THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination CORPORATE GOVERNANCE JUNE 2011 Time allowed 3 hours Section A Compulsory case study Section B 5 long questions (attempt any 3) DO NOT OPEN THIS PAPER UNTIL INSTRUCTED TO DO SO BY THE INVIGILATOR Important Note: Candidates are allowed 15 minutes reading time to read through the question paper before the commencement of the examination between 1:45pm-2:00pm. During the reading time, all candidates must be silent and must not write or mark anything on their question papers or answer books. Candidates must close all their reference books, notes or other unauthorised materials and put these under their chairs. If any candidates write or make any marks during the reading time, or if they speak or in any other way communicate with anyone either in or outside the examination hall during this period or read any unauthorised materials, they will be disqualified from continuing this examination paper. Once candidates have opened the question paper, they are not allowed to leave the examination hall until 2:30pm. Page 1 of 12
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SUBJECT NO 10M CORPORATE GOVERNANCE JUNE 2011 The examination paper is divided into TWO Sections. Section A is a case study with compulsory questions which carries 40 marks. Candidates should attempt THREE questions from Section B, all of which carry 20 marks each. You should allow yourself approximately 70 minutes in total to answer the questions in Section A, and 35 minutes for each of the questions attempted in Section B. Unless otherwise stated, $ denotes Hong Kong dollars. Wednesday afternoon 1 June 2011 Time allowed: 3 hours SECTION A (Compulsory answer ALL parts of this question) Question 1 A. S. Eastwell & Sons Limited (Eastwell) is a private company incorporated in Hong Kong. Albert founded the company in July 1992 and has acted as its Chairman and Chief Executive Officer (CEO) ever since. Other members of the board include Ben, Charles and Dan, who are in charge of the financial, administrative and marketing functions respectively. Eastwell runs a supermarket chain which competes with two market leaders. Its articles of association are in the form of Table A in the First Schedule to the Companies Ordinance (CO) (Chapter 32, Laws of Hong Kong). The next board meeting is scheduled to take place in four weeks time. As the Company Secretary, you have been busily preparing the agenda for that meeting. Details of two of the matters that the board is due to discuss at the 4 July meeting are as follows. The first matter About a month ago Dan was approached by Sparkin Shop Limited (Sparkin), one of the market leaders, to consult with them on selling organic fruits and vegetables to the high end of the market via the Internet. The consultancy contract is estimated to be worth $1.5 million per year for three years. Dan has been keen to accept Sparkin s offer for two reasons. First, he regards Internet shopping and sale of organic products as the two growth areas in the stagnant food retailing sector. Page 3 of 12
However, Eastwell has been uncertain whether it should develop those two areas. While the board did discuss the possibility of integrating its organic products sales division with the Internet shopping facility during its last two board meetings in March and April, it failed to reach any consensus. Second, Dan complains that although his marketing campaigns have contributed significantly to Eastwell s commercial success in the past three years (annual growth of 10%), he has been remunerated much less than Ben and Charles. The Sparkin contract, however, represents a 40% premium on Dan s current salary. Dan has privately sought your advice on the consequences of signing the consultancy contract without the board s knowledge or resigning from office should the board refuse to let him accept the Sparkin offer following disclosure. The second matter In celebration of the 20 th anniversary of its founding, Eastwell would like to list its shares on the Main Board of the Stock Exchange of Hong Kong Limited (SEHK) by the second quarter of 2012. To ensure Eastwell s corporate governance standards meet the SEHK s requirements, the board asked you last October to conduct a preliminary review of Eastwell s operations and internal control systems. You have made two recommendations to the board. First, Albert should not perform the roles of Chairman and CEO at the same time as this is a possible breach of the Rules Governing the Listing of Securities on SEHK (Listing Rules). Albert, however, does not see any problems arising from his holding the two positions concurrently. Second, Eastwell s internal control systems should be revamped and upgraded as a matter of urgency. Ben has obtained from each of the four international auditing firms (Big Four) a price quote for the revamp and upgrading. However, the board thinks that the fees charged by the Big Four are too high. Instead, Albert has advocated that the board should award the contract to Grant Thurston Howard (GTH), a firm which has audited Eastwell s accounts since the company was established. According to Albert, GTH has successfully reviewed the internal control systems of a variety of clients in the past ten years and it charges only $400,000 for the job. The sum is at least 70% cheaper than any of the quotes from the Big Four s but still amounts to 52% of Eastwell s audit fees for last year. Page 4 of 12
