By Kuo-Ming Huang, CSO / Senior Partner of Formosan Brothers, Attorneys-at-Law

NT$640,000,000. This is the average amount of damage the directors, supervisors and financial reports signatories are faced with in the claim asserted by the Securities and Futures Investors Protection Center  in a “fraudulent financial reporting” case. What’s worse is, they are also faced with a criminal sentence of three years or more (Article 171 of the Securities Exchange Act) besides civil liabilities. In addition, other than the risk of fraudulent financial reporting, independent directors may also be subject to aggravated offenses (the so-called “offense of special breach of trust”) if they breach their fiduciary duty on asset transactions of a large amount which results in damages of NT$5,000,000 or over to the company.

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In practice, we often hear the following arguments in a “fraudulent financial reporting” case: “I did not attend the directors’ meeting that day.” “I’m not involved in the day-to-day operation of the company.” “The financial reports were audited by the CPA. If the CPA could not identify the problem, how could I see the problem?” However, most courts do not accept the arguments above. Moreover, in a “special breach of trust” case, since one of the key points is usually whether a director “breached his/her fiduciary duty,” the dispute is often over what the standards for such fiduciary duty are. Are they the judge’s standards (and social experiences)? Or are they the directors’ personal standards? Or the standards of the industry involved? The fact that standards vary is often because everyone has different social experiences (and thus different demands) and the specialization and complexity of commercial transactions. However, varying standards have caused a certain degree of insecurity in independent directors when they perform their duties.

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We have advice regarding how an independent director can cope with such kind of high legal risk: With respect to the possibility of misrepresentation in highly specialized and complex financial reports, Article 14-3 of the Securities Exchange Act shows us a way to avoid such a risk: “note your dissenting or qualified opinions in the minutes of the directors meeting.” That means, in the future, if any misrepresentation is found in the financial reports, but because a certain independent director has expressed dissenting or qualified opinions in the minutes of the directors’ meeting (in which such misrepresented financial reports were passed), such independent director would be more likely to be relieved of legal responsibility. However, due to the limitation of their background or professional expertise, sometimes an independent director may not be able to opine, not to mention noting their opinions in the minutes of the directors meeting. Therefore, independent directors need to know how to utilize two statutory weapons: CPAs and the company’s internal audit officers. Specifically, they can invite CPAs to the meeting and have the CPAs explain the financial reports or certain important transactions, and use the opportunity to ask questions and record such interchanges in the meeting minutes. They may even invite the department head who handled an important transaction to the directors meeting to provide explanations.

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As to how directors should handle the risks of the special breach of trust offense, that is, when examining different types of transactions (especially those involving real estate, securities, and derivative financial products), to what the independent directors should pay attention in order to avoid suspicion from the prosecutors and judges (for breach of fiduciary duty), the Financial Supervisory Commission (“FSC”) seems to have provided a solution in the “Corporate Governance 3.0 – Sustainable Development Roadmap” published in 2020. In the roadmap, the FSC suggested that regarding the lack of consensus on the roles and functions of independent directors: “It is necessary to provide independent directors and audit committees a code of conduct relating to their performance of duties.” Although this suggestion is not meant to resolve the issue of lack of standardized criteria regarding the special breach of trust offense, in a sense, such a code of conduct may serve as a criterion for judging commercial incidents in the future, particularly the special breach of trust offense, to determine if independent directors fulfilled their duties. However, the caveat is:  such code of conduct has not been formulated, plus even after it is formulated, it still needs to be recognized by the court (i.e., when an independent director performs his/her duties according to such a code of conduct, he/she is deemed to have fulfilled his/her obligations.)

Therefore, before such a code of conduct is provided, we advise that independent directors can familiarize themselves with the relevant provisions in the Company Act and the Securities Exchange Act and understand the relevant key points in the “Corporate Governance Practice Code for TWSE/TPEx Listed Companies,” “Sample Code for Governing the Scope of Powers of Independent Directors in a Company Limited by Shares,” “Guidelines of Corporation Operation Directions for Compliance with the Establishment of Board of Directors and the Board's Exercise of Powers” promulgated by the competent authority. However, since there are numerous articles in the aforementioned regulations, and some of the provisions are difficult to comprehend, we suggest that independent directors should at least know the two following articles: Articles 14-3 and 14-5 of the Securities Exchange Act. Why? Observing prosecutors’ practices, the eleven types of circumstances prescribed in these articles are common in the methods and features of financial crimes. That is, the competent authority would pay special attention to such features after a crime takes place. The following are examples of situations (in the same order as the subparagraphs in Article 14-5) that might be specially examined. In the case of unlawful material asset transactions, the prosecutors often examine the effectiveness of internal control involved in the disputed transaction; whether the internal control of the disputed transaction has been intentionally altered before, during, or after the incident; whether the asset handling rules have been modified at an unusual point in time; whether there exist related parties (or dummies) in the disputed transaction; whether there have been important officers reported or resigned after the transaction occurred; and whether there have been significant changes in the accounting treatment of the financial statements of the disputed transaction.

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In the development of the legal system, good corporate governance has to some extent, become more dependent on independent directors. However, if the legal risks faced by independent directors are extremely high, it will keep professionals at bay. Therefore, for independent directors to perform their duties independently and fearlessly, adequate director/supervisor insurance and the formulation of relevant codes of conduct in the future are still important. Before the regulations are completed, independent directors must be good at communicating with accountants and internal audit officers. At the same time, pay special attention to the relevant transactions and processes indicated in Articles 14-3 and 14-5 of the Securities Exchange Act.

(This article was published in the Expert's Commentary Column of the Commercial Times. https://view.ctee.com.tw/legal/28807.html)

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