Revisiting the fiduciary duties of the board of directors and management

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Cesar L. Villanueva

M. A. P. Insights

Part III

Prior to the promulgation by the SEC of the original Code of Corporate Governance, corporate governance literature abounded with championing the “Maximization of Shareholders Value” against the “Stakeholders Theory” and “CSR,” on the primary grounds that: (a) to use corporate resources for certain segments of the public would be contrary to the fiduciary duties of the Board and Management to employ corporate assets for the benefit of stockholders who are clearly the legal beneficiaries of such relationship of trust; and (b) that both the latter doctrines did not provide a proper “equilibrium” upon which regulating agencies and the constituencies entitled to benefit could determine whether the Board and Management were properly complying with their fiduciary duties.

In 2000, the Securities Regulation Code (SRC) expanded the corporate governance regime in publicly held companies, as it began to expand the duties of transparency, responsibility and accountability beyond the realm of stockholders, but included the members of the public who held all forms of “securities” in such companies. The SRC also formally instituted the system of Independent Directors, who would be elected into the Boards of such companies essentially to represent public interests, exercising business judgment “independent” of directors who represented the controlling stockholders.

It would be imprudent to conclude that the SRC formally instituted the “Stakeholders Theory” in publicly held corporations, for indeed the standing of “constituencies” was expanded to include only creditors who held the debt-securities issued by said covered corporations. There is no mention under the SRC of owing duties of transparency, accountability or responsibility to stakeholders beyond the members of the public who held the equity and debt securities issued by said covered corporations.

Even independent directors, who in theory were meant to represent the public interests, were not formally mandated to represent the interest of stakeholders other than the stockholders and debt-security holders of the covered corporation. Moreover, aside from disclosure obligations required under the SRC, the duties and obligations of directors of publicly held corporations continued to be governed by the Corporation Code, which by its legal structure provides for the “Maximization of profits” as the primary duty of the Board and Management.

Chronologically, it was the Bangko Sentral ng Pilipinas (BSP), through the exercise of its quasi-legislative powers in 2001, that introduced formally the “Stakeholders Theory” to the Philippine banking industry when it promulgated a series of memorandum circulars beginning with BSP Memorandum Circular No. 283, s. 2001, where it provided that —

The position of a bank/quasi-bank/trust entity director is a position of trust. A director assumes certain responsibilities to different constituencies or stakeholders (e.g. the bank/quasi-bank/trust entity itself, its stockholders, its depositors and other creditors, its management and employees, and the public at large). These constituencies or stakeholders have the right to expect that the institution is being run in a prudent and sound manner.

It should be noted that the formal regulatory adoption of the “Stakeholders Theory” into the banking industry by BSP was preceded by jurisprudential development of the theory under the aegis of our Supreme Court, which held that the banking industry is vested with public interests, and that consequently the degree of diligence that must be exercised by the banks and their officers should be more than just the diligence of a prudent person but must be of the highest form of diligence (extraordinary diligence) and recognized that bank directors and officers owed a fiduciary duty of diligence not only to depositors (i.e., creditors), but in all their dealings with the public.

In other words, the formal introduction of the “Stakeholders Theory” into the banking industry by BSP operated within a regulatory framework that has already evolved through the various decisions of the Supreme Court already providing for the hierarchical resolution of the fiduciary duties of diligence that is owed by banking institutions to their various stakeholders, i.e., stockholders, depositors, borrowers and other members of the public that they deal with.

In 2002, the SEC formally adopted into the realm “publicly held companies” the “Stakeholders Theory” under the original Code of Corporate Governance, through:

• Formally defining “Corporate Governance” as “a system whereby shareholders, creditors and other stakeholders of a corporation ensure that management enhances the value of the corporation as it competes in an increasingly global marketplace.

• Granted legal “stakeholders” standing to creditors, employees, managers, and the community who are affected by the corporate enterprise, and thereby expands considerably the constituencies to whom the Board of Directors owe certain fiduciary obligations; and

• Expanded the objective of the Board of Directors from one of “maximization of profits,” itself an objective that can be gauged from a corporation’s financial statements, to “enhancing the value of the corporation” to make it more competitive in the long run, and best suited to protect the varied interests of all stakeholders.

It should be noted, however, that the original SEC Code on Corporate Governance failed to provide a “equilibrium formula” required by Boards in exercising their business judgment in situations where the conflicting interests of the stockholders and other stakeholders are to the properly addressed in the exercise of their business judgment. In fact, a close reading of the original CG Code gives an impression that the commercial success of the company was a central fiduciary responsibility owed by the Board primarily to the stockholders, and only the duty to inform how the company operations would affect other stakeholders was the primary duty owed by the Board to stakeholders other than the stockholders. To illustrate, under the original CG Code, the central obligation of the Board “to foster the long-term success of the corporation and secure its sustained competitiveness is a manner consistent with its fiduciary responsibility,” was to be exercise for “the best interest of the corporation and its shareholders,” without referring to other stakeholders. In fact, the original CG Code provided for a parallel, but separate communication policies between stockholders on one hand, and other stakeholders on the other, thus:

iv. Identify the corporation’s major and other stakeholders and formulate a clear policy on communicating or relating with them accurately, effectively and sufficiently. There must be an accounting rendered to them regularly in order to serve their legitimate interests.

Likewise, an investor relations program that reaches out to all shareholders and fully informs them of corporate activities should be developed. As a best practice, the chief financial officer or CEO should have oversight of this program and should actively participate in public activities.

