MEXICO’S CODE OF BEST CORPORATE PRACTICES
Published by the Business Coordinating Council and
The National Banking and Securities Commission
Translation © David D. Spencer All Rights Reserved
NOTE: A NEW MEXICO VERSION OF THESE BEST PRACTICES WAS PUBLISHED LAST SUMMER (2010). I WILL BE POSTING A TRANSLATION AS SOON AS POSSIBLE.
Preface to Translation
Mexico’s Code of Best Corporate Practices is a matter of mandatory study for publicly-traded companies. Under the regulations of the Mexican Stock Market the listing applications must contain a signed representation that the applicant is familiar with the Code. It is also important note, however, that the Code is equally applicable to closely-held businesses that wish to be managed in accordance with international standards. A link to the Spanish text to the Code appears after the footnotes at the end of this translation.
Translation of Code
At the initiative of the Business Coordinating Counsel, the Committee of Best Corporate Practices (Committee) was formed. The Committee issues this Code of Best Practices (Code), which establishes recommendations for better corporate governance of Mexican companies.
The recommendations of the Code are directed toward defining principles that contribute to the improvement of the operation of the Board of Directions (Consejo de Adminstración) and to the disclosure of information to shareholders. Specifically, the recommendations provide: (i) that companies should broaden the information relating to their administrative structure and the functions of their internal groups (órganos sociaels); (ii) that companies should have mechanisms that assure that their financial information is sufficient; (iii) that processes should exist that promote the participation and communication among directors; and (iv) that processes should exist that promote adequate disclosure to shareholders. It is important to point out that these principles are found in the Code in boldface and preceded by a bullet point. The remainder of the text of the Code seeks to give a brief explanation and contextualize each principle.
In creating the Code the Committee recognized the reality and needs of Mexican companies. Among these is the stock structure of the companies, as well as the importance that shareholders can have in company administration.
Finally, it is important to emphasize that the Code can apply to all Mexican companies, whether or not their shares are quoted (listed) on the exchange, while recognizing that certain principles only apply to listed companies. For listed companies, it is considered adequate that they report their degree of adhesion to the practices suggested. In the case of a listed company that does not follow said practices, the reasons for not doing so should be stated, along with an alternative mechanism to replace them. It should be emphasized that for the purpose of facilitating the fulfillment of the recommendations of the Code, subsidiaries may choose to adhere to the Code through their parent companies.
I. Board of Directors
The daily operation of a company is the responsibility of its management team, while the work to define the strategic vision and to approve administration should be responsibilities of the Board of Directors. All Board members are responsible for these tasks.
To fulfill its objective, it is recommended that the Board include members that are not involved in the daily operation of the company and that can contribute an external and independent vision. Likewise, to facilitate its work the Board should be supported by intermediate bodies whose job it is to evaluate information and to propose actions in specific areas of importance for the Board, which will provide the Board with better information for making more efficient decisions. Finally, there should be clear rules with respect to the operation and functioning of the Board.
While it is true that the law anticipates that the Board will have certain powers, the Committee considers that compliance with the following functions helps the Board to delineate its work and contribute to more useful, timely and dependable information for the company.
• It is recommended that, besides the obligations provided in the General Law of Commercial Companies, the Law of Credit Institutions, the Law of the Stock Market and other specific laws, the Board’s functions should include the following: (i) establish the strategic vision of the company, (ii) assure that the shareholders and the market have access to the public information of the company; (iii) establish mechanisms of internal control; (iv) assure that the company has the necessary mechanisms to permit compliance with applicable law; and (v) evaluate regularly the performance of the General Director and the high-level officers (n.1) of the company.
The composition of the Board of Directors constitutes an essential element for its adequate operation. Accordingly, it is considered necessary that there be a minimum number of members sufficient to provide a plurality of opinion within the Board. However, a maximum number ought to be established to insure that members actually have the opportunity to express and argue their points of view without falling into the inefficiency that can result from an excessive number of members.
• It is recommended that the Board of Directors be comprised of between 5 and 15 regular members.
It is important to avoid the casual substitution of absent Board members with just any substitute member, thereby diluting the absent Board member’s obligations to the rest of the Board. Similarly, it would be appropriate that the regular member act as a team with her/his substitute for the purpose of achieving more effective participation. In this sense it is considered relevant to permit that the regular member to participate in the selection of her/his substitute.
