The Role of Independent Directors in Monitoring Related Party

Transaction (RPT) in Malaysia, Thailand and Singapore

Muhammad Umar bin Abdul Razak

Faculty of Law, Universiti Teknologi MARA, Shah Alam,Malaysia

Keywords: ASEAN, concentrated ownership, transaction, independent director.

Abstract: Related-party transaction (RPT) represents a potential “self-dealing” between the company and its directors,

material owners, officers, and investees and as such most countries require some form of additional

monitoring over it. In dispersed ownership countries, such as the United States (US) or United Kingdom (UK),

the companies are expected to adhere to the high standard of corporate governance as the owners and

managers are separate. However, such expectation is challenging in concentrated companies such as in family-

owned companies and government-linked companies that are common in selected ASEAN countries such as

Malaysia, Thailand and Singapore. The objective of this paper is to analyse the role of independent directors

in concentrated companies. Despite having several laws and policies governing RPT which are basedon the

Anglo-Saxon framework, the dynamics of Asian companies’ structure may render them ineffective at the

expense of the minority shareholders. The author employed doctrinal analysis of data from both primary and

secondary legal sources from Malaysia, Thailand and Singapore. It is suggested these countries should review

the existing regulatory framework for RPT by strengthening the role of the independent director. This paper

will contribute to the existing literature by discussing the necessity of strengthening the role of independent

director in monitoring RPT.

1 INTRODUCTION

Related-party transaction (RPT) represents a

potential self-dealing between the company and its

directors, material owners, officers, and shareholders.

It may include activities such as the selling and

purchasing of assets, guaranteeing of loans, and

exchanging of assets with different qualities.

Previous literature mainly focuses on the

controlling shareholder in the US and UK, which is

based on dispersed company ownership and not

within the in a concentrated company environment

which has different agency problem. In a dispersed

ownership structure, the key agency problem is the

outside directors and managers can misuse their

powers to pursue their personal interest at the expense

of the shareholders. Meanwhile, in concentrated

ownership jurisdictions, the key agency issue is the

act of shifting the resources out of a company to its

controlling shareholders or known as tunnelling.

Therefore, this paper seeks to fill the gap by

critically analysing the existing RPT regulations in

Malaysia, Thailand and Singapore. These countries

are chosen because they are the participating

members to the ASEAN Disclosure Standards, which

allow cross-listing initial public offerings among the

member states. This paper is divided into several

parts, starting with Section 2 on theories on RPT,

followed with Section 3 that discusses the laws and

regulations in Malaysia, Thailand and Singapore on

RPT and appointment of independent directors,

Section 4 on the analysis of the role of independent

director in RPT and finally Section 5 concludes.

2 THEORIES ON RELATED

PARTY TRANSACTION

2.1 Conflict of Interest

The theory views the transaction as undermining

directors’ fiduciary responsibility to the company and

the monitoring function of the board on behalf of the

shareholders as a whole (Farrar & Watson, 2011).

Others such as earning management (a purposeful

intervention in the external financial reporting

process(Marchini, Mazza, & Medioli, 2018), with the

Razak, M.

The Role of Independent Directors in Monitoring Related Party Transaction (RPT) in Malaysia, Thailand and Singapore.

DOI: 10.5220/0010053404170423

In Proceedings of the International Law Conference (iN-LAC 2018) - Law, Technology and the Imperative of Change in the 21st Century, pages 417-423

ISBN: 978-989-758-482-4

417

intent of obtaining some private gain), tunneling

(Cheung, Rau, & Stouraitis, 2006) or transferring

wealth out of the company by the controlling

shareholders, excessive compensation to directors

who are a related party and misleading financial

statement. These drawbacks are consistent with the

agency issues in a dispersed ownership company

where it was argued that due to the outside

shareholders’ conflict with the managers, there was a

tendency for the managers to appropriate the firm’s

resources for personal consumption (Berle & Means,

1933; Fama & Jensen, 1983). The managers are not

holding significant number of shares in the company,

and this led to weak incentive to act appropriately. As

a result, theycould be simply incompetent and

ignorant by abusing their power at the expense of the

minority shareholders (Kraakman et al., 2006).

