The success of corporate governance rests on the shoulders of directors, who have immense responsibilities in safeguarding the interests of all stakeholders. However, the VBS Mutual Bank scandal serves as a sobering reminder of how the often-blurred line between shareholders, directors and management can have disastrous results.
Though the VBS scandal occurred in South Africa, the similarities of the applicable legal framework allow us to use this as an important case study to underscore the gravity of director responsibilities.
The shocking revelation of the bank’s downfall brought to light not only financial improprieties but also glaring lapses in corporate governance, with the directors and in particular the chairman at the centre. Issues including a lack of segregation of roles, abuse of systems, negligence, mismanagement, and regulatory and legal violations are a few of the irregularities that caused the downfall of what promised to be the Peoples’ Bank. The collapse of the bank not only sent shockwaves throughout the financial sector but also led to financial losses, job cuts and dented public confidence.
In terms of the Companies Act (section 127), “the business affairs of a company shall be managed by, or under the direction or supervision of the board of the company.” The board has all the powers necessary for managing and directing the management of the company. The board is responsible for the ethical leadership, strategy, values, and culture of an organisation. These values, ethics and strategy then flow top down in a business and are the basis of the corporate integrity of an organisation. A failure at the board level ultimately results in a managerial failure.
Below we explore some of the director’s responsibilities as set out in the Companies Act and the Pula Governance Code:
- Fiduciary Responsibility
From the date of appointment onto a board, a director, though part of a “board” stands individually in a fiduciary relationship to the company. A fiduciary is “someone who agrees to act on behalf of and in the best interests of another person in the exercise of certain powers which will affect the legal, financial, or other interests of that person (here the company).
In accordance with section 130 of the Companies Act, this therefore requires that from the date of appointment, a director must act in utmost good faith towards the company and all dealings on its behalf and not use any information obtained for personal gain or benefit. This requires that each director, at all times be: –
- Informed: At a minimum, this requires that directors read the information provided to them in board packs and through management. Additionally, it requires directors to be knowledgeable about the business of the company, its transactions, its plans, regulatory framework applicable to it. A director cannot act in the best interests of the company without this knowledge that enables correct assessment, analysis and the making of sound decisions. From a company perspective, this requires proper onboarding and continued training and development of directors to enable directors to keep abreast of industry trends.
- Sceptical: Test everything presented by management to ensure that the actions proposed are in fact in the best interests of the company.
- Independent: As this is an individual duty, a director must at all times act independently of management and fellow directors to ensure that every decision he/she makes in the best interests of the company is without influence. A director cannot simply rely on the skills, expertise, or reasoning of other directors.
As this is an individual duty owed by each director to the company, each director may be held personally liable for a breach of this broad duty. The compromise of this fiduciary duty was the foundation of a pillaging plan undertaken over a 3-year period in VBS Mutual Bank. This resulted in countless instances of personal gain by directors to the detriment of the company, shareholders, depositors, and other stakeholders.
- Skill, care, and diligence
In line with section 158 of the Companies Act, this requires each director to exercise “the degree of care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances” when undertaking their duties.
The test is both subjective and objective in that the minimum standard is that of a reasonably prudent person, however, a director who possesses greater skills, knowledge or experience is expected to give the company the benefit of those greater skills. Directors are entitled to request all such information as may be necessary to enable them to properly discharge their duties. By being informed in this manner, a director is able to fully accept responsibility for the decision he/she makes on behalf of the Company.
While there is no limitation on the number of directorships an individual may hold, it is important that a director ensure that they have sufficient time to devote to properly carrying out their duties and responsibilities owed to each company. A basic failure of this duty arises when directors attend board meetings without having studied the board packs and obtained a clear understanding of the decision that the board will be asked to make and their potential impact on the company. By failing to apply the diligence and care that a reasonable person ought to have applied, the chairman was essentially allowed to usurp management power which allowed irregularities to fester unchecked, leading to the bank’s eventual downfall.
- Acting within the powers granted
Every director is obligated in terms of section 130 of the Companies Act “to exercise their powers in accordance with the Companies Act and with the limits and subject to the conditions and restrictions established by the company’s constitution.”
Directors may only act within the scope of their express and implied authority and may use their authority only for the specific purpose for which those powers are conferred. The powers of individual directors are undefined, however, by implication from the power of management granted to the collective board by the Companies Act, it is implied that directors have such powers as are necessary to enable them to manage the company and direct its affairs. Neither the chairman nor the directors are individually empowered to manage or direct the affairs of the Company as seen in the VBS scandal. The abandonment of the duty to act within the powers granted often results in a blurred and confused line between management and the board and results in an overly operational board to the detriment of the oversight and risk management required of the board.
- Ethical leadership
Maintaining the foundation of trust through transparency. Establishing confidence among stakeholders requires transparency above all else. Directors must ensure the disclosure of relevant, accurate and timely information at all times. In the VBS scandal, the lack of transparency contributed to the erosion of public trust, emphasising the critical nature of this responsibility.
- Conflict of Interest Management
This duty is tied intrinsically to the fiduciary duty. Due to the trust placed in a director, directors have the responsibility to always put the company’s interests before their own and to disclose any conflicts of interest that could jeopardise their impartiality. Conflict of interest is the tension between multiple competing interests whether personal or financial. Section 130 of the Companies Act makes clear the restrictions on a director’s ability to use company information for any other purpose than as permitted, to not compete with the company and to account to the company for any monetary gain or value or advantage obtained by them in connection with their position as director.
Where a director acts in competition with the company on which he serves as a director, conflict is inevitable. This can arise where a director takes up an opportunity that could have been taken up by the company or where the director holds directorships in rival companies or has an interest in service providers and/or clients of the company be it through shareholding, directorship or any other direct or indirect interest.
In the VBS case, the looting was undertaken through the financing of entities directly or indirectly related to some members of the board. These financing facilities were granted in breach of policy and remained unpaid resulting in a “cash hole” that saw the crippling and pillaging of the bank. The starting point of this downward spiral was a failure of fiduciary duties and management of conflict of interest by the board which had ripple effects.
The VBS Mutual Bank scandal is a sobering reminder that directors and leaders are not above the law. Fraudulent and negligent conduct resulting from a dereliction of your duties is punishable civilly and criminally. Mervyn King, suggests that where a company wants to apply sound governance, directors should, amongst others, ask themselves these four questions before making any decision that could affect the future of the company: –
- Is there any conflict (personal or financial) between the director and the company in relation to the decision to be made?
- Does the director have all the facts to make the decision?
- Is the decision rational?
- Is the decision in the best interest of the company?
Upholding directorial responsibilities has far-reaching consequences for an organisation’s stakeholders, reputation, and financial well-being. The financial and reputational implications of the VBS matter serve as an example of how failing to uphold these obligations can have irreparable results for companies and directors in their personal capacities
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The information contained in this Legal Brief was intended for our clients and correct to the best of the authors’ knowledge at the time of publication. Before making any decision or taking any action, you should consult the contacts listed here.