Project Paper IE2001_Nasarudin

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INCEIF

The Global University in Islamic finance

Kuala Lumpur, Malaysia

CIFP IE2001

Ethics and Governance

Case Study : The Sime Darby Financial Fiasco

_________________________________________________________

Semester June 2015

Name: Nasarudin Bin Che Ahmad

Matric No: 1300455

Lecturer: Prof. Dr. Syed Abdul Hamid Aljunid

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Abstract

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In May 2010, Sime Darby Berhad announced that its

earnings may be cut by up to RM964 million due to losses in

its Energy & Utilities Division, from cost overruns in four

projects. Following the announcement, its share price

plunged to RM7.47 on 27 May 2010, a 10-month low. In this

case, we look at some of the events leading to the loss as well

as the actions taken by the board of directors in response.

The objective of this case study is to allow a discussion of

issues such as board composition, the board's role in

oversight, and responsibilities of the board versus

management.

Key terms of the research

1. Sime Darby 2. Corporate Governance 3. Datuk Seri Ahmad Zubir 4. Fiasco

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Objectives of the research:

The objective of this case is to allow a discussion of issues such as board composition, the

board's role in oversight, and responsibilities of the board versus management.

Table of content Page

Question No 1 4 - 6

Question No 2 7

Question No 3 8

Question No 4 9 - 10

Question No 5 11

Question No 6 12

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DISCUSSION QUESTIONS

Q1. The board of Sime Darby includes very experienced and high profile directors. How

can such a board fail so spectacularly to safeguard the interests of the company?

As stated in annual report 2009 of Sime Darby, the system of checks and balances at the

boardroom and top management level is sturdy and robust, befitting its status as a sprawling

multinational corporation.

Not counting Ahmad Zubir, Sime Darby has 12 directors. Half of these are independent directors

and all 12 are non-executive directors. Together, they form a team with deep and varied

experience and knowledge. Among the independent board members are stalwarts such as Tun

Musa, Raja Tan Sri Arshad Raja Tun Uda, Datuk Seri Panglima Andrew Sheng and Tan Sri Dr

Ahmad Tajuddin Ali.

“You can‟t accuse the board of being sleepy. There are some heavyweights there,” Yet, the

directors have missed the extent of Sime Darby‟s project woes until, reportedly, PwC went to

Tun Musa to express its concerns over the energy and utilities division. Furthermore, we could

be noticed that none of the professionals and ex regulators in the board as mentioned above had

enough business experience such that they depended more on the advice of Zubair rather than

overseeing his business decisions

One of the main responsibilities of board members is to maintain financial accountability of the

organisation. Board members act as trustees of the organisation‟s assets and ought to exercise due

diligence to ensure well management of the organisation and sound financial system. In order to

maintain stability position in the market, the board has to work hand in hand, share the same

objectives and good strategy implementation..

Board members, as stewards of public trust, must always act for the good of the organization,

instead of their own benefit. They should exercise reasonable care in every decision making by

minimizing the potential risk of the organization. Take for example, in 2008, internal audit of

Sime Darby discovered some losses incurred in oil and gas segment which was brought to the

attention of the audit committee, but the losses were reported as immaterial losses with the

clarification from the CEO. In this case, the board failed to exercise reasonable care in decision

making and interest of company was affected.

In addition, poor corporate governance was criticised by internal auditor as they discovered there

was a huge amount RM1.7 billion cost overruns blew up. The question raised is what are the

roles of independent directors of Sime Darby? In general, conflict of interests is common when

the management team or the board failed to make right decision in good faith of company. For

instance, the board has the responsibility to ensure all the financial information of the company is

accurate and precise. As an independence director, he or she must strengthen the responsibilities

of audit committees, and improves the quality of financial and shareholders disclosures.

Furthermore, Sime Darby is one of the greatest listed companies in Malaysia and they must have

accountability and transparency in order to satisfy all the major shareholders for example

Permodalan Nasional Berhad.

In the finding, some principles of corporate governance practiced by Sime Darby Fiasco are

questioned, the discussion as below:

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i) Lack of absence of leadership & strategic orientation.

The practice of patronage where corporate positions at helm of GLCs and their perks are

part of reward system for political contributions past present or future. The appointments

are also political, recommended or endorsed by politicians or their cronies. Little wonder

many of the CEOs & directors are bestowed honorific titles or affiliated to ruling political

parties. They are not there necessarily for competence; certainly not corporate governance!

ii) Over concentration of power in the board or management.

