In 2011 and 2012, Idistributed my own personal proposal for amendment of Japan's Company Law to a number of legislators, regulators, members of the MOJ Company Law Subcommittee, and investors.
Inasmuch as the Democratic Party of Japan had promised to push for the mandatory appointment of outside directors, I thought it was a good time to propose the additional features of the law that, based on my experienceas an outside director in thereal world,would be essential in order for outside directors to add significant valueto corporate governance and shareholder returns. Theobjectives that were uppermost in my mind were:
Ensuring that executive directorswhoare likely tobe affected by their own self-interest by a particular decisionwill not be in the room when the most important part of that decisionis made, especiallyif it is an decision likely to significantly impactthe value of thecompany (such as nomination of new directors, pricingand negotiation of anMBO transaction, the deployment of takeover defenses, or special investigations about executive impropriety). This of course requires companies to be able to form committees, and to be required (or highly incentivized) to form them under certain circumstances;
Ensuring that themost important monitoring function of the board – the hiring and firing of the CEO – can actuallybe performedinterms of practical reality, andthat a broad range ofcandidates can realistically be considered instead of just asmall number of incumbent directors who may be loyal to their predecessor or his/her policies and strategies;
Ensuring thatallmembers of the board(whether external or executive)know enough abouttheir duties under the law, relevant corporate and securities laws,governance best practices,and the subjects ofboard oversight (financial statements, risk management, review ofM&A transactions etc.), -thatthe board canrealistically be expected tofunction asa unifieddecision-making groupthat engagesinmeaningfulprocesseswith dueconsideration by all in orderto make the best possibledecisionson behalf of shareholders and stakeholders;
Ensuring thatcompanies and boardshave an incentiveto: a)appoint truly independent outside directors, b) provide them (and internal appointees)with continuing education, and c) actuallyuse theminseparate committees for the purposes set forth in (1) and (2) above; and
Ensuring that there are likely to besuch qualified independent outside directors on Japanese boards in sufficient numbersthat they actually will add value, rather than resulting in public disappointment later on when they did not perform their role for the simple reason that there were not enough of them and the aforementioned essential infrastructure was not in place.
Having sat for a total of eight years on various Japanese boards, in my experience these things were essential in order to make most Japanese boards more effective in general, and particularly, to achieve most of the benefits that independent outside directors could bring to Japanese boards.
Most of the above goals are precisely the objectives that most major jurisdictions seek to achieve with systems that employ(and usually require)outside directors. However, in Japan the debate about the roleoutside directors has been carefully anddeliberatelydefined narrowly so that: a) it is only necessary to consider appointing one or two, since the role is usually definedmainly as giving outside [advisory] perspectives and telling the CEO whathis employee-directors find difficult to say; b)the practicalrealities of actually removing a poorly performing CEO on a timely basis never get considered; and c) the underlyingpurpose of the way the whole discussion isframedis actually to avoidtalking aboutthe need for independent outside director-comprised committees in cases of hostile M&A, MBOs, and similar transactionsthat potentially create or destroyvalue in large magnitude…since that would require more than one outside director, and the creation of legally valid committees where heand others like him could actually act independently, out of range of control by internal executives (something that everyone knows that the Keidanren will be even more upset about than it already is whenever the topic of outside directors comes up; see immediately below.)
As is well known, in 2011 and 2012 the Keidanren was adamantly opposed tomandatory rules requiring even one outside director, just as it had been for many years.(Which of course can only makea normal investorwonder and worry: what are they so afraid of, from just one outside director? Domany companieshave something to hide? ) The Keidanren's main argument are that: a) the statutory auditor system provides fully enough independence and neutrality; b) there is no clear proof that outside directors improve operating performance (though no one sensible everbased arguments for outside directorson such a claim); and c) that each company (i.e. internal management) should be able todecide what is best for itself, by itself.
Knowing that the MOJwould never be able to overcome this deep-seated political opposition, I purposely did not propose that Japan promulgate rules that would make the appointment of even a single independent director mandatory. Instead, I proposed a Japanese version of what Delaware's Court of Chancerycame up with in the 1980s. Namely, I proposed that in lawsuits questioningwhether a director has complied with hisduty of due care, the burden of proof regarding that issue should be shifted from plaintiff to defendant director(s) in those high-impact situations where: a)managerial self-interest needs to be constrained, but b) the decision has notbeen entrusted to a committee (or a special board) comprised solely of independent directors. It is this sort ofincentive-based rule-rather than mandatory requirements – that resulted inmost of the increase in independent directors in the U.S. during the 1980s.
