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Point of Law

Francisco Ed. Lim

New term limit for independent directors

Francisco Ed. Lim

May 13, 2016

In an advisory dated March 31, 2016, the Securities and Exchange Commission (SEC) limited the term of independent directors to a maximum of nine years.
 
The original rule under SEC Memorandum Circular No. 9, series of 2011, prescribed a 10-year term limit. This old rule, more popularly known as the “5-2-5” rule, provided that an independent director shall have an initial term limit of five years, followed by a cooling off period of two years, and then he or she could be elected again for another five years.
 
After the second five-year term, the independent director will be perpetually barred from being elected as such in the same company. The original rule became effective in 2012.
 
The new rule will be implemented in 2017, when the initial five-year term for incumbent independent directors will expire.
 
In anticipation of the expiration of the initial five-year term, the Department of Finance, on April 15, 2015, issued Order No. 054-2015 (DO), prescribing a fit-and-proper rule for independent directors of publicly listed and insurance companies.
The DO set an ideal term limit for independent directors of 10 years following the “5-2-5” rule of the SEC.
 
Some independent directors, especially those serving in blue-chip companies, opposed limiting the terms, basically reasoning out there was no empirical proof this will improve board effectiveness. They also said this would further deplete an already insufficient local pool of independent directors.
 
The Shareholders’ Association of the Philippines (SharePHIL) publicly took issue with these personalities.
 
The group supported a term limit for independent directors. SharePHIL pointed out a 10-year limit is “long enough for a qualified director to serve and contribute meaningfully to the success of the company” and “fresh blood with a fresh perspective can be as much an asset to the company as a long staying director.”
 
SharePHIL went further by proposing that the term limit be reduced to nine years, using the “5-2-4” rule, which is basically the same as the “5-2-5” rule except that the last term is shortened to four years. It cited the cases of the BDO Unibank, Inc., China Banking Corporation, Globe Telecom, Inc., and the Philex Mining Corporation as among the listed companies that have adopted the nine-year term limit under the “5-2-4” format.
 
SharePHIL also argued the reduction of the term limit to nine years would be in accordance with regional best practice in the Asean region as expressly recognized under the Asean Corporate Governance Scorecard (ACGS).
 
The ACGS is the product of studies by corporate governance experts and reflects the prevailing best practices in corporate governance globally and in the region. The scorecard has been adopted and endorsed by the Asean Capital Markets Forum, which represents regulators from all participating member countries.
 
The new SEC rule adopts SharePHIL’s proposed nine-year term limit with a modification that the term will be a nonstop nine years.
 
The new rule provides that independent directors whose terms will expire in 2017 may be re-elected as such until 2021 at which time they will no longer be qualified as independent directors for the same company.
 
The rule is not automatic, however. The listed company must show there are no “suitable replacements” for their independent directors.
 
For this purpose, the listed company must notify the SEC and provide justification for the re-election of their independent directors beyond 2017.
 
Some have raised the question on whether the advisory applies only to independent directors whose initial five-year term will expire after 2017. By its terms, the advisory seems to provide the same.
 
They also point out the new rule allows the SEC to decide on the matter with much subjectivity. They also say it is an accommodation of noted personalities who are concerned about not being re-elected after the two-year cooling off period under the old, but still existing rule.
 
I think the SEC advisory is a good start. I am positive the SEC will address with finality the issues related to the new rule once it amends the Code of Corporate Governance, which I understand is the reason why the new rule is merely in the form of an advisory.