2.2 Efficiency Hypothesis

On the other hand, the efficient hypothesis theory

does not view RPT as harmful to shareholders, but in

fact, beneficial. Proponents provided an alternative

view that RPT is an efficienttransaction that rationally

fulfils other economic demands of a company such as

securing in-depth skills and expertise between

participants with private information or providing an

alternative form of compensation (Gordon, Henry, &

Palia, 2004). It would be more cost efficient for the

company to engage a related party than an outsider.

There would be better coordination between the

contracting related parties because the information is

reliable and this could mitigate the hold-up problem

contracting process (Ryngaert & Thomas, 2007).It

could also be argued that RPT is inevitable if the

market is inefficient and incomplete information

(Pizzo, 2013a). The argument putforward by these

proponents of efficiency theory is this that the

minority shareholders are not prejudiced because the

efficiency of RPT is benefitting them in long-

term(Balsam, Gifford, & Puthenpurackal, 2017).

However, these arguments could unreasonably be

used to justify the abusive RPT practices including

tunnelling. It was reported that abusive RPT, whether

in the form of one-off material expropriation of

wealth or the slow expropriation of wealth via

continuous operational transactions, are one of the

biggest corporate governance challenges facing

Asian businesses (OECD, 2009).

2.3 Contingency Perspective Theory

The literature on the above theories (conflict of

interest and efficiency) have been inconsistent and

unable to cope with different situations. For example,

in certain jurisdiction in ASEAN where there is a

higher concentration of ownership in a company (as

opposed to dispersed ownership in the US or UK),

both theories are unable to reconcile with the

intricacies of concentrated ownership issue especially

in ASEAN.

Under this theory, the effectiveness of a corporate

governance structure is mediated by

interdependencies between organizations and their

environments; namely (i) costs, (ii) contingencies and

(iii) complementarities. Cost refers to the value of

inputs to corporate governance, contingencies refers

to how corporate governance interrelates with

variations in internal and external strategic resources

that share a firm’s interdependence with market,

sectoral, regulatory or institutional environments and

last but not least, complementarities refers to the

overall bundles of practices that are aligned to

mutually enhance the ability to achieve effective

corporate governance(Aguilera, Filatotchev, Gospel,

& Jackson, 2008).In relation to corporate governance,

this theory holds that universal best practices should

be rejected because its effectiveness varies upon the

internal or external contingent factors.

Pizzo supported the idea that it is necessary to

interpret them bearing in mind contingency factors,

such as specific organisational contexts and

institutional environments, and to take into account

the influence of complementarity/substitution

between governance factors(Pizzo, 2013b). E.g., we

could consider the possibility of viability when

applying the legal transplant from foreign

jurisdictions into another jurisdiction due to a

different type of ownership like USA and Asia.

Increased monitoring and the roles of independent

directors as being done in the US, which is to address

the agency perspective in dispersed ownership, may

not be effective in Asian jurisdiction where the latter

is known for the prevalent of concentrated ownership.

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3 LAWS AND REGULATIONS IN

MALAYSIA, THAILAND AND

SINGAPORE ON RPT AND

APPOINTMENT OF

INDEPENDENT DIRECTORS

3.1 Malaysia

3.1.1 Companies Act 2016 (CA 2016)

The terms “related party” and “transaction” carry

different meanings depending on the regulation.

Section 7 states that, a corporation is deemed to be

“related” to each other if:

a) It is a holding company of another corporation;

b) It is a subsidiary of another corporation; or

c) It is a subsidiary of the holding company of

another corporation.

