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The Companies Act, MFMA/PFMA and King III in Perspective
Governance is essentially about effective leadership based on an ethical foundation. Compliance, as any other business activity, should take place within the context of leadership and sound governance principles.
The board of a company has a duty to ensure that the company complies with all applicable laws and rules. In addition, the board also has the responsibility to consider adherence to codes and standards. All these compliance responsibilities are very onerous and especially so where the state is involved. This is exacerbated by the fact that different single provisions in laws, rules, codes and standards cannot be read in isolation, but need to be interpreted in the context of the whole compliance universe applicable to an entity.
The State-owned companies (SOCs) are subject to a bouquet of regulations – their regulatory universe: the Companies Act, the MFMA/PFMA and others. King III, for which compliance is not legislated, but applicable to any organisation, completes the governance picture.
The release of the King Report on Governance for South Africa – 2009 (King III) brought with it significant opportunities for SOCs that embrace good governance. King III brings with it principles and recommendations that correlate with the requirements of the Companies Act and the PFMA.
The Companies Act, the MFMA (for local government, including the Municipal Systems Act (MSA))/PFMA (for national and provincial government) and King III share many of the principles of good governance applicable to SOCs. Alignment is possible and should in fact be strived for in the spirit of the overarching governance principles of accountability, fairness, transparency and responsibility.
When attempting to resolve areas of conflict, it is to be noted that the MFMA/PFMA prevail only where there are irreconcilable differences. If it is a case for instance that the Companies Act has the "more onerous requirements", then compliance with the Companies Act is necessary. This will then encompass compliance with the MFMA/PFMA.
Reconciling the law (which must always be adhered to) with governance recommendations (to be applied voluntarily) sometimes poses a challenge when there are indeed clear contradictions that cannot be reconciled. In these instances it will not be sufficient for the boards of SOCs to wash their hands of these matters as they are the focal point of governance and they bear ultimately responsibility. What is required, firstly, is that SOC boards play an active role in advocating changes to bring about amendments to enabling legislation that is in line with sound governance principles.
Secondly, until such changes are effected, SOC boards should attempt to work within legislative constraints to bring about a sound governance outcome. For instance, if enabling legislation requires the executive authority (per PFMA) to appoint the CEO as opposed to the appointment being made by the board (as required by King III), the board should actively engage the executive authority on this issue in order to bring its input to bear on the executive authority's decision as to who to appoint.
The board should understand that the risk that King III is managing in recommending that the board appoints the CEO, is that there may be confusion around accountability and reporting lines if the executive authority makes this appointment. In recognition of this risk, the board could make it very clear in the employment agreement with the CEO that he or she is accountable and must report to the board.
By being proactive in this way, an SOC board may then achieve the result that was envisaged by King III despite the fact that it needs to work within the constraints of legislation. It should be noted that the MSA (as amended) and King III both require the CEO to be appointed by the board and therefore no contradiction exists for local government.
Other issues to be considered are the following:
- Practice recommendations contained in King III and that are widely adopted by directors set a new benchmark for directors' standard of conduct. When the "reasonable director" test is applied by the courts, this will be taken into account.
- The fiduciary duties of directors and management of conflicts of interest are expressed differently in the Companies Act, King III and the MFMA/PFMA. However, there is no conflict and all of these provisions should be read together in order to adhere to the highest standards.
- The specific MFMA/PFMA provisions that relate to the role and functions of the board can all be matched to an appropriate King III principle, and SOC boards should interpret the legislation against the wider framework of King III.
- Even though there is a contradiction in the PFMA and the Companies Act on who elects the audit committee, it does not change the sound governance principle that SOC boards should be proactive in ensuring an effective and independent audit committee. This contradiction does not exist in the MFMA.
- The duties of the audit committee as set out in its terms of reference should encompass all of the duties contained in the MFMA/PFMA, the Companies Act and King III in order to achieve the higher governance standard.
- Although not required in terms of applicable legislation, an SOC board should have regard to the recommendation in King III that the audit committee should base its report concerning the effectiveness of internal financial controls on a documented review conducted by internal audit.
- The audit committee of an SOC should fulfil the wider role in relation to the appointment of an auditor as recommended in King III.
- Reporting requirements for audit committees are more extensively provided for in King III than in the legislation. SOC audit committees should aspire to attain those higher reporting requirements.
An SOC's existence is normally based on legislation referred to as "enabling legislation", which provides for its establishment, control, powers, function and funding.
The laws, rules, codes and standards that typically impact on SOCs' governance in South Africa can be depicted schematically:
Click here to view the Effective, Ethical Leadership diagram
Chapter 6 of the PFMA (as well as other sections) apply to public entities, whilst Chapter 10 of the MFMA and 8A of the MSA deal with municipal entities, which may include companies. Where the legal status of the public or municipal entity is that of "company" the Companies Act applies.
Section 3(2) of the MFMA and 3(3) of the PFMA determine that if any conflict exists between these acts and another Act, the MFMA/PFMA prevails.
The interrelationship between the MFMA/PFMA and the Companies Act is evident from the similarity of its respective requirements imposed on directors and the boards of SOCs.
However, as a broad statement, it can be argued that the major differences lie in the fact that the MFMA/PFMA focus primarily on aspects of financial management within public entities, while the Companies Act covers matters in relation to companies that are wider in scope than simply financial management.
SOCs should strive to apply King III in conjunction with the regulatory provisions, even contradictory provisions, in order to achieve the overarching principles of sound governance, namely, responsibility, accountability, fairness and transparency in the interest of the substance rather than the mere form of sound governance.
By approaching compliance and governance with this view in mind, directors of SOCs will have a positive effect on SOCs and their stakeholders, including most importantly, the vested interests of the citizens of South Africa. In the context of "Clean audit 2014" launched during 2009 by the Minister of Co-operative Governance and Traditional Affairs, this approach to governance will provide the necessary drive to achieve "clean" audit opinions in years to come.
(This article is an excerpt from the Public Sector Working Group: Position Paper 1, jointly issued by PricewaterhouseCoopers and the Institute of Directors in Southern Africa, titled: "State-owned companies: Companies Act, PFMA and King III in perspective" and incorporates additional thoughts on local government). asa
Christoph Braxton CA(SA) is an Associate Director at PwC.
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