When it came to the area of “Accountability and Audit,” the original CG Code limits their application to the stockholders, thus: “The Board is primarily accountable to the shareholders and Management is primarily accountable to the Board. The Board should provide the shareholders with a balanced and understandable assessment of the corporation’s performance, position and prospects on a quarterly basis. x x x

Indeed, the original CG Code reiterates and expands on the rights of stockholders as already provided for in the Corporation Code, in specific areas such as voting rights, preemptive right, power of inspection, right to information, right to dividends, appraisal right, etc., and does not define clearly what may be the rights of the other stakeholders that it has recognized in defining the term “corporate governance.” It did not provide for a listing of what rights stakeholders other than stockholders were entitled to demand from the Board and Management of publicly held companies in the exercise of their fiduciary duties.

The lack in SEC’s original Code of Corporate Governance (SEC Memo Circular No. 2, s. 2002) of a clear delineation of what particularly are the metes and bounds of a director’s fiduciary obligations to stakeholders other than stockholders, and what would be the proper resolution when the legitimate interests of the various stakeholders collided with one other, had brought much uncertainty in corporate governance practice in publicly held companies. Unfortunately, before the sphere of public companies had been able to work out developing the hierarchical system of evaluating the legitimate interests of the stockholders and other stakeholders in the realm of publicly held companies, the SEC pulled the plug on “Stakeholders Theory” when it issued in SEC Memo Circular No. 6, s. 2009, deleting all provisions in the original CG Code having to do with “stakeholders” and limiting its operations to stockholders.

In the meantime, the Philippine Stock Exchange (PSE) formally adopted Corporate Governance Guidelines which placed at center stage the maximization of shareholders’ value as the primary obligation of the Boards of publicly listed companies, but with “due regard to their stakeholders.” (No. 1 Guideline: Shareholder return is optimized through a sound and well-executed strategy). Under Guideline 8, the Boards of publicly listed companies are mandated to “respect and protect the rights and interests of its employees, community, environment, and other stakeholders.” In brief, therefore, the PSE CG Guidelines, did not seek to recognize a new right or standing of stakeholders of the company, but merely enjoined the Boards of publicly listed companies to “give due regards” (an ethical management guide, not a legal duty or obligation), to its stakeholders, and to respect whatever rights and interests such stakeholders have been granted, if any, under existing laws.

Under the leadership of Chairperson Teresita J. Herbosa, the SEC in 2014 reinstated the stakeholder provisions of the original CG Code under SEC Memo Circular No. 9, s. 2014. However, the reinstatement of the “Stakeholders Theory” for publicly held companies merely reignited the long-drawn debate on what under such corporate governance regime is the equilibrium formula that should be relied upon by the Board and Management to determine whether the corporate resolution or decision they arrive at fulfills their fiduciary duties to the various stakeholders of the company: How can they determine that by seeking the maximization of shareholders’ value, which is their primary duty when serving a publicly listed company, they do not undermine the conflicting or opposing interests of other stakeholders?

During those debates, the writer had always proposed that responsible Boards for publicly held companies did not have to fear the “lack of equilibrium” feature of the “Stakeholders Theory,” since the original CG Code itself had provided the key to allow the Board of each publicly held company the ability to answer to the such query. It will be recalled that the original CG Code made it mandatory for covered corporations to adopt formally their company manual of corporate governance to be formally approved by the SEC.

The key provision in the original CG Code, which this writer thought was a stroke of genius, was the one which mandated that the Board of covered corporations shall “Identify the corporation’s major and other stakeholders and formulate a clear policy of communicating or relating with them accurately, effectively and sufficiently. There must be an accounting rendered to them regularly in order to serve their legitimate interests.” Therefore, the Board of every publicly held company had the legal ability to determine in the provisions of its manual of corporate governance, who the stakeholders of the company are, and provide for their “legitimate interests,” and finally to then work out in the manual provisions the hierarchical placement of such legitimate interests.

The SEC recognized under the original CG Code, that it is the Board of publicly held companies, rather than for the SEC, which are in a better position to determine who the various stakeholders of the company are, their legitimate interests, and to work out a hierarchical valuation of their varying, if not conflicting, interests. Such company-centered formulation of the implementation of “Stakeholders Theory” within the company would form an integral part of the company charter once the manual is formally approved by the SEC.

Unfortunately, when the “Stakeholders Theory” was reinstated in the Revised Code of Corporate Governance, SEC Memo Circular No. 9, s. 2014, provided for a watered-down version of the stakeholders-identification clause which read: “Identify the corporation’s stakeholders community in which the corporation operates or are directly affected by its operations, and formulate a clear policy of accurate, timely and effective communication with them.” Under the present version, the Revised CG Code merely recognizes that stakeholders are entitled to only “a clear accurate, timely and effective communication” of matters of corporate affairs that affect them. This is the same situation under the PSE Guidelines which mandates that in pursuing company affairs, the proprietary interests of stockholders is foremost in the exercise of business judgment, but only with “due regards” to the interests of other stakeholders. In fact, under Article 5 on “Accountability and Audit” section of the Revised CG Code, it is expressly provided that “The board is primarily accountable to the stockholders,” without any reference at all to other stakeholders.

With the recent promulgation of the CG Code for PLCs, the question that must be answered is “What is the corporate governance doctrine that prevails under the Code of Corporate Governance for Publicly Listed Companies?” The brief answer is: A hybrid system of corporate governance that has put together the best features of the “Doctrines Maximization of Shareholders’ Value,” “Stakeholders Theory,” and the “CSR Doctrine.”

The article reflects the personal opinion of the author and does not reflect the official stand of the Management Association of the Philippines or the M.A.P.


Cesar L. Villanueva is a member of the Management Association of the Philippines (M.A.P.), the former Chair of the Governance Commission for GOCCs and the Founding Partner of the Villanueva Gabionza & Dy Law Offices.