DEFINING, DISCLOSING AND DISCOURAGING RELATED PARTY TRANSACTIONS (RPT) Presented by John K M Lim Council Member and Hon. Secretary Singapore Institute of Directors Based on a paper prepared by Dr Mak Yuen Teen, Associate Professor NUS Business School, National University of Singapore The Fourth Asia Roundtable on Corporate Governance Mumbai, India 11 – 13 November 2002 Singapore Institute of Directors Excellence in Corporate Governance

AGENDA Definitions of Related Party Transactions (RPT) Importance of managing RPT Legal and regulatory framework International Practices - USA - UK - Australia - Hong Kong - Singapore Conclusion Singapore Institute of Directors Excellence in Corporate Governance

Related Party Transactions (RPT) RPT – a transfer of resources or obligations between related parties Related Parties (RP) – subjected to common control or common significant influence May expose a reporting entity to risks or provide opportunities Tendency not to be effected on same terms & conditions as between unrelated parties May not be given accounting recognition Have a material effect on the operating results & financial position of an enterprise Singapore Institute of Directors Excellence in Corporate Governance

Related Party Transactions (RPT) RP and RPT not always easily identifiable Potential for distorted or misleading financial statements in the absence of adequate disclosure Instances of fraudulent financial reporting and misappropriation of assets facilitated by RPT Undisclosed RP a powerful tool in the hands of unscrupulous person Identification, disclosure and approval form basis of regulatory framework Singapore Institute of Directors Excellence in Corporate Governance

Various terminology and definitions are used to describe RPT & RP in different countries Common law jurisdictions framework : 1) Requires information to be filed with a central registry maintained by governmental authorities 2) Required to maintain up-to-date registers 3) Listed companies – required to disclose information of their top management team, substantial shareholders to the Exchange 4) Required to disclose identity of RP in annual reports Legal & Regulatory Framework Singapore Institute of Directors Excellence in Corporate Governance

Disclosure of RPT is make up of 3 requirements : 1) Under the common law : - Primarily concern directors, no common law rule for other RP (ie.key managers, substantial shareholders) - Director-related transactions require shareholder approval 2) Under corporate legislation - Usually more specific than (1) & carry criminal or penal sanctions - Requires companies to furnish shareholders with annual report & audited accounts 3) Quasi-legislative requirements - Eg : stock-exchange listing requirements - Focus – relevant, accurate & timely disclosure of RPT Legal & Regulatory Framework Singapore Institute of Directors Excellence in Corporate Governance

Must include disclosures of material RPT The disclosures must include : - The nature of the relationships involved - A description of the transactions - The dollar amounts of the transactions & any changes - Amounts due from or to RP & the terms of settlement Disclosure of RPT that are eliminated in the preparation of consolidation financial statements is not required International Practices – USA “FASB Statement No. 57” Singapore Institute of Directors Excellence in Corporate Governance

Should include a description of all elements of RPT necessary for an understanding of its business purpose: - The identity of RP - How the transaction price was determined - How any evaluation of fairness was made & whether there are any ongoing commitments as a result of RPT The effect on the company’s financial statements and special risks or contingencies arising from RPT International Practices – USA “SEC Release No ” Singapore Institute of Directors Excellence in Corporate Governance

Disclosure of RPT required in the company’s annual report, proxy statements & SEC fillings RPT is to be reviewed & evaluated by the Audit Committee or another comparable body Some RPT require shareholder approval - NYSE Listing Company manual Section “Shareholder Approval Policy” should be considered - Exemptions: - Any public offering for cash; - Any bona fide private financing International Practices – USA “NYSE Listed Company Manual Section ” Singapore Institute of Directors Excellence in Corporate Governance

Disclose the existence of RP & the nature and extent of any transactions with them Requires 2 parts of disclosure: 1) Disclosure of control 2) Disclosure of transactions Exemptions – Transactions with : - Group entities that are eliminated on consolidation - Providers of finance in the normal course of business - Utility companies, suppliers, customers (for huge volume of business) - Government bodies International Practices – UK FRS 8 “Related Party Transactions” Singapore Institute of Directors Excellence in Corporate Governance

When entering into a RPT, the company must : - Make an announcement stating all elements of the RPT - Furnish its shareholders with a circular - Obtain shareholders approval Exemptions include : - Companies without listed securities - Overseas companies with a secondary listing - Transactions in the normal course of business - Joint investment arrangement on normal terms - Small transactions International Practices – UK UK Listing Authority’s Listing Rules, Chapter 11 Singapore Institute of Directors Excellence in Corporate Governance