• It is recommended that there be no substitute Board members, and if there are, they should substitute only for a particular Board member, previously designated. In this latter case, it is recommended that each candidate for a regular Board position suggest who should be her/his substitute.
The composition of the Board is fundamental to the ability of the Board to define the company’s strategic vision and support its operation. Consistent with this idea is the importance of the independent Board member. The term independent member is utilized to identify those who are not tied to the management team of the company. These independent members are called to serve on the Board by virtue of their personal and professional prestige Their primary job is to contribute an impartial vision to the strategic planning of the company and to the other functions that are appropriate for the Board.
• Independent Members: Those selected for their experience, capabilities and professional prestige and who also when appointed are not: (i) employees or executives of the company; (ii) shareholders with the power to direct company executives, despite not being employees or executives themselves; (iii) advisors of the company or associates or employees of firms that act as advisors or consultants of the company or its affiliates and whose income depends significantly (n.2) on this contractual relationship; (iv) clients, suppliers, debtors or creditors of the company or partners or employees of a company that may be an important client, supplier, debtor or creditor (n.3); (v) employees of a foundation, university, civil association or civil company that receives important contributions from the company (n.4); (vi) the General Director or high level officer of a company on whose Board of Directors the company’s General Director or high level officer sits; (vii) relatives (n.5) of any of the persons mentioned in the foregoing clauses (i) through (vi).
It is also important to recognize the investor member. This member is one who has assumed the risk implied in contributing a significant portion of the capital of a company. Her or his participation is appropriate since by monitoring permanently her or his investment the entire company benefits.
• Investor Members: Those selected because they are significant shareholders (n.6) , or those who act as proxies of such shareholders. Depending on whether the significant shareholder and her or his proxy posess the characteristics of the independent member, they may be deemed Independent Investor Members or Related Investor Members.
• Related Members: Those who are not within any of the previous definitions.
In order to fulfill the purpose of having investor and independent members it is necessary that they be represented as a sufficient percentage of the Board.
• It is suggested that the independent and investor members jointly constitute at least 40% of the Board of Directors. It is also recommended that independent members comprise at least 20% of the total members.
For the purpose of permitting the market to evaluate the composition of the Board of Directors, it is necessary for the company to provide information regarding the profile and characteristics of its members.
• It is suggested that the annual report presented by the Board of Directors mention which members are independent members, and which are investor members, and indicate whether the latter are independent or related.
• It is suggested that in the annual report presented by the Board of Directors state the principal responsibilities of each director as of the date of the report.
I. 3 Structure
The Committee considers that there are at least three specific areas in which the Board of Directors should take important decisions for the company. These are: evaluation and compensation, audit, and finances and planning. Consequently, the Board requires mechanisms to assure adequate decision making in these areas.
The Committee recommends the creation of one or various intermediate bodies as mechanisms to support the Board of Directors in its functions. Structurally, said bodies should consist of advisors, and functionally, they act as an extension of the Board to support its decisions on diverse matters.
It is important to emphasize that the intermediate bodies do not interfere in the operation of the company. Accordingly, to fulfill their functions they will support the work of the administrative structures. In this way, the intermediate bodies do not constitute an executive function nor do they assume functions that correspond to the Board and to the operating areas of the company.
• It is recommended that for the purpose of making better informed decisions, the Board of Directors should carry out the functions of evaluation and compensation, audit, and finances and planning, (defined subsequently in the Code), through one or various intermediate bodies.
Although the Committee recognizes that the organizational structures for distinct companies should be flexible, the international practice is to utilize committees to fulfill these specific functions. The matter of special relevance is that the Board of Directors should take informed decisions on important subjects.
For example, is considered important that the investor and independent Board members participate in the work of the intermediate bodies, the independent members because they were selected in light of their professional prestige and experience, and the investor members because they have incentives to involve themselves and resolve the matters before said bodies.
It is recommended that the following principles be followed with respect to the intermediate bodies:
• One or more may be created provided they have a clear objective and the membership avoids conflicts of interest.
• They should be composed only of regular Board members.
• It is recommended that they be composed of three members at a minimum and seven at most.
