Improving the Effectiveness of Corporate Governance in Canadian Financial Institutions

Historically, the statutes (e.g. the Bank Act and the Insurance Companies Act) included few specific duties for directors, and those that were prescribed were mostly routine. Boards tended to be old boys clubs, stacked with cronies of the controlling shareholder and the CEO. Friends of insiders were rewarded with a sinecure board position and an annual director’s fee, with duties which mainly consisted of attending a few meetings per year, rubber-stamping various routine matters and otherwise exchanging pleasantries with comrades. The board meeting was usually accompanied by an excellent dinner at a fine restaurant, supplemented with port wine and good cigars. (Needless to say, board members were almost invariably men.) Yes, if you were a board member of a Canadian financial institution, those were indeed the Halcyon days.

But commencing in the 1990s, Canada’s financial institution statutes were subject to a vast expansion of board responsibilities. This broadening was in our opinion driven by the realization of regulators and legislators that it is much easier to make the board responsible for many desirable features of institutional stewardship, and then to verify that the board is fulfilling its responsibilities, than to specify that institutions should follow certain practices and then try to somehow ascertain that those practices are being followed.

We cannot quarrel with the effectiveness of the new approach – but there are practical limits with regard to how far it can be extended. In our view, boards at many institutions are beginning to find that they just do not have sufficient time or sufficient expertise to fully consider the huge range of issues with which they are being presented. Today, every aspect of business operation, from risk management to internal controls to financial oversight to fair treatment of consumers to strategic initiatives, and on and on, requires board consideration and approval. While the new approach to directors’ responsibilities is fully understandable and completely sensible, we believe we are in danger of seeing “too much of a good thing”.

There are a number of possible adverse outcomes to these developments, including increasing difficulty in finding well qualified individuals to serve on boards. Most importantly, however, is the possibility that boards will be overwhelmed and not able to do a good job by thoroughly and thoughtfully considering all of the items for which they have been made responsible by law.
Over the course of this wholesale revamping of the role of the board of directors, there has been virtually no change in how boards are structured. We believe it is time to consider ways in which boards could be re-engineered to better handle their currently immense, and constantly increasing, range of legislative responsibilities. Four possibilities, not mutually exclusive, are described below:

1. European institutions frequently have a two-tier board structure. One board is essentially comprised of senior management, but with specific responsibilities under law and having to come to consensus recommendations on key management decisions, which are then considered by the senior board, mostly comprised of independent directors (i.e. directors who are not shareholders, officers or others who have a vested interest in the institution). The approach provides for a larger number of individuals to have input on key issues. On the other hand, some feel that it doesn’t greatly alleviate the amount of time needed by members of the senior board to assess and approve proposals.

2. Another possibility would be to have some full time board members, whose job would be to thoroughly evaluate issues that will come before the full board and to present recommendations to the full board. At present, management has this role, but the problem for board members is that management’s reasons for making particular recommendations may be in the interests of management or shareholders but not necessarily to the benefit of consumers and other stakeholders – which board members are legally required to bear in mind. Ideally any full time board members would be extremely well qualified so that the rest of the board would be able to have confidence that evaluations and recommendations are highly credible. Some disadvantages of this approach are that it would be more costly for the institution and could possibly lull regular board members into routinely accepting the recommendations of the one or more permanent directors. (But of course all board members would still be legally responsible for using their best judgement to consider and possibly modify or reject as a full board, recommendations from the permanent board members.)

3. An additional option would be to include in the legislation a responsibility for boards of directors to seek professional advice when considering areas where they feel they may lack expertise. Such a responsibility is currently implicit because directors are responsible for their input and if they feel that they lack expertise with regard to a particular issue, they would have an obligation to seek advice. However in practice, we suspect that the desire to be seen as expeditiously dealing with matters brought before the board, will sometimes cause boards to approve management recommendations even though they may have some qualms about their own ability to fully assess those recommendations. If there were an explicit requirement in the law that outside advice should be sought in any case where individual directors feel there is insufficient board expertise to fully assess an issue, we believe it would be effective in raising the calibre of decision making. Of course this would again give rise to some additional expense for the institution, but we believe it would be relatively negligible when compared to the potential for helping to ensure that the quality of board decisions would not be reduced as a result of increased workload.

4. We believe boards could also be more efficient and effective if it were required that not only at least a third of the board members be independent, as at present, but also that those independent directors have at least a basic understanding of the business involved, e.g. banking, life insurance, etc. Various studies have shown that many independent directors, although having demonstrated success and solid experience in specific fields, may have little or no understanding with regard to the business of the financial institution they are supposed to be overseeing. We suggest that at best, this impairs their potential contribution in terms of the discussion of many issues that will arise at the board level. At present there are training programs for directors but these are focused on overall governance and not with providing fundamental knowledge about particular financial institution businesses.

Unfortunately change often comes only after events highlight the fact that change was needed. It was a series of high profile financial institution insolvencies in the 1980s and early 1990s – for example Northland Bank, Canadian Commercial Bank, the Ontario “trust companies affair”, Confederation Life, etc. – which gave rise to the enormous expansion of board responsibilities. It would be nice to make improvements in the system while we are ahead of the game.