Section 208 states : - Shareholders’ approval is required except for those exempted under Section RPT must take place within 15 months after approval Exemptions under Section include : - Transactions in the normal course of business - Renumeration & reimbursement for employee - Indemnities, insurance premiums & legal costs -Transactions of small amounts (less than $2,000) - Benefit to or by closely-held subsidiaries International Practices – Australia “Corporations Law, Chapter 2E” Singapore Institute of Directors Excellence in Corporate Governance

Prescribe disclosure of all RPT where control or significant influence exist Disclosure requirements for transactions within the wholly owned group are less detailed than others Required to disclose items eliminated on consolidation Disclosure on an individual basis is required when the sum of the RPT is significant Exemptions – transactions in the normal course of business Singapore Institute of Directors Excellence in Corporate Governance International Practices – Australia AASB 1017 “Related Party Disclosure”

Transactions covered by this chapter include : - Acquiring & disposing of substantial assets to RP - Issue of securities to RP Shareholder approval must be obtained A report from an independent expert is needed The following transactions are exempted : - Between the entity & a wholly owned subsidiary - Between wholly owned subsidiaries of the entity - Issue of securities under an underwriting agreement; under an employee incentive scheme; on the conversion of convertible securities - Value of securities issued do not exceed $3,000 International Practices – Australia AASB 1017 “Related Party Disclosure” Singapore Institute of Directors Excellence in Corporate Governance

Should disclose the nature of all RPT including : - Types & elements of RPT - Volume of the transactions - Amounts of outstanding items - Pricing policy Transactions of a similar nature may be disclosed in aggregate Exemptions include : - Transactions eliminated on consolidation International Practices – Hong Kong “HKSA Statement 2.120” Singapore Institute of Directors Excellence in Corporate Governance

Rules – require companies : - To disclose details of “Connected Transactions” - To obtain shareholders approval for material transactions 3 categories of “Connected Transactions” 1) Rule 14.24: Not subjected to disclosure & shareholders approval 2) Rule 14.25: Subjected only to disclosure requirements 3) Rule 14.26: Subjected to both disclosure & shareholders approval Active consultation with HKSE International Practices – Hong Kong “HKSE Listing Rules, Chapter 14” Singapore Institute of Directors Excellence in Corporate Governance

All RP relationship involving control should be disclosed regardless of whether RPT occurs Requires disclosure of : - The nature, types & elements of RPT Transactions with the following are exempted: - Common directorships - Provider of finance; Trade union - Public utilities; government department & agencies - A single customer, supplier (transacting huge volume of business) International Practices – Singapore “SAS 21” Singapore Institute of Directors Excellence in Corporate Governance

RPT ≧ 3% of issuer’s latest audited NTA require immediate disclosure through announcement RPT ≧ 5% of issuer’s NTA require shareholders’ approval - Opinion of Independent Financial Adviser (IFA) required on whether RPT is: (i) on normal commercial terms (ii) prejudicial to the interests of the issuer and its minority shareholders - Opinion of Audit Committee required if different from that of IFA Announcement required for RPT local property irrespective of value - Review by and approval of audit committee required - Shareholder approval required for RPT ≧ 5% of issuers’ NTA International Practices – Singapore SGX Listing Manual, Chapter 9 Singapore Institute of Directors Excellence in Corporate Governance

Exceptions : - Transactions below $100,000 - Dividends, bonus issue, approved options - Director’s fees, employee remuneration - Provision of goods, services on normal commercial terms, normal course of business - Awards by public tender - not a substantial shareholder International Practices – Singapore SGX Listing Manual, Chapter 9 Singapore Institute of Directors Excellence in Corporate Governance

Take-over offers by RP MBO Safeguards - Offeree required to obtain independent advice - Equality of information International Practices – Singapore Take-over Code Singapore Institute of Directors Excellence in Corporate Governance

Not all RPT are necessarily disadvantageous to issuer Accounting standards tend to focus on identification and measurement of RPT not disclosure Over reliance on management and principal owners to identify RP and RPT Proactive role of Audit Committee, Board and major shareholder Check and balance Strong regulatory framework, active watchdogs and effective enforcement are key success factors Rule based procedures no substitute for honesty and integrity Concluding Remarks Singapore Institute of Directors Excellence in Corporate Governance

Thank you Singapore Institute of Directors Excellence in Corporate Governance