• It is suggested that they report regularly on their activities to the Board of Directors.
• The Chairperson of each intermediate body should invite to its meetings the executives of the company whose responsibilities are related to the functions of the intermediate body.
• It is suggested that each independent Board member, in addition to obligations of Board membership, participate on at least one intermediate body.
• It is recommended that the intermediate body responsible for the audit function be chaired by an independent director.
The Board should meet with a frequency that assures the permanent and adequate monitoring of the matters of the company.
• It is suggested that the Board of Directors meet at least four (4) times a year. It is recommended that one of these meetings be dedicated to defining the medium and long term strategy of the company.
It is also important that companies have mechanisms that guarantee openness within the Board so that its operation does not depend on a single person.
• It is suggested that it be possible for a minimum of 25% of the directors to call a meeting of the Board.
The active participation and responsibility of the members of the Board of Directors translates into better institutionalization of that body. To support this, it is important to provide information to Board members in advance to that they have the tools necessary to fulfill their function.
• It is recommended that Board members have access at least five (5) days in advance to information that may be relevant for decisions on matters set forth on the agenda contained in the notice of the meeting. The foregoing shall not apply to strategic matters that require confidentiality; however, in such a case procedures necessary for the adequate evaluation of proposals concerning such strategic matters should be established.
A first-time Board member should have the information necessary to adequately fulfill his or her position. For this reason, he or she must have broad knowledge of the business. Among other things, he or she should understand the company’s position within its market and the identity of its principal competitors, clients and suppliers.
In addition, Board members are legally responsible for the performance of their functions. Ignorance of their responsibilities does not relieve them of their obligations. Accordingly, it is important that new Board members be informed of the nature and legal and statutory consequences of their position.
• It is suggested that when Board members are named for the first time they be given an adequate introduction to their new responsibilities. At a minimum, the company should provide information concerning this responsibility and its environment, as well as the obligations, responsibilities and powers implicated in the position of Board member.
I.5 Obligations of Board Members
Board members assume obligations and responsibilities when they accept their position. For this reason it is considered important that the company have a generic performance framework that establishes the standards of conduct applicable to Board members
In this regard six principles are recommended:
• Communicate to the Chair and Secretary of the Board of Directors any situation that may give rise to a conflict of interest and abstain from participating in the corresponding deliberation;
• Utilize the assets or services of the company only for the fulfillment of its corporate purpose, and define clear policies for the exceptional instances when such assets are used for personal matters;
• Dedicate to their position the time and attention necessary, attending at a minimum 70 percent of the meetings that may be called (only applies to regular Board members, not substitute members);
• Maintain absolute confidentiality with respect to all information that could affect the operation of the company, as well as the deliberations of the Board;
• Board members and, as applicable, their respective alternates should keep themselves informed of the matters discussed in the Board meetings they attend; and
• Support the Board of Directors through opinions, recommendations and discussions that may be derived from the analysis of the performance of the company, so that the decisions that may be adopted are duly substantiated with professional criteria and qualified personnel who have a more broad and independent focus regarding the company’s operation.
II. Evaluation and Compensation Function
The Committee recommends there be a procedure that supports the Board in the fulfillment of the function of evaluating and compensating the General Director and high level officers of the company. Fulfillment of said function will support the company’s internal structures, such as the area of human resources.
The Committee considers the essential element of the chosen procedure to be assurance that proposals are elevated to the level of the Board of Directors so that body may take appropriate decisions. Moreover, the existence of the procedure should be disclosed and its operation should be transparent in order to increase investor confidence in management.
II. 1 Generic Functions
The following functions are directed to the company having adequate human resources and compensation policies.
• It is recommended that the following functions be achieved: (i) suggest to the Board procedures for making proposals to the General Director and to high-level officers; (ii) propose to the Board the criteria for evaluating the General Director and high level offices, in accordance with general guidelines established by the Board of Directors; and (iii) analyze and raise to Board level the General Director’s proposal for the structure and amount of remuneration for the principal executives of the company.
