Directors and the law, director development and audit

A managing director learns that a client would give a contract to him personally, not to his company. He tells the board he is unwell, leaves, and takes the contract. His old company sues and wins every naira of profit. A director who sits on the board of a supplier and says nothing, or who sells shares a day before bad news is published, faces the same law.

Directors hold power, and the law sets limits on it, with personal liability for those who step over them.

This topic covers the powers and rights of directors, service contracts and fixed terms, appointment, election, retirement by rotation and removal, directors’ duties (fiduciary duty, conflicts and disclosure of interest), share dealings and insider dealing, disqualification, changing directors, the board’s response to non-compliance with laws and regulations (NOCLAR), induction, training and performance evaluation, and the role of external audit, internal audit and the audit committee.

The previous topic covered the board, its composition and committees. The next area covers advanced investment appraisal. Neither the May 2014 nor the November 2014 Pathfinder sets a stand-alone question on this topic.

Key terms in plain English

Syllabus check

This topic is in syllabus area D (corporate governance, 5% of the marks). It covers:

• the main laws relating to directors and the board’s responsibility for NOCLAR;
• induction, training and performance evaluation of directors;
• the relevance of external and internal audit and the role of the audit committee.

CAMA 2020 and directors

The Companies and Allied Matters Act 2020 (CAMA 2020) is the main source of law on directors in Nigeria.

Powers and rights of directors

The company’s powers sit with the board as a whole, although many are delegated to executives. An individual director normally has authority to enter contracts in the company’s name. In UK law a director has an implied power to bind the company.

Service contracts. Executive directors are employees. Their contract includes pay, pension rights and a minimum notice period. If they are asked to resign as directors, it is accepted that they are also dismissed as managers. They have the rights in the contract and by law on dismissal.

Fixed terms. Non-executives are usually appointed for a fixed three-year term, renewable once for three years with shareholders’ approval, in Nigeria as in the UK.

Appointment, election and removal

• A vacancy during the year is filled by the board. At the next annual general meeting the director stands for election and needs a simple majority (more than 50%) of votes.
• Directors must stand again at regular intervals. In Nigeria and the UK, most articles require one-third of the directors to retire by rotation each year, so each stands every three years. ICAN says the Nigerian code requires re-election at least every three years. Retirement is at the AGM.
• Shareholders can vote against a director, for example the chair of the remuneration committee if pay seems too generous, but dissidents in a large company find it hard to win a majority against the board.
• The usual way a failing director goes is by being asked to resign.
• Shareholders with the minimum holding can call a meeting to remove a director by a simple majority. A removed director keeps contractual rights, which can be a large payment. ICAN cites the payment to Sir Fred Goodwin of the Royal Bank of Scotland in 2009 as an example of “reward for failure”.

Changing directors

A well-governed company renews its board. A director may retire at any time. The board may decide not to renew a non-executive’s three-year term, not to recommend a re-election, or to ask a poor performer to go. An executive who leaves the board usually leaves the job and negotiates compensation.

Duties of directors

Directors owe duties to the company and may be personally liable for a breach. In the UK, the Companies Act 2006 lists duties to act within powers, promote the success of the company, exercise independent judgment, use reasonable skill, care and diligence, avoid conflicts of interest, not accept benefits from third parties and declare interests in proposed transactions.

Earlier law had two duties: skill and care, and a fiduciary duty of utmost good faith. In Nigeria the duties are in CAMA 2020 (see the table above). Breaches such as putting personal interest first, or not disclosing an interest, are agency problems.

Conflicts of interest

ICAN’s UK example: a managing director of a consultancy company, when a client said it might give the work to him personally, told the board that he was ill, left, and took the contract. His former company sued and recovered the profit. The court held that he put his own interest ahead of the company’s.

Disclosure of interests

A director with an interest in a contract with the company, for example as a major shareholder in a supplier, must disclose it to the board as soon as possible and obtain approval. If not, the director may have to hand over secret profits. ICAN says that in Nigeria, as in the UK, failure to disclose an interest is also a criminal offence punished by a fine.