As the presentation materials available below show, I proposed:
With respect to statutorily defined board decisions with respect to which managers have an inherent conflict or self-interest, all public companies will have a choice:
'Appoint (in advance) 3 independent directors that meet a detailed definition of independence“ subject to “comply or explain” disclosure on an ongoing basis, and use them to compose a special board“ [per a newly drafted Article 373 (2)] that is solely comprised by those directors. In this case, the business judgment rule will operate in the usual fashion: the plaintiff bears the full burden of proof, with the likely result that only rarely is anyone held liable;'
'Don‘t appoint any independent directors if you don’t want to, and/or you are extremely confident about your decision-making. In this case, with respect to the pre-defined types of board decisions, IF there is damage ostensibly caused by such a board decision and a director who voted for it is sued in a shareholder derivative action, there will be a rebuttable presumption that the director has breached his or her duty of due care. That director can rebut the presumption with a showing of facts and an explanation. (At the same time, note that the plaintiff shareholder will still bear the burden of proving damages and causation. )'
The defined types of board decisions are:
Nominations and terminations of board members (includes statutory auditors)
Determination of the compensation of board members
Resolutions or decisions that could have an impact on “control” of the company, such as the adoption or triggering of takeover defenses, MBOs and certain M&A transactions
Decisions or special investigations regarding impropriety by directors, or actions to be taken in response
Any other decisions which the board has determined may be affected by inherent self-interest of directors (even if latent in nature)
In another document, I also proposed:
IF a mandatory requirement for independent outside directors were imposed, it should require at least three of them (i.e., enough to compose a meaningful board committee comprised only of INEDs);
Legal infrastructurethat wouldenableStatutory Auditor Committee-style companies (SACCs, whichcomprise98% of exchange-listed companies in Japan)tocreatelegally valid committees and flexibly delegate decisions to them as necessary. (Delegationwas necessary because there would be no assurance that a majority of the board would be controlled by INEDs; flexibilitywas needed because one cannot predict the type of decision for which independent, good faithjudgment is necessary);
Statutoryinfrastructure enabling SACCs to appoint legally valid executive officers (with duties of due care and loyalty, asconfirmed by recent Delaware decision)even if they are not board members. Without this feature, practically speaking it is extremely difficult to terminate an acting CEO. The reason for this is that under the present SACC systems (which has nostatutory basis for executive officers), only a sitting director can be appointed as a Representative Director (theequivalent of aCEO in a SACC). This means thatif the board decides to terminatethe present CEO, the only candidatesit can consider to replace him or her immediately are the small number ofpresently sitting board members (mainly,otherinternal executives whom the present CEOappointed,who thusownloyalty to him, his actions and strategies). In order fora SACC'sboard to consider other internal executives who are not board members, or qualified outside persons with the experience and skill sets that the company badly needs,the company must spend about 15 weeksplanning an expensive extraordinary shareholders meeting, hope it can gathera quorum of voting shareholders at short notice, and hope that its proposednew board member is accepted by shareholders.
As you might guess,since there are virtuallyzero Japanese companies whichwould ever want to go throughthe public embarrassment and risk that this all implies, for all practical purposes only existing board membersare ever appointed as replacementCEOs, andeven after three years ofred ink only 9%of CEOs step down.In effect, the absence of legal infrastructure for executive officersgives the board a huge incentive to simply do nothing abouta poorly performing (or, transgressing) CEO for thetime being.At the very least, itis much easier to simply wait untilthe next AGM… which might beten months later. Hence, the process for the most fundamentalmonitoring role of theboard – firing the CEO – does not meaningfully even function at present,since board donot have thelegal ability to appointa CEOwho is not an existingboard member; and
That the Tokyo Stock Exchange TSEexercise its responsibility as one of the world's majorstock markets to do what almost every other market has done: promulgate rules with regard to director training and continuing education, or disclosure about company policy with respect to those topics. Specifically, I proposed that theTSEsimplycopy the minimalsteps that the NYSE listing ruleshave takenon this score (which requires much less than say, Singapore) by requiring companies to disclose inthe Corporate Governance Reports that they submit to the TSE, a summary of the corporation'spolicy with regard to director training and orientation. If a company has not policies whatever on these subjects, it could simply state: we have noset policy with regard to these matters, which we handlein an ad hoc manner.
My proposals met with the following reactions:
Japanese lawyersvery quickly understood the logic and sensibility of shifting the burden of proof as a way of avoiding a mandatory requirement whilestrongly incentivizing Japanese companies to appoint INEDs and helping them understand (realize)thereal reasons why INEDs are needed by capital markets. Most of them I spoke to complimented me on this idea, which I had justsort of copied from Delaware. (This fact always makes me wonder about the sincerity of the MOJ Subcommittee members who know much about US law butseem to almost consciously avoiddescribing aspects like this);
The person in charge of theCorporate System Division, Mr. Nasuno, apparently felt so threatened by the very concept of shifting the burden of proof that he attended my study group for the express purpose of interrupting me and aggressively criticizing the concept;
Certain legislators took my concepts to heart and discussed them with the MOJ and other persons, but ran into stiff opposition from METI, presumably the Keidanren, and a number of others who were interested in wrapping up the MOJ advisory committee with just a simple rule requiring a single outside director, as a first step;
The ACCJ incorporated many of my concepts, including the idea of shifting the burden of proof, in its Viewpoint on reform of the Company Law; and
Of course,a greatnumber of persons just ignored or did not know about my proposals.
Below isthelengthy proposalthat I made (including detailed proposed language foramending the statute),as well asmemos or presentation materialsabout my ideas.If you wish todownload these documents, please register as a BDTI userif you are not one already(use the register button at thetop right of this screen), and then click on the name of the file after clicking these links:
Benes – PowerPoint Presentation re Company Law Amendment-1-2012