Tun Musa was chairman since 2007. The losses were incurred in Sime‟s Engineering Oil

Gas Division in relation to Bakun Dam and Qatar. Assuming Tun Musa had visited Qatar,

Sime‟s Board and him have regularly been kept informed of the Group‟s operating

performance; Bursa Malaysia requires quarterly financial results to be disclosed accurately

to the market on quarterly basis; and statement of former Prime Minister, Tun Dr Mahathir

that he was informed of Sime‟s “cost overrun and delay three years ago (in 2007) when Tun

Musa became Chairman. If it were true as what highlighted that Tun Musa acted like

executive chairman to involve in/enquire into management matters by reason of his not

getting along all that well with CEO Zubir (“the Assumptions”) – then how could he plead

ignorance or defense to lack of supervision of Sime‟s finances as part of his fiduciary duty?

iii) Lack of transparency and unclear policies or enforcements.

The main is the direction of the conglomerate and all other GLCs. Eventually the

government should shoulder some responsibility for not properly defining the scope and

objectives of the GLCs. What is the main purpose of GLCs?

The investment evaluation process for GLCs should be more transparent and stringent

because they are public trust companies. GLCs should have a clear risk barometer or level

that they should not break. Should GLCs be further burdened with public projects and at

the same time expected to deliver profitability as public listed companies?

The essential role of the board of directors is to ensure that all the organization matters

must be in transparent manner, in order to guide effective decision making which Sime

Darby failed to do so. In this case, the minority shareholders were expected the board to be

fully accountable and conduct a forensic investigation and make its findings transparent to

shareholders in a prompt manner.

iv) Poor meeting and conduct

12 board meetings were conducted in year 2009. Not many listed companies in Malaysia

hold these meetings this frequently. In addition, there are seven board committees and they

each meet several times a year. On top of these, Sime Darby has set up a supervisory

committees team to “assist the board in the oversight of the respective divisions (of the

company)”. The board has identified certain non-executive directors to sit on these

committees.

Clearly, this is not a case of the directors having limited exposure to the company‟s

management and affairs. So how is it that the many warning signs had not prompted the

board to initiate a probe to review the energy and utilities division‟s operations? Or just

wonder if the directors had asked the right questions at the right time!

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v) Agency problem/information asymmetry.

In April 2008, for example, reports were released claiming that Sime Darby Engineering

Sdn Bhd (Sime Engineering) had incurred cost overruns of between RM120mil and

RM150mil in its offshore engineering, procurement, construction, installation and

commissioning project for Maersk Oil Qatar (MOQ). However, the boards soon after

declared that the articles weren‟t correct. Furthermore, in February 2009, also alleged that

there had been costs overruns in the same project, but the figure mentioned was far bigger.

vi) Effectiveness of Audit Committee

The committee establishes procedures for accepting confidential, anonymous concerns

relative to financial reporting and internal control matters. Often referred as “whistle-

blower policy,” the procedures allow individuals to voice out questions and issues without

fear of retribution.

Although Raja Arshad is a distinguished and well-respected corporate individual with

impeccable credentials, he might not be the best choice to lead Sime Darby‟s audit

committee. Given that the independent auditors are PwC, never mind that it has been

almost five years since he had left the PwC. However, PwC is likely to insist that his

position in the audit committee does not change how the firm conducts its audit of Sime

Darby. Furthermore, if it is true that PwC went straight to Musa to express its concerns over

the energy and utilities division, this perhaps shows that the firm was not dependent on

Raja Arshad as an intermediary to the board.

Sime Darby‟s whistleblowing policy encourages employees to report wrongdoings by

anybody in the company to the authorities. It also provides for complaints and reports to

submit directly to a senior independent director or the audit committee chairman “should

the complainant believe that the group is better served if the report was addressed to levels

higher than the management”. According to its website, Sime Darby has over 100,000

employees. Could it be that not even one of them raised the alarm over the problems in the

energy and utilities division? Or if there had been such complaints, were they handled

appropriately?

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Q2. What are the critical attributes of an effective board? To what extent does the Sime

Darby board possess such attributes?

The board‟s role is to provide entrepreneurial leadership of the company within a framework of

prudent and effective controls which enables risk to be assessed and managed.