II.2 Operating Aspects
It should be the Board’s job to evaluate the policies for determining the compensation of the General Director and the high-level officers of the company. It is important for those policies to consider matters such as achievement of goals, personal performance, and the performance of the company. The Committee considers that compensation policies implemented by the Board of Directors should be revealed to the market. To protect the capital of the company it is important that the Board be authorized, through review of contractual provisions, to avoid excessive indemnification payments to the principal officers.
• It is suggested that the Board be authorized to review the company’s contract terms with the General Director and the high-level officers, and that likely severance payments follow guidelines approved by the Board.
• It is suggested that the annual report presented by the Board of Directors disclose the policies applied to establish, and the elements comprising, the compensation packages of the company’s Directors, General Director and high level officers.
III. Audit Function
The Committee recommends that a mechanism exist that enables the Board to verify the fulfillment of the audit function, assuring itself that external and internal audits are carried out with the greatest objectivity possible and that the financial information is useful, timely and reliable; that is to say, that the information received by the Board of Directors, the shareholders and the general public is transparent, sufficient and adequately reflects the financial position of the company. Carrying out this function will support the company’s internal structures for internal and external audits.
III.1 Generic Functions
Is important that coordination exist during all the phases of the audit process among the internal and external auditor and Statutory Auditor (Comisario)
• It is suggested that the following functions be implemented: (i) recommend to the Board of Directors the candidates for external auditors of the company; (ii) recommend to the Board the contract terms and scope of work of the external auditors; (iii) support the Board of Directors’ supervision of auditor contract compliance; (iv) provide a channel of communication between the Board of Directors and the external auditors in order to insure the independence and objectivity of the latter; (v) review the scope of work, the letters of observations and the audit reports and inform the Board of Directors of the results; (vi) recommend to the Board the data for the preparation of financial information; (vii) assist the Board during is review of financial information and the process of issuing it; (viii) contribute to the definition of the general guidelines of the internal control system and evaluate its effectiveness; (ix) help the Board in the coordination and evaluation of the annual internal audit programs; (x) coordinate the work of the internal and external auditors and Statutory Auditor; and (xi) verify that the company has the necessary mechanisms to permit verification that the company is in compliance with the various rules to which it is subject.
III.2 Selection of the Auditors
The selection process should take into account both the technical ability of the auditors and their independence. In this process attention should be paid to circumstances that might affect the objectivity of the auditors, such as might be the case if the auditors’ income depends significantly on the company.
In the event that the auditors provide services distinct from those of the audit it is important that there be consistent review of the nature and extent of such services so that the objectivity of the auditors is not affected.
• For the external audit of financial statements as well as for any another external review, firms that earn more than 20% of their total income from services provided to the company should not be recommended to the Board for contract.
The audit statement provides the opinion of an independent third party concerning the reasonableness of the financial statements. If the person who provides the statement is in charge of this function for a prolonged period, there is a risk that he or she will lose objectivity in issuing the opinion. For this reason the Committee considers it important that the company establish a rotation of the person in charge of issuing audit statements.
• It is suggested that a rotation procedure for auditors be recommended to the Board for the purpose of maintaining objectivity. It is suggested that this rotation be at least every 6 years.
As established in the General Law of Commercial Companies, the Statutory Auditor is appointed by the shareholders and is in charge, among others things, of reviewing the financial statements as well as the application of accounting principles. On the other hand, the auditor is appointed by company management to give an opinion on the financial statements. Although some of the functions of the Statutory Auditor and the auditor are similar, those who appoint them do so for different purposes, therefore to put the Statutory Auditor in charge of the audit produces conflicts of interest.
• It is recommended that the person who signs the audit opinion for the company’s annual financial statements be different from the person who acts as Statutory Auditor. However, both persons may be members of the same firm.
• It is recommended that the person appointed as Statutory Auditor of the company possess the professional credentials that will permit the fulfillment of his or her legal obligations. It is recommended that the annual report presented by the Board of Directors disclose those credentials.
III.3 Financial Information
The financial information presented by management to the Board contains unaudited data. To guarantee that the Board’s decisions are based on reliable information there should be internal company structures for issuing an opinion on the processes that validate the information.
The internal audit constitutes a tool for supporting company management that permits the evaluation of company financial information as well as the effectiveness of internal controls.
• It is suggested that the company have an internal audit section.