Section 221 of CA 2016 states that a director must

declare his material interest in the proposed contract

with the company. Furthermore, the section above

excludes the director concerned from disclosing any

information despite him being the member or creditor

of the company ‘if the interest of the director may be

regarded as not being a material interest.’ Section 222

also provides that a director who is anyway whether

directly or not, interested in a contract entered into

with the company, shall not participate in the

discussion when the contract is being considered and

shall not vote on the contract or proposed contract.

Section 228 prohibits the company from entering or

carrying into any effect any arrangement or

transaction where a director or a substantial

shareholder of the company or its holding company

or its subsidiary,or a person connected with a director

or substantial shareholder.

3.1.2 Bursa Malaysia Listing Requirements

(BMLR)

BMLR defines RPT as “a transaction entered into by

the listed issuer or its subsidiaries that involves the

interest, direct or indirect, of a related party”.

Meanwhile, “related party” in related to a

corporation, means a director, major shareholder, or

person connected with such a director or major

shareholder.

In addition to that, Para 10.08(7) disallows

interested directors, substantial shareholders and

those connected to them from voting when

shareholder approval is sought from the general

meeting. Depending on certain percentage threshold,

BMLR also require disinterested shareholders’

approval in a general meeting. The advice from an

independent adviser is required to provide an opinion

as to whether the proposed RPT is fair and reasonable

and whether such a transaction is to the detriment to

the minority shareholders.

Every RPT must be reviewed by the audit

committee where all members are must be non-

executive with a majority of them are indpendent.

They are also required under Paragraph 15.12 to

review the proposed RPT or any conflict of interest

situation that may arise that could affect the

company’s management integrity.

3.1.3 Code of Corporate Governance 2018

(CGG 2018)

CGG 2018 is“apply and explain an alternative

approach” in nature.If the company intends not to

follow the recommendation under the code, it has to

explain any alternative measures to compensate the

non-compliance.

In relation to the appointment of independent

director, the coderecommends half of the board must

be from independent directors or for a large company,

majority of the board must be independent. The

tenure of the independent directors is up to nine years

and if the company intends to retain the director

exceeding that period, shareholders’ approval must be

obtained. The code also require if the independent

directors’ tenure has exceeded twelve years, two-tier

approval is required. Under the two-tier voting

process, shareholders’ votes will be cast in the

following manner at the same shareholders meeting:

• Tier 1: Only the Large Shareholder(s) of the

company votes; and

• Tier 2: Shareholders other than Large

Shareholders votes

3.2 Thailand

3.2.1 Securities and Exchange Act B.E. 2535

(1992)

Thailand legal system is a hybrid by combining civil

and common law legal system. Publicly listed

companies are also subject to the provisions of the

Securities and Exchange Act BE 2535 (1992) (SEC

Act), and regulations issued under the SEC Act, as

well as coming under the supervision of the Office of

the Securities and Exchange Commission (SEC) and

the Stock Exchange of Thailand (SET).. According to

the Disclosure of Information and Other Acts of

Listed Companies Concerning the Connected

Transactions S.E. (2003), connected transactions

The Role of Independent Directors in Monitoring Related Party Transaction (RPT) in Malaysia, Thailand and Singapore

419

refers means any transaction between a listed

company or a subsidiary company and the listed

company’s connected persons; or any transaction

between a subsidiary company and its connected

persons(Thailand, 2003). Connected person includes

directors, executive, major shareholders, controlling

person, proxy, spouse and any juristic person (legal

entity) with a major shareholding in the company.

The act also state that a related person refers to

spouse, underage children, business partners,

partnership where spouse or underage children are

partners with unlimited liability with 30% control,

limited company or public company where either

spouse, underage children, ordinary partners, or any

one of these persons hold at least 30% share in

limited or public company or any juristic person

authorized to represent another juristic person under.

As for the disclosure and approval process, it

depends on the categories and transaction size where

the approval is concerned. For example, a small

normal business transaction, regardless of the value,

does not require any disclosure to SET, board’s

approval or shareholders’ approval for that matter.

