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Corporate Governance, Cadbury and Friendly Societies

Professor Janet Dine

Department of Law, University of Essex, dinej@essex.ac.uk.

Professor Dine is a Commissioner for Friendly Societies.

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Summary

The Cadbury Report upon corporate governance has inspired both the Friendly Societies Act 1992 and also a recently published Code of Practice by the Friendly Societies Commission. In this note, Janet Dine sets out details of this Code and comments upon the significance of the new ‘Cadbury-inspired’ regime for Friendly Societies.

The ramifications of the Cadbury Committee Report on the Financial Aspects of Corporate Governance have been considerable. The Cadbury committee was set up in May 1991. The stated objective of the Committee was "to help to raise the standards of corporate governance and the level of confidence in financial reporting and auditing by setting out clearly what it sees as the respective responsibilities of those involved and what it believes is expected of them." The Committee concluded that the recommendations in the final report "will involve a sharper sense of accountability and responsibility all round." (Report of the Committee on the Financial Aspects of Corporate Governance, 1992)

The interest in corporate governance which the Cadbury report helped to fuel in the United Kingdom has resulted in a number of regulators issuing advice to the bodies which they seek to regulate. Both the Building Societies Commission and the Friendly Societies Commission have issued "Cadbury" advice. (The Building Societies Code and the Friendly Societies Code can be obtained from the Registrar of Friendly Societies, 15, Great Marlborough St, London W1). The Building Societies Commission Code follows Cadbury more closely than that issued by the Friendly Societies Commission (henceforth described as "the Commission"), the difference being principally caused by the huge range of different Friendly Societies still in existence. The Commission wished to identify matters which were to be regarded as "best practice" without destroying the individuality and variety found in this sector.

The Friendly Societies Act 1992 established the Commission for Friendly Societies to implement the Act fully and regulate the sector. Although Friendly Societies are now mainly involved in life and other insurance and their business is indistinguishable in nature from insurance companies, many still retain a large number of small accounts reflecting their roots in the need of the urban poor to make provision for times of hardship. The Societies pride themselves on their continuing service to this sector of society. The 1992 Act permits Friendly Societies to incorporate and to increase greatly the range of their activities, conducting the new business through subsidiary companies. Prior to the Act all Friendly Societies were unincorporated associations of individuals which made mutual provision for times of need such as sickness, retirement and death. This loose definition led to an enormous proliferation of different types of Society with vastly differing constitutions and management structures. In its annual report 1993-4 the Chairman of the Commission describes the "core purpose" of the Commission as the promotion of "sound stewardship of members' funds by the societies". He points out that the "[o]ther regulators are concerned to see that societies' marketing is conducted fairly".

In future this responsibility will be undertaken by the PIA (Personal Investment Authority) which will take over from LAUTRO (Life Assurance and Unit Trust Regulatory Organisation). It is to be hoped that the system of regulation does not reflect the fears expressed in 1806 by Colquoun in A Treatise on Indigence (quoted in the Commission's annual report) of a time when "numerous societies of ill-informed individuals, open to seduction, and heated by political frenzy, artfully worked up and holding 164,672 public meetings, under a benevolent and legal pretence, at 9,672 different alehouses, may alarm and afflict the peaceful subject".

One of the concerns of the Friendly Societies Commission as regulator is that the criteria of prudent management set out in the Act are met. Section 50(3) of the Friendly Societies Act 1992 sets out the criteria of prudent management for the purposes of the Act. These include;

"4. Direction and management -

(a) by a sufficient number of persons who are fit and proper to be members of the committee of management, or, as the case may be, other officers, in their respective positions,

(b) conducted by them, with prudence and integrity, in the interests of the members of the society. . .

6. Conduct of the society's activities with adequate professional skills."

In Commission Practice Note 1994/1 the Commission used these elements of the criteria for prudent management as a basis for their "Cadbury" advice. The Commission expressed its belief that it is impossible to ensure that a society pays proper attention to the interests of its members unless an adequate system of checks and balances is in place to ensure that the governance of a society is not tilted towards the interests of management "and/or other categories of people rather than those of members, nor tilted towards one class or generation of members rather than others". The latter part of this sentence reflects the tension present in many Societies between distribution of assets of the Society to its present members and retention of a comfortable "cushion" for the protection of future members. The "cushion" can in certain circumstances protect a management from the need to be at the forefront of efficiency.

