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Life's not a round of golf for outside directors

For one independent company director, the worst part of the job is the jolting, sweltering two-hour bus ride to the company's mainland factory.

The rest is easy. Mainland executives take him and his fellow Hong Kong directors on a 30-minute tour of the plant before everyone stops and grins for a group photo for the annual report. After that, it is time to hit the golf course.

'I've been an independent director for many years and, frankly, I don't think there's much we can do to prevent frauds or scandals,' said the man, who asked not to be identified. 'It is very difficult, if not impossible, for a Hong Kong-based independent director to detect problems in a listed mainland firm.

'That is particularly true when you're on the board of a large company that has businesses all over the country. How can a director residing in Hong Kong ever visit all of a company's factories or all of a bank's branches in China?'

Sooner or later, all conversations with independent directors of mainland firms would seem to arrive at this point, with the subject saying that idealism may be very well but essentially we're talking about mission impossible.

However, people who watch corporate governance trends in Hong Kong and the mainland warn being left out of the loop by management would not prevent any director from being sued by irate shareholders if the company goes bust in suspicious circumstances.

And they say as the legal risks of serving on a board mount, it may become impossible for principal owners to persuade anybody besides their friends to do the job.

The director we interviewed sits on the boards of several locally listed firms, including two in the mainland. 'I accepted the invitation to come on their boards because all of these companies are managed by friends of mine whom I trust. I would never join any company where I didn't know the management or executive directors.

'I don't doubt that independent directors can be beneficial but only if the executives are willing to listen to their advice. Some firms don't share very much with their independent directors. They just appoint them to meet stock exchange requirements.'

In 1993, Hong Kong changed its listing rules to make it mandatory for all publicly traded companies to have at least two independent directors. To measure up fully to international best practice, it raised the requirement to three in 2003.

Richard Williams, the head of listing at Hong Kong Exchanges and Clearing, thus summarises the responsibilities of non-executive directors: to 'undertake appropriate professional development, make appropriate inquiries and give a statement of reasons to the board if they resign'.

If all independent directors followed Mr Williams' advice, investors probably would sleep better at night. But in Hong Kong, board members seldom make good whistleblowers.

After scandals involving mainland firms, people have often been left to wonder if the independent directors involved were too shy to ask questions or if the executive directors kept them in the dark.

For example, Euro-Asia Agricultural Holdings collapsed in 2002, a year after its listing, after it as found it had inflated its revenue 20 times in the four years before going public. Its chairman Yang Bin was sentenced to 18 years in jail.

Just last week, Ocean Grand Holdings and subsidiary Ocean Grand Chemicals went into provisional liquidation after more than HK$800 million went missing from their bank accounts.

All seven of the group's independent directors quit, five of them citing only 'personal reasons', despite what Mr Williams says about directors having a duty to fully explain themselves when they resign. (Critics say the excuse is an egregious stonewalling tactic too often used by departing directors.)

Only two of the directors admitted the obvious - that bringing in liquidators had made their continued presence meaningless. One of them, legislator Tommy Cheung Yu-yan, said independent directors faced a host of limitations.

However, Mr Cheung said that he and the other independent members of the Ocean Grand Chemical board had done their best to safeguard shareholders' interests.

'After the auditors told us about some suspicious figures three weeks ago, we asked Deloitte to investigate the problem and then appointed the provisional liquidators to prevent more assets from being lost,' he said.

'As an independent non-executive director, you don't know much about the day-to-day operations since you're not there all the time. We have to rely on the executive directors to keep us informed.'

But students of corporate governance say ignorance of the true state of a company's affairs affords little protection before the law.

Stephen Cheung Yan-leung, a professor of economics and finance at City University of Hong Kong, said: 'In the case of a lawsuit seeking compensation from the board, all directors, be they executive, non-executive or independent non-executive, have the same responsibilities.'

Lawsuits against directors of failed firms are common in the United States. In Hong Kong, because of higher litigation costs, such investor class action suits have been rare but the climate may be changing.

Late last month, 55 clients of failed brokerage Tiffit Securities said they would sue to recover their investments. Not long before that, liquidators filed a suit seeking US$206.67 million in damages on behalf of 1,300 people who lost money in the collapse of the CSA Absolute Return Fund. They are suing the fund's custodian, HSBC Institutional Trust Services (Asia); its administrator Bank of Bermuda and auditors, Ernst & Young.

Professor Cheung said higher litigation risks would discourage many people from becoming independent directors. 'It is not a highly remunerated task and the risks are very high. At the end of the day, it may only be close friends of the management that are willing to take these jobs.'

Some smaller mainland companies must hire headhunters and offer more generous directors' fees in order to find people willing to join their boards.

Andrew Tsui Pui-yan, the Hong Kong managing director of executive search firm Korn/Ferry, said the latest scandals might awaken people to the risks and responsibilities that go with being a director in China.

'An outside director of a state-owned enterprise must be prepared to spend time and effort on board paperwork and committee work. Recent cases have shown that people who just lend their names without putting in any time are exposing themselves to huge liabilities,' Mr Tsui said.

According to Korn/Ferry's latest Annual Board of Directors Study, independent directors of Hong Kong-listed companies take home twice as much pay today as they did five years ago, though they lag far behind their counterparts in the United States. Last year, their average annual remuneration was HK$160,000 but in the US a director earns on the average the equivalent of HK$500,000.

But in attracting independent directors, money is not the most vital element, Mr Tsui said.

'Many people who are willing to play the role of independent director are retired professionals such as lawyers, accountants or bankers. They do not do it for a living. They take on it as a public duty.'

Most candidates are prepared to serve only at large state-owned enterprises with good names and good executive directors. However, many believe that regulators are wasting their time by trying to rely on independent directors to sniff out corporate corruption.

Chu Chung-tin, who served as a committee member of the Hong Kong stock exchange in the 1970s, said the people who now run the institution put too much stress on the role of independent directors.

'I think Hong Kong Exchange and Clearing has the wrong focus. The key to ensuring high standards of corporate governance is to keep a very close eye on the behaviour of executive directors,' Mr Chu said.

Nowadays, with more than 1,000 companies listed, including over 300 from the mainland, there is no point trying to have lunch with everybody. Instead, firms are asked to follow rules and regulations.

'Nowadays the exchange uses numbers to determine if a company is good - it needs to have at least three independent directors, a certain amount of capital and free float. As long as you get the numbers right, the company gets a passing mark,' Mr Chu said.

'Personally, I think it's wrong. The vital element is the conduct of the executives. If an executive was determined to engage in misconduct, he could easily bend the figures and it wouldn't matter if you had a dozen independent directors on the board.'

At HKEx, regulators continue to take a high-minded view of the independent directors' role.

Mr Williams, the listings head, said the exchange encouraged all non-executive directors to review their internal control systems.

Critics of the current governance set-up say some independent directors work for so many companies simultaneously that they do not have enough time to devote to any one firm. But then, not all investors care about the work of independent directors.

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