. IDs are required to submit a written confirmation to the exchange which must state their independence with regards to each of the factors listed in the rules.

The factors for determining independence in the HK listing rules are also on the whole considerably stricter than in Singapore. For example, it is common here for partners of law firms to be serving as IDs while their firms are providing legal services to the company. Even if the quantum of fees exceed $200,000 (which is now in the Practice Guidance of the Code), we see cases where the director is still deemed independent. In HK, the provision of services, regardless of quantum, will result in a director to be deemed as non-independent. Directors on HK boards have confirmed with me this strict standard.

Other countries have introduced two-tier voting for IDs, whereby such directors are elected by a vote of all shareholders and a vote of only minority shareholders. This applies regardless of the tenure of the IDs. Countries that do so include Israel and UK, with the latter requiring it for premium listings. India is considering adopting a similar practice.

Sweden has a nominating committee whose members are elected by shareholders at the general meeting. Such a committee include non-board members and members who are not associated with controlling shareholders. This makes the nomination process more independent.

Singapore needs to improve the implementation of director independence if it is going to arrest the erosion of trust in independent directors.