Author: | Published: 9 Oct 2003
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In January 2003 the Italian government adopted a much-needed new law that radically reforms the models of corporate governance available to Italian joint-stock companies (Società per Azioni). The reforms, part of a wider overhaul of the Italian Civil Code's corporate law provisions, are arguably among the most important and revolutionary changes to Italian corporate law in recent years given the potential impact on the current governance system. The introduction of the new law (planned to come into force in January 2004) signals a recognition by the Italian legislature of the fact that many of the corporate law provisions, including those relating to corporate governance, needed to be updated to bring them into line with the requirements of today's economic and business environment which, thanks to new technology and globalization, has changed significantly in recent years.

One of the most positive aspects of the reforms is that Italy has now begun to participate in the process, already underway in most other EU countries, of attempting to harmonize member states' legal systems as much as possible. The aim of this process is to create a true common market, one of the goals of the founders of the European Community. Italy still has some way to go before this goal can be achieved, but the reforms represent an important and significant step. If nothing else, by introducing the reforms Italy has recognized the need to bring, among other things, the models of governance available to Italian companies into line with those available in other EU countries. It is hoped that this will lead to an increase in the number of foreign investors prepared to base their businesses (and therefore increase their investments) in Italy by offering these investors governance models that are well established in their own jurisdictions.

The reforms to the corporate governance provisions represent the first wholesale review of Italian corporate governance rules in 60 years. Attempts were made with the Decreto Draghi in 1998 (a law that applied solely to listed companies), which contained limited corporate governance provisions, and subsequently in 1999 with the Codice di Autodisciplina (a body of non-compulsory best-practice rules for the governance of listed companies, which have been applied by a large number of listed Italian companies) of Borsa Italiana, the private company which manages the Italian Stock Exchange. It is hoped that the choice of models the reforms contain will improve the quality of corporate governance by giving shareholders the benefit of being able to adopt the most appropriate balance between corporate management and supervision, taking into account the nature and therefore the requirements of individual companies.

In essence, the reforms will allow Italian companies to choose between three models of governance: the traditional Italian model, which has been slightly modified by the reforms, a new single-tier system and a new two-tier system. The two new models are inspired by those of other EU countries, where these systems have been shown to work well, notably the UK, France and Germany.

The traditional model is based on a board of directors (Consiglio di Amministrazione) (which may have only one member, acting as amministratore unico), a board of statutory auditors (Collegio Sindacale), (both of which are appointed by shareholders, have no common members, and, in the case of the board of statutory auditors, has registered accountants included among its members) and shareholder meetings. Under this model, the board of directors has the power to decide on how the business of the company is conducted and all administrative and managerial matters are either dealt with directly by it, or delegated to one or more managing directors or to an executive committee. The board of statutory auditors carries out a supervisory function over the board of directors, checking the legality of the company's financial statements and the application by the directors of general principles of good management. The shareholders' meeting has powers relating to the appointment and the termination of appointment of directors and statutory auditors and it may elect to bring claims against directors; in addition, financial statements, capital increases, changes to the by-laws, mergers and other important decisions must be approved at shareholders' meetings.

While the traditional model continues to be a valid form of corporate governance and will continue to apply to all companies (unless a decision is taken by the shareholders to adopt one of the alternative models), there was a perceived need to provide further choice to companies so that a model better suited to the size and type of each company could be adopted. With this in mind, the legislator has included the single-tier system and the two-tier system in the reforms.

The single-tier system has arguably been introduced with small or closely-held companies in mind. The system is substantially similar to the traditional model but adjusted with management being carried out through a board of directors (Consiglio di Amministrazione) and a control committee (Comitato per il Controllo sulla Gestione) made up of members of the board of directors. The board of directors maintains a central role exercising management powers and duties, although a fundamental difference to the traditional model is that a single director (amministratore unico) may no longer be appointed to manage the company - only the board of directors (made up of a minimum of three members), acting together or through delegation of powers to individual directors or groups of directors, may manage a company. A further significant change from the traditional model is the removal of the board of statutory auditors which has been replaced in this system with the control committee. This committee is appointed by the board of directors from among those members of the board who do not hold management posts in the company and who are deemed to be independent, in the sense that they are not related to the executive directors of the company (that is, through family ties) or party to any contract with the company itself (such as consulting agreements). The control committee is charged with carrying out certain administrative functions, such as ensuring that the company complies with all relevant laws and its by-laws, as well as keeping a watchful eye on the board of directors' compliance with general principals of good management. Due to the overlap between members of the control committee and the board of directors, the single-tier system is expected to guarantee greater transparency between the management and supervisory bodies. This implies that there should be greater coordination and cooperation between the two bodies which should, in turn, lead to less time and money being spent on administration. In this system, the shareholders' meeting maintains largely the same role as in the traditional model.

As previously stated, this system should be of interest to companies that are small or closely held, such as family companies of which there are a large number in Italy, as the involvement of third parties in the company's management is limited.

In comparison, the two-tier system is possibly more appropriate for bigger companies with a large number of diverse shareholders. It is made up of a supervisory board (Consiglio di Sorveglianza) and a management board (Consiglio di Gestione), which may not share any of the same members. The management board has exclusive responsibility for management of the business of the company and is comprised of a minimum of two members. The supervisory board itself appoints the management board members. The management board is broadly equivalent to the board of directors in the other two models and therefore most of the rules governing the traditional board of directors also apply to the management board. The supervisory board, on the other hand, is appointed by the shareholders and is made up of at least three members, one of whom must be a registered accountant.