However, for financial assistance transaction where

the value is less than 100 million baht or 3% of net

asset tangible value, the company must disclose the

transaction to SET and to seek board approval. For a

transaction exceeding this threshold, the company

must convene a meeting to acquire the shareholders’

approval by giving at least fourteen days notice (14)

to the shareholders and to SET by disclosing certain

material information such as the identity of the

connected persons, the business company and its

operation, any recent inter-transactions as well as

summary of financial statement for the past three (3)

years as laid down in Clause 20 of Information and

Other Acts of Listed Companies Concerning the

Connected Transactions, 2003.

The law also requires the opinion from the

independent financial advisor (IFA) as to the

rationality and benefits of the transactions to the

company, the fairness of the transaction and the

reasoning whether the shareholders should approve or

reject the transaction. Finally, for the transaction to be

approved, at least three-fourths (3/4) of the

shareholders (excluding interested shareholders)

must agree. Similar to Malaysia, independent

directors must be a member of the audit committee

and required to review the proposed transaction

before it can be approved by the board(Thailand,

2015).

3.3 Singapore

3.3.1 SGX Mainboard Rules

Rule 904 of the Mainboard Rules define interested

person transaction as a transaction between an entity

at risk and an “interested person”. Interested person is

defined as :

(i) a director, chief executive officer, or controlling

shareholder of the issuer; or

(ii) an associate of any such director, chief executive

officer or controlling shareholder.

Under Chapter 9 of the Listing Manual, subject to

certain exceptions, all other interested person

transaction must be either be announced immediately

or approved by the shareholders. The interested

transaction is defined as a transaction between an

entity at risk and an interested person. Such

transactions must be announced if it reaches certain

threshold amount.

According to Rule 905, if the transaction is

equivalent to three percent (3%) of the listed

company’s net tangible asset (NAT) according to its

latest audited accounts.The second threshold that

requires announcement is when the amount is

equivalent to five percent (5%) of the listed

company’s NAT according to its latest audited

accounts. Furthermore, if the transaction is below

than SGD100, 000.00, it will be exempted from the

announcement. Therefore, the announcement can

only be made if the amount is within the 3-5 percent

threshold. The announcement must contain the

following information:

(a) the details of the interested person and the nature

of the interest of the interested person;

(b) details of the transaction including the relevant

terms and the bases on which the terms were

arrived at;

(d) a statement as to whether or not the audit

committee is of the view that the transaction is

on normal commercial terms and is not

prejudicial to the interest of the listed company

and its minority shareholders, or that the audit

committee is obtaining an opinion from an

independent financial adviser before forming its

view, which will be announced subsequently;

and

(e) the current total for the financial year of all

transactions with the interests persona and the

current total of all interested person

transactions.

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3.3.2 Code of Corporate Governance 2018

The Singaporean Code of Corporate Governance

2018 is ‘comply and explain’ in nature. It is stated that

an independent director is one who is independent in

conduct, character and judgement, and has no

relationship with the company, its related

corporations, its substantial shareholders or its

officers that could interfere, or be reasonably

perceived to interfere, with the exercise of the

director's independent business judgement in the best

interests of the company.

The code also stipulates that the audit committee

must comprise of at least three non-executive

directors and the chairman who is also an independent

director. The committee’s scope of work includes

reviewing ‘significant financial reporting issues’

which may also covers interested person transaction.

4 NALYSING THE ROLE OF

INDEPENDENT DIRECTORS IN

RPT

It is well documented that independent directors

monitor management more in the interests of

shareholders than inside directors do (Liu, Uchida, &

Yang, 2012). By having independent directors’

monitoring the RPT, it could send a signal to

investors that there is monitoring in place (Kohlbeck,

Mayhew, Lafond, & Warfield, 2004).