Share dealings by directors

Directors may learn confidential price-sensitive information, for example about a takeover bid. Using it to buy or sell shares, or encouraging others to, is insider dealing, a criminal offence. The director may face a fine and prison and may be liable in civil law to those who lost out. A director who sells before bad news is also in breach of fiduciary duty.

In ICAN’s example, most directors of a listed company sold shares before poor results and news of an anti-competitive arrangement came out. ICAN says insider dealing in Nigeria was prohibited by the Investments and Securities Act 2007. Note: the 2025 Act has replaced it, so cite the current law.

Because directors are often better informed, stock market rules add restrictions. In the UK the Market Abuse Regulations say directors must not deal during a close period before results, must not deal when they hold price-sensitive information and must seek the chairman’s permission before dealing at other times.

Disqualification

A court may bar a person from acting as a director of any company. ICAN says that in Nigeria, as in the UK, grounds include bankruptcy, mental disorder and conviction for a crime connected with forming or running a company, such as misappropriating funds. It tends to happen after a company has become insolvent, so it protects shareholders only after the event.

The board and NOCLAR

Non-compliance with laws and regulations (NOCLAR) is any act or omission, intentional or not, by a client, an employer or an employee, that is contrary to law on matters directly affecting the financial statements or the business in a material or fundamental way. It covers fraud, corruption and bribery; money laundering and terrorist financing; securities trading; banking; data protection; tax; environmental protection; and public health and safety.

ICAN says NOCLAR rules are now in its Code of Conduct, following the IESBA Code, and let professional accountants set aside confidentiality in some cases to report to the authorities.

The rules bind accountants, but they matter to boards. If the board does not build a culture of compliance, accountants in the company will be expected to report breaches. Boards should keep financial and compliance controls effective (using internal audit to review them) and run an effective, anonymous whistleblowing system.

Induction, training and evaluation

Induction

New directors, especially non-executives, must learn about the company. The Nigerian code requires a formal orientation to familiarise them with operations, strategy, senior management and the business environment and to induct them in their fiduciary duties. The Higgs guidance says induction should help the director understand the business and markets, meet the people and understand main relationships.

A programme may include site visits, product demonstrations, meetings with managers and advisers, and meetings with major shareholders if they want. For the role itself, a new director should get the matters reserved for the board, the share dealing rules and insider dealing law, recent minutes, a schedule of meetings and details of committees.

Training and development

All directors should refresh their skills regularly, and the chairman should make sure they do. ICAN says continuing education is mandatory for directors in Nigeria and is paid for by the company. Needs are discussed in the annual review. Topics include strategy, governance and financial reporting developments, and new products. Higgs says non-executives need continued professional development tailored to them, not classroom courses.

Performance evaluation

An effective board needs regular review, which the board itself does, led by the chairman. It should check that the board and committees fulfil their roles, that individual directors contribute and that skills remain suitable. The Nigerian code asks for a formal and rigorous annual evaluation of the board, committees, chairman and individual directors, with stated criteria and targets, and allows external consultants.

The chairman oversees the evaluation of the CEO, and the CEO evaluates the executives. A director who performs poorly may be retrained or removed. The UK Code requires an annual evaluation, an independent external facilitator at least every three years in the FTSE 350, and a review of the chairman by the non-executives led by the senior independent director.

Singapore gives the job to the nominations committee and looks at share price over five years. The directors’ report states how the evaluation was done.

Questions for the board:

• performance against targets
• contribution to strategy and risk management
• whether composition and skills suit
• response to a crisis
• length and frequency of meetings and use of time

For a non-executive: attendance and preparation; time and effort; quality of contributions; contribution to strategy and risk; refreshing skills; giving in too easily; relationships; and contact with management beyond the executive directors.

Audit and corporate governance

External audit

Shareholders and creditors rely on audited accounts. The auditor gives an independent opinion on whether the statements give a true and fair view of position and performance, and on some other disclosures. This reassures stakeholders about the board’s stewardship. It is not the purpose of the external audit to find fraud.