The Commission accepted that the guidance issued by the Cadbury Committee is not suitable for wholesale adoption by Friendly Societies. A major concern in formulating the guidance was to take account of the variety of constitutions found in the movement together with the small size of many of the societies. In formulating the guidance the Commission emphasised the importance of the Cadbury Committee's view of the value of diversity and the need to attend to substance rather than form:

"The Committee has made clear that the Code is to be followed by individuals and boards in the light of their own particular circumstances. They are responsible for ensuring that their actions meet the spirit of the Code and in interpreting it they should give precedence to substance over form."

The points put forward as "best practice" for Friendly Societies are: (The Code contains some explanatory notes which are omitted)

1. The Committee of Management

"1.1 The Committee should meet regularly, retain full and effective control over the society and monitor the executive management, subject always to the authority vested in members

either annually or at other properly constituted meetings.

1.2 There must be appropriate arrangements such as a clearly accepted division of responsibilities at the head of a society, which will ensure a balance of power and authority, such that no one individual can exert undue influence."

So far as Friendly Societies are concerned this will mean that the post of Chairman and Chief Executive should be separately held. This is not an express statutory requirement but a position clearly envisaged by the legislation. Section 28(2) provides for the appointment of the Chief Executive of a society by the Committee of Management, section 28(3) provides for the appointment or election of a Secretary and section 28(5) provides that the offices of Chief Executive and Secretary may be held by the same person. The appointment of these officers is clearly wholly separate from the operation of the Committee of Management and the appointment of the Chairman of that Committee which is dealt with by section 27. It seems clear that the legislature envisaged that the offices should be held by two different persons.

"1.3 In relation to the size of the society, the Committee should include non-executive members of sufficient calibre and number for their views to carry weight in the Committee's decisions.

1.4 There should be an agreed procedure for any member of the Committee to seek additional information from the executives and to take independent professional advice at the society's expense; as may be necessary in the furtherance of his/her duties."

2. Non-Executive Members of the Committee of Management

"2.1 Non-executive members of the Committee of Management should bring an independent judgment to bear on issues of strategy, performance, resources, including key appointments, and standards of conduct.

2.2 They should be independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement.

2.3 If fees are paid they should reflect the time which non-executives commit to the society and the particular responsibilities related to the size, complexity and diversity of the society's business.

2.4 Non-executive members should be appointed for specified terms subject to the ceiling imposed by paragraph 6(1)(a) of Schedule 11 to the Friendly Societies Act 1992 (the basic rule is five years); election should not be automatic. Candidates for election as non-executive members should be selected from as wide a constituency as possible."

In relation to this requirement the Commission stressed the need to ensure relevant expertise is available where a Society is planning to take advantage of the wider powers available under the 1992 Act.

"2.4 Non-executive members should be selected through a formal process which places sufficient emphasis on the need to move towards equality of opportunity in employment."

3. Executive Members of the Committee of Management

"3.1 Where appointments of senior executives are subject to a formal service contract for a fixed term, the term should not exceed 3 years.

3.2 There should be full and clear disclosure of the total emoluments and terms of appointment (including notice) of all of the executive members of the Committee of Management."

The efficacy of Codes such as the Cadbury Code is not yet clear. A survey by Pensions Investment Research Consultants (PIRC) (January 1995) found that 53% of the top 190 companies do not fully comply with the Cadbury Code in key areas such as the composition of the audit committee, independence among the non-executive directors, the separation of powers between the chairman and chief executive, the composition of the remuneration committee and pay disclosure recommendations. With the varied composition of Friendly Societies it is expected that even the slimmed down Cadbury guidelines will not be widely observed, although the Code has been received without any significant protest. The appointment of the expected "son of Cadbury" committee is expected to further enliven the debate as will the expected proposals for the reform of company law about which the Department of Trade and Industry and the Law Commission are issuing consultation papers. Watch this space . . .