REQUIRED: (a) Advise Dan whether he will breach any laws on directors duties ín Hong Kong by accepting the Sparkin offer. If a case can be made against Dan, discuss the actions that he can take to avoid breaking the law. [Where appropriate, candidates may refer to case law to support their arguments in answering Part (a).] (15 marks) (b) (c) Discuss the corporate governance procedures under the Listing Rules and the Code on Corporate Governance Practices that the board should observe if a director is caught in a conflict of interest situation. (5 marks) Advise the board of any corporate governance implications under the Code of Corporate Governance Practices by letting Albert continue to perform the roles of Chairman and CEO concurrently. If Albert is to continue with both roles, discuss the actions that the board can take to prevent any possible breach of the Listing Rules. (10 marks) (d) Critically analyse, in the context of corporate governance, whether or not the board should award GTH the contract to review Eastwell s internal control systems. If you agree that the board should give the contract to GTH, discuss the factors that the board should consider to ensure GTH s objectivity and independence. (10 marks) (Total: 40 marks) Page 5 of 12
SECTION B (Answer THREE questions from this section) 2. One of the internal auditors of Roy Group Limited (Roy Group) has discovered an accounting error in the company s books $0.5 million in revenue expenditure was falsely reported as capital spending, which increased the company s profits erroneously. The internal auditor reported his concerns to the head of internal audit then to the company s external auditors and finally to the audit committee, but all to no avail. The new Chairman of the audit committee realises that it is the time to propose to the board that published internal procedures for dealing with whistleblowers be adopted. REQUIRED: You are the Company Secretary of Roy Group. Prepare a proposal on a whistle blowing policy and its related procedures for the new Chairman of the audit committee. (20 marks) Page 6 of 12
3. Your friend has recently agreed to act for the first time as the Company Secretary of a listed Hong Kong company. Among the areas that your friend was asked to come to grips with is directors and officers insurance (D&O insurance). He does not know much about it but was told that D&O insurance, which also covers company secretaries, can promote good corporate governance in the company. Your friend is also required to plan and design a directors induction programme, which, in his view, is an expensive exercise in terms of cost and management time. REQUIRED: (a) Brief your friend about D&O insurance and explain the role of these policies in promoting good corporate governance. (10 marks) (b) Advise him on the significance of director induction programme and suggest the content of a typical induction programme. (10 marks) (Total: 20 marks) Page 7 of 12
4. John was recently chosen to be the Chairman of the board of Qincy Limited (Qincy), which is an information technology company listed on the Main Board of the SEHK in October 2002. Impressed by the suggestions made in the HKEx Consultation Paper on Review of the Code on Corporate Governance Practices and Associated Listing Rules (HKEx Consultation Paper), John, in a recent meeting with Qincy s top executives, floated the idea of delegating many of the board committee responsibilities particularly those of the nomination committee to a corporate governance committee. John was also told in the meeting that Qincy had not provided its board members with any development programme to update their changing responsibilities and to improve their effectiveness. REQUIRED: As the Company Secretary:- (a) Write a report to John suggesting the possible functions, composition and meeting procedures of the corporate governance committee. [Where appropriate, candidates may make reference to the principles in the Listing Rules, Code on Corporate Governance Practices and HKEx Consultation Paper] (13 marks) (b) Discuss with John the importance of continuous training and motivation for directors in helping them carry out their responsibilities. (7 marks) (Total: 20 marks) Page 8 of 12
5. The year-end bonus payment to the global sales director of A Limited is based on certain pre-determined performance indicators like sales targets and working capital management (such stock turnover days and trade receivables days). During 2009, the company stopped manufacturing a low-margin and price-competitive product category. As a result, there was a very significant one time write-off of machinery and equipment as well as obsolete inventory. A Limited recorded a loss that year. Despite the loss, A Limited rewarded the global sales director with a substantial bonus in 2009 for achieving the target performance indicators. The new Chairman of the remuneration committee joined A Limited less than three months ago. REQUIRED: Brief the new remuneration committee Chairman on: (a) The issues in this case; and (8 marks) (b) The issues to be considered in designing performance-related incentives. [Candidates should make reference to all relevant principles in The UK Corporate Governance Code and the Code on Corporate Governance Practices in Hong Kong.] (12 marks) (Total: 20 marks) Page 9 of 12
6. Chatham Asia Limited (CAL), which is a Hong Kong-incorporated company which was listed on the Main Board of the SEHK in May 2010, the company is considering whether it should appoint Mary to be its the Company Secretary. Alex, the Chairman, has asked you to brief him before the board interviews Mary next week. REQUIRED: Brief Alex on the following: (a) The Listing Rules requirements that Mary has to meet in order to be appointed as CAL s Company Secretary. If CAL were incorporated in Mainland China, how would the requirements on Mary be different? (8 marks) (b) The corporate governance responsibilities that Mary will undertake if she is appointed. (12 marks) (Total: 20 marks) End of paper Page 10 of 12
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