The supervisory board is charged with the same supervisory functions and responsibilities as the board of statutory auditors under the traditional model. It also exercises many of the powers that are typically reserved to shareholders, such as the appointment, termination of appointment and fixing of the remuneration of the management board and the bringing of claims against its members. A further innovation is that the supervisory board has the power to approve the financial statements (including consolidated financial statements) of a company, although one-third of the members of the supervisory board or management board may resolve, on an ad hoc basis, that this power be referred to shareholders. As can be seen, these provisions reduce the need for calling shareholders' meetings that can be costly and time-consuming affairs, particularly for listed companies, and therefore allow those shareholders who have little interest in the day-to-day life of the company to entrust the decision-making process on most matters to the directors. The shareholders have a residual role in this system that includes the appointment, termination of appointment and remuneration of the members of the supervisory board, the distribution of dividends and the appointment of the company's independent auditors.

Whichever model is chosen, accounting control and review (including auditing) must be carried out by an independent individual auditor or by an independent auditing firm. An auditing firm is required where the company's shares are listed or are widely held by the public. However, the control and review function may be carried out by the board of statutory auditors of companies adopting the traditional model where the share capital is neither listed nor widely-held and where the company is not required to prepare consolidated accounts.

A recurring theme in the reforms is to increase the direct involvement of directors in the management and running of a company - there is an increase in the powers of the board of directors (or supervisory board or management board, as appropriate), including the power to resolve on issues of bonds (including, if so delegated, convertible bonds), to appoint directors to represent the company and the power to open or close secondary offices. In addition, in the two-tier system, many powers that were previously reserved to shareholders have been passed to the supervisory board. This is aimed at reducing the administrative burden of calling shareholders meetings, but at the same time increases the responsibility of directors.

In parallel to increasing the responsibility of directors brought about by the reforms, significant changes have been introduced in relation to directors' liability. The current fiduciary (good paterfamilias) relationship between directors and companies has been replaced with the concept of "diligence required by the nature of the appointment and duties". This is widely accepted as introducing a higher standard of care due from directors than the good paterfamilias standard. In addition, the existing liability for failing to supervise the company's general affairs adequately has been replaced with a system of joint liability of the directors to the company for breach of specific obligations. As a consequence of such increased levels of responsibility, there is a corresponding extension to the rights of shareholders to bring claims against directors.

The reforms are not without their critics. Scholars began criticizing the new system on the day the reforms were published. A choice of three corporate governance models is viewed by many as excessive. Why did the legislator not focus on further improving the traditional model rather than offering two new models and adding confusion to the corporate governance debate? How can a company (or its shareholders) determine the model best suited to it? Why is there no obligation on companies to review their systems of governance and decide which model they think is best for them? Indeed, the way the law is drafted means that unless companies take positive action, the traditional model will continue to apply - there is therefore a possibility that companies will either maintain the traditional model due to uncertainty as to which of the other models they should adopt or that companies will be reluctant to promote a switch in systems given the unknown implications of a change in something as important as corporate governance rules.

Other more fundamental issues arise. In the single-tier system, the fact that the board of directors appoints the control committee from its own members, while potentially cost effective and streamlined, cannot be without risk. It is accepted that this structure should guarantee a constant flow of information between the two bodies, increasing the level of transparency between the two and leading to, at least in theory, greater coordination and cooperation. However, the fact that the supervised body (board of directors) appoints the supervising body (control committee) may limit the advantages of the reforms significantly in that potential conflicts of interest may arise and lines of authority may be blurred.

In the two-tier system, reserving for the supervisory board powers that are normally the province of shareholders potentially weakens the voice of those shareholders and deprives them of authority. This system may be of value in large companies where shares are widely held as several administrative duties traditionally reserved to shareholders are carried out by professionals (other than, arguably, the approval of financial statements which many claim should remain with the shareholders). In companies where shareholders are interested in holding a liquid investment, rather than becoming involved in the management of the company, the two-tier system could work well. However, the fact that the supervisory board can exercise all powers in relation to members of the management board - appointment, termination, supervision, remuneration, claims against members - removes the autonomy and independence of the management board that many would have preferred to see guaranteed.

Finally, a key issue is how these reforms will fit in with existing legislation. The Decreto Draghi is of equal legislative importance to the reformed Civil Code - this means that listed companies will be subject to a double regime with no guidance, at present, as to which prevails or as to how the two are to interact. Knowing how best to comply with the reforms and the Decreto Draghi at the same time will raise many questions, which can probably only be resolved by clarification from the legislature. It will also be of interest to see how the reforms fit with the Codice di Autodisciplina, which, although only a set of guidelines without the force of law, has been closely followed by large Italian listed companies. Without doubt, further legislative intervention will also be required here in order to coordinate the transition from the old to the new rules.

On balance, the reforms can be seen to improve the current situation. They not only push corporate governance fully into the spotlight in Italy (which is of particular relevance in view of the recent corporate scandals in the US), but they also mark an important step towards the harmonization of the various European models of corporate governance, a step that it is hoped will lead to increased competition in the single market and, in particular, investments in Italy. They also give companies a choice between three systems which was previously not available. However, it is too early to come to any firm conclusions on the new models or on how (and whether) they will be adopted. Perhaps the true tests of the reforms will be not only whether the new models are adopted by listed companies but also the reaction with which they are met by those who have particular influence on the development of corporate practice - the large institutional investors and investor interest groups. In the meantime it is likely that most companies will continue to use the revised version of the tried and tested traditional model of corporate governance.

Clifford Chance
Via Clerici 7
Milan, 20121
Tel: +3902806341
Fax: +390280634200