The Board of Directors should be aware of the general accounting principles that will be applied in the preparation of financial statements. This guarantees to the users of company information that it conforms to the accounting principles deemed the most satisfactory for the company’s needs.
• It is suggested that the accounting principles to be applied in the preparation of company financial information be submitted to the Board of Directors for approval.
Maintaining a consistent accounting policy assures consistency in financial information and facilitates the formation of expectations regarding the future of the company. It is considered that in the exceptional case when a decision is made to change an accounting policy, this change should be announced and justified as soon as possible so that users may evaluate the impact of the change.
• When changes in accounting policies are submitted to the Board of Directors for approval, the reasons for the changes should be justified.
For the purpose of promoting investor confidence and certainty in the information it is important that the basis for the preparation of the annual statement be consistent with that which was used in practice during the year.
• It is recommended that the Board assure itself the day-to-day financial information is prepared with the same policies, criteria and practices with which the annual information is prepared. In this process it should be assisted by the company’s internal and external auditors and the Statutory Auditor.
• It is suggested that the procedures that may be necessary for assuring that financial information of good quality is presented to the Board be proposed to the Board for approval. The company’s internal and external auditors and Statutory Auditor should participate in this process.
III.4 Internal Controls
The internal control system (n.7) constitutes the means by which the Board assures itself that the company operates in a general environment of control. The system gives greater certainty that what the Board has agreed upon is being adequately carried out.
• It is suggested that the general guidelines of the internal control system be submitted to the Board of Directors for approval.
It is important that shareholders have information concerning the existence of defined processes within which the company operates, that the company has an orderly management process, and that there is adequate control over its assets. To carry this out, the reports issued by external and internal auditors can help verify the effectiveness of the control system.
• It is suggested that the Board be supported in evaluating the effectiveness of the internal control system and issuing an opinion on the operational and financial controls.
• It is suggested that the external auditors validate the effectiveness of the internal control system and issue a report regarding said controls.
III. 5 Legal Compliance Review
The Committee considers it important that companies have a mechanism that permit the Board to be informed of compliance with applicable legal dispositions.
To comply with the foregoing it is necessary that there be periodic information on all aspects of the legal compliance area. With this information it is possible to be in a position to issue an opinion concerning the level of legal compliance and the absence of any legal contingency for the company. With this process the possibility of unexpected costs is reduced and the market is provided with certainty concerning the legal situation of the company.
• It is suggested that the company assure itself that mechanisms exist that permit the determination of whether the company is in compliance with applicable legal dispositions. To this end it is recommended that a review be conducted at least once a year.
• It is recommended that the Board of Directors be informed periodically regarding the legal situation of the company.
IV. The Finances and Planning Function
The Committee recommends that a mechanism exist that supports the Board in the area of finances and planning, especially in the evaluation of long-term strategy of the business and the primary policies of investment and financing. Internal structures of the company in areas such as finance will help carry out this function.
The Committee considers that the essential element is that the chosen mechanism be responsible for compliance with the functions here indicated and assure that the proposals are elevated to the Board of Directors for appropriate decision. Likewise, the mechanism chosen should assure that the policies of investment and financing are consistent with the strategic vision.
IV.1 Generic Functions
The following functions focus on the support of the Board in defining policies and strategies.
• Compliance with the following functions is suggested: (i) evaluate and, as appropriate, suggest changes to the investment policies of the company proposed by management, for later submission to the Board for approval; (ii) evaluate and, as appropriate, suggest changes to the financing policies (equity or debt) of the company proposed by management, for later submission to the Board for approval; (iii) evaluate and, as appropriate, suggest changes to the general guidelines for determining the company’s strategy plan; (iv) opine on the premises of the annual budget and propose them to the Board for its approval; (v) monitor the application of the budget and the strategic plan; and (vi) identify the risk factors that apply to the company and evaluate the policies for managing them.
IV.2 Operational Aspects
In order to support the decision-making of the Board of Directors, it is considered important that the Board receive opinions regarding the different investment and financing transactions that the company intends to carry out. In this work the priorities and policies established by the Board of Directors should be taken into account.
• It is suggested that the Board of Directors be provided with an evaluation of the viability of the principal investments and financing transactions of the company, in accordance with established policies.
Strategic planning implies not only the definition of objectives, but also the establishment of processes to monitor the strategies and plans developed to achieve those objectives.