The board is responsible for preventing and detecting fraud and for the internal control system, and is fully accountable for the annual report. Auditors assess the risk that fraud or error has made the statements misleading, report control weaknesses to the board (the audit committee), and report any fraud they find. Whether they should find every major fraud is disputed. A failure to find one may be professional negligence.

Internal audit

Internal audit is a part of risk management and control. It may be an in-house team or an outsourced firm. It reviews accounting and internal control systems and helps management as organisations grow. There is no legal duty to have one. Typical activities: monitoring internal control; examining financial and operating information; reviewing economy, efficiency and effectiveness (value for money audits); and reviewing compliance with laws and policies. Specialists carry out IT audits.

The audit committee

The Nigerian code calls for board committees, including an audit committee, to oversee matters where executives have a conflict. Members should be non-executive, mostly independent if possible.

Its tasks, as ICAN lists them, include:

• checking that accounting policies follow the law
• reviewing the scope and planning of the external audit
• reviewing the management letter on control weaknesses
• recommending the appointment, removal and pay of the external auditors
• keeping the effectiveness of accounting and other controls under review
• authorising internal audit investigations
• receiving quarterly reports from internal audit

The rules in more depth

Why disclosure of interest is a duty and not a favour

The other directors cannot protect the company from a conflict they do not know about.

Why insider dealing harms others

The director’s gain is another investor’s loss, and confidence in the market suffers.

Why external audit does not remove the board’s duty

The auditors give an opinion on the accounts the directors prepare. The directors remain responsible for what is in them and for the controls.

Why the audit committee is mostly independent

It checks the executives who prepare the accounts and manage the controls. If executives sat on it, they would be checking themselves.

Effect on analysis

In a case, identify the duty at issue, say whether it was breached, state the consequence and recommend a control.

Worked examples

1. Directors retiring.
   12 ÷ 3 = 4 a year.
2. Each director stands for re-election every three years.
3. Shareholders thereby get a regular chance to vote on each director.

1. He had a duty to disclose the interest to the board and obtain approval.
2. He may have to hand over the secret profit, which is his share: 40% × ₦40m = ₦16m in this example.
3. Non-disclosure may also be an offence and he may face removal.

1. Contract value.
   2 × (120 + 30) = ₦300m.
2. This is a “reward for failure”.
3. Prevention: shorter notice periods (for example one year) and pay that depends on performance.

1. Gain = 500,000 × (28 − 20) = ₦4m.
2. This is insider dealing. He faces a criminal charge, and civil liability to the sellers.
3. He should not have dealt, and should have told the chairman of his knowledge.

How to score full marks

• Name the duty or rule at issue.
• Apply it to the facts and say whether it was breached.
• State the consequence: liability, disqualification, removal.
• Recommend a control: disclosure, close periods, whistleblowing, an independent audit committee.
• For audit, separate the board’s duty from the auditors’.
• For evaluation, give the purpose, who does it and how often.

Common mistakes in the exam

• Saying external audit is meant to find fraud.
• Treating the audit committee as an executive body.
• Missing disclosure of interest as a separate duty.
• Confusing election with retirement by rotation.
• Quoting UK law without Nigerian equivalents, or old law as current.
• Forgetting that the board owes duties to the company.

Quick revision

• Fixed three-year terms for non-executives. Rotation: one-third a year. Removal by simple majority.
• Duties: good faith, care and skill, avoid conflicts, disclose interests.
• Insider dealing is a crime; close periods and chairman’s consent.
• NOCLAR: build compliance and whistleblowing.
• Induction, training, annual evaluation.
• External audit: true and fair opinion, not fraud detection. Internal audit: controls, VFM, compliance. Audit committee oversees both.
• CAMA 2020: ss. 303, 305, 306, 308, 309, 404.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

Recent ICAN papers are written, although older papers such as May 2014 included multiple-choice questions. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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