Under the OECD Guide to Fighting Abusive RPT

published in 1999, among recommendations is to

have a coherent regulatory system dealing with RPT,

particularly on disclosure, board oversight and

shareholders’ approval in each jurisdiction. There is a

notion that corporate governance is poor in

concentrated companies, and therefore it is crucial to

monitor the RPT/connected transaction/interested

party transaction at ASEAN level could be introduced

to strengthen the corporate governance. There is

already a monitoring mechanism by independent

director in moderating the effect of the transaction. In

Malaysia, Thailand and Singapore, the independent

directors who are also in the audit committee

members must review the RPT and its impacts to the

company.

The OECD principles, which are based on

corporate governance model from the US and UK

have been transplanted in the Asian region since the

financial crisis in 1997 (Chen, Wan, & Zhang, 2018).

The model was to ensure that higher level of

independence could address the tunnelling or

expropriation by the controlling shareholders in

concentrated companies in Asia. This is because, one

of the factors contributing to the crisis was poor

governance in highly concentrated companies where

there was no check and balance in the board then.

For years, scholars and regulators have been

searching the right mechanism in minimising the

effects of the agency. The US and UK might be

successful in implementing many good corporate

governance practices but would they be effective in

the other part of the world? In short, they have been

successful in empowering the dispersed shareholders

and became a model of a ‘successful good corporate

governance’ to the world (Puchniak, 2014). Emerging

economies like ASEAN requires a different approach

as most of the companies in the region are family-

owned via a complex pyramid structure, state-owned

or large controlling shareholders (Juliarto, 2012;

Lemmon & Lins, 2009). Questions like how the

independent directors can play their monitoring role

when their appointment is at the behest of the

controlling shareholders? There are many scholars

(Farrar & Watson, 2011) have expressed their

concern on the independence level of the non-

executive directors because of social and economic

factors (Le Mire & Gilligan, 2013).

Despite the extant of literatures on the advantages

of having the independent directors approval, it is also

acknowledged that the quality of ‘independence’ is

questionable. This is because the appointment is still

being done by the executive directors who usually

nominate their trusted business associate to be an

independent director (Ferrarini & Filippelli, 2014).

This idea should be supported provided that there is

genuine independence, a clear procedure and the

interested person is prohibited from voting (Farrar &

Watson, 2011).

Ultimately, the process of approval lies in the

hand of the disinterested shareholders. It is a general

rule that, in any conflict transaction, the directors or

shareholders concerned is not allowed to vote.

However, the disinterested shareholders (who are also

the minority) still tend to approve the RPT because

the presence of the interested directors or controlling

shareholders during the voting process (despite not

allowed to vote) .It is not common that the minority

shareholders will vote against the proposed RPT

especially when the majority shareholders are the

founder/family members of the company or

politically-connected shareholders (like Genting

Group or CIMB Group)(Chan, 2010; Rachagan,

2011). Being a minority has always been

intimidating, more so if the proposed RPT could be

‘disguised’ as beneficial to the company.

The Role of Independent Directors in Monitoring Related Party Transaction (RPT) in Malaysia, Thailand and Singapore

421

5 CONCLUSION

In conclusion, this paper recognises that there is a

legitimate concern as to the effectiveness of the

independent directors within the existing regulatory

framework on RPT in these countries. The nature of

concentrated ownership in the region requires a

different approach in addressing the key agency issue;

tunnelling.

The test that can be applied is whether the said

director can exercise independent judgement and act

in the best interests of the company (listed issuer).

When an independent director is appointed to the

board, he is expected to lend his views without any

restriction or biases (Abdul Razak, Adam, & Mahali,

2017).This remain a debate until today.

ACKNOWLEDGEMENT

I would like to thank Mazlina Mahali for putting up

with my busy schedule in completing this article.

Also, not forgotten the unwavering support from my

supervisors Prof Dr Aiman Nariman and Dr Wan

Zulhafiz.

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