• It is recommended that the strategic position of the company be evaluated periodically in comparison to the terms of the strategic plan.
There should be a link between the company’s investment and financing policies and its long-term objectives. If those policies do not take into account the company’s strategic vision, the long-term objectives will not be achieved. For this reason the company ought to verify that these policies are consistent with its strategic vision and make sure they are incorporated in its various documents.
• It is suggested that the Board be assisted to oversee the consistency between the company’s investment and financing policies and its strategic vision.
• It is suggested that the Board be assisted to review the company’s financial projects to assure consistency with the strategic plan.
V. Disclosure of Information to the Shareholders
To facilitate access to funds under the most favorable conditions, it is necessary for companies to provide adequate information to the market. It should be noted that the following recommendations apply as much to regular shareholder meetings as they do to special shareholder meetings.
V.1 Information and Agenda for the Shareholder Meeting
It is considered important that in the notice of the shareholder meeting the agenda be stated and clearly specify the matters to be considered. In practice it is common to include various subjects in only one point of the agenda. However, a separate discussion of each subject facilitates analysis and avoids an aggregate resolution on matters on which there may be different opinions. This is also what occurs when the agenda includes an item dedicated to “Various Matters”.
On the other hand, is important that the shareholders have access, with the proper advance notice, to all information necessary for adequate decision-making at the shareholder meeting.
• It is suggested that the agenda should not include an item for “Various Matters”, no should it group matters concerning different subjects under a single item. This is to assure that the shareholders may vote on each matter separately and may be informed of the subjects to be discussed at the meeting.
• It is suggested that all information on each point of the agenda for the shareholder meeting be available 15 days in advance.
• It is suggested that through a form that contains in detail the information and possible voting alternatives on agenda items shareholders can provide instructions to their proxies on how they should vote on each agenda item at the meeting.
Thus for example, is important that the shareholders receive all that relevant information concerning director candidates, specifically a brief curriculum vita, in order to understand their qualifications and proceed to an informed vote.
• It is suggested that the proposed composition of the Board of Directors and a professional profile of each candidate be part of the information provided to the shareholders.
V. 2 Information and Communication Between the Board of Directors and the Shareholders
It is responsibility of the Board to guarantee effective communication between the company and the shareholders. The purpose of presenting an annual report to the annual shareholder meeting is to reveal the company’s financial position as well as the plans and activities that it has completed and intends to complete. In order to enrich the information provided by the company it is recommendable that the shareholders have access to information relating to the activities of the intermediate bodies.
• It is suggested that the Board of Directors include in its annual report to shareholders the relevant aspects of the work of each intermediate body. It is suggested that the reports of each body presented to the Board be available to the together shareholders with the material for the meeting, with the exception of information the confidentiality of which could affect the competitiveness of the company. Also, it is recommended that the annual report include the names of the members of each intermediate body.
The lack of participation of shareholders at shareholder meetings and the limitations of these meetings as forum of communication of the company with its investors justifies additional efforts to create other means of communication that permit those investors and the general public to obtain desired company information.
• It is suggested that each company have policies, mechanisms and persons responsible for providing investor information, in order to maintain channels of communication with shareholders and potential investors.
1. High-level officeres are those immediately below the General Director.
2. Significant income is considered to be an amount in excess of 10% of the income of the advisor or firm.
3. A client o rprovider is considered important when the sales from or to the cdompany represent more than 10% of the total salws of the clienht or provider, respectively. A debtor or creditor is considred important when the amount of the credit is greater than 15% of the assets of the company or the debtor or creditor.
4. Contributions are considered important when they represent more than 15% of the total contributions received by the institution.
5. This clause applies to the spouse and up to the third degree of consanguinity and kinship, with respect to persons described in clauses (i) and (ii), and to the spouse and to the first degree of consanginity and kinship with respect to the persons described in clauses (iii) and (vi).
6. A significant shareholder is considered one who holds, directly or indirectly, at least 2% of the outstanding shares.
7. The internal control system is understood as the operational controls established for the purpose of causing the company to operate in conformity with the general guidance established by the Board of Directors. Among other things, these controls cover policies and procedures, separation of functions, operations manuals and safeguarding of assets.