An effective board develops and promotes its collective vision of the company‟s purpose, its

culture, its values and the behaviours it wishes to promote in conducting its business. In particular

it:

i) provides clear direction for management;

ii) demonstrates ethical leadership, displaying and promoting throughout the company –

behaviours consistent with the culture and values it has defined for the organisation;

iii) creates a performance culture that drives value creation without exposing the company

to excessive risk of value destruction;

iv) makes well‐informed and high‐quality decisions based on a clear line of sight into the

business;

v) creates the right framework for helping directors meet their statutory duties under the

Companies Act 1965, and/or other relevant statutory and regulatory regimes;

vi) is accountable, particularly to those that provide the capital for the company; and

vii) thinks carefully about its governance arrangements and embraces evaluation of their

effectiveness.

An effective board should not necessarily be a comfortable place. Challenge, as well as

teamwork, is an essential feature. Diversity in board composition is an important driver of a

board‟s effectiveness, creating a breadth of perspective among directors, and breaking down a

tendency towards „group think‟. However, in the corporate milieu of GLCs such as Sime Darby,

as a case of the wider political milieu, there is a wide gap between the powerful and the

powerless. The latter defer to the former. They don‟t challenge those in powerful positions

whether these positions relate to a corporate, a government department or political party. Those at

the helm are tolerated in their shenanigans and excesses. They are part of privileges to be enjoyed

at the top. If someone challenges them, one finds that whatever recourse sought from the various

institutions, regulators and government agencies will not only lead to nowhere but invite a

backlash. The reasons are that the top decision makers of these institutions, regulators and

government agencies are equally occupying their positions due to political patronage and played

by the same rules i.e. listen to those in power!

The practices of patronage where corporate positions at helm of GLCs and their perks are part of

reward system for political contributions past present or future. The appointments are also

political, recommended or endorsed by politicians or their cronies. Little wonder many of the

CEOs & directors are bestowed honorific titles or affiliated to ruling political parties. They are

not there necessarily for competence; certainly not corporate governance to contribute to effective

boards! The gravity of the crime of mismanagement can easily be overlooked if they are the

cronies of those in the powerful position. Knowledge and expertise is also not at all important so

long as you follow orders from the top.

It was reported that, the Board of Directors failed to safeguard Sime Darby shareholders and

contributed to the RM1.7 billion cost overruns blew up, by allowing Sime Darby Fiasco to

engage in high risk accounting, and inappropriate conflict of interest transactions. The Board

witnessed numerous indications of questionable practices and potential cost overruns by Sime

Darby‟s Energy & Utilities Division which included Sime Engineering management, but chose to

neglect it which may affect the interest of Sime Darby shareholders, employees and business

associates.

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Q3. Should the board members also be held accountable and not just Datuk Seri Ahmad

Zubir Murshid?

The board is collectively responsible for ensuring that the organisation has systems in place to

monitor and adequately control the organisation‟s material risks and that there is adequate and

effective operational procedures, internal controls for assessing, measuring, controlling,

monitoring and reporting of risks.

As board members, they are fully accountable for Sime Darby organisation and, thus, responsible

for governing in a way that effectively and clearly delegates both direction and protection and

assures both. If they did not do that, they shirked their responsibility and failed their

accountability in so doing. So the key question for boards like Sime Darby is, did they serve their

governance duty and someone below failed in their responsibilities and the board did not know

it? The Policy Governance is designed to assure the board says (and checks) what it must say and

check and there should be no out of compliance situation the board doesn't know about, unless

the organisation is hiding it. Then the board has a different problem.

Examining further this issue of „principles of corporate governance‟ – true there was external

probe was likely defined within parameters set by the Board and take directions from the Board.

If the Board were in the front line of Public‟s focus as to whether its directors have breached their

fiduciary duties of oversight then whosoever on the Board, including the Chairman, who by

position and conduct know or ought to know or have known about the gathering storm of cost

overruns since 2007 and have power and responsibility to sound the early alert/alarm and mitigate

these losses but have not done so ought, if accountability were the first objective, resign or, at the

least tender resignation as gesture.

If everyone stays put because Datuk Seri Ahmad Zubir had taken the fall, how could any of the

rest of board member who might be responsible for lack of vigilance be eventually held

accountable when he is allowed to remain on the Board to exert a measure of control on how the

external investigators and task force investigate?

Can Board members be entrusted the objectivity to exercise oversight over investigations of the

adequacy or otherwise failings of their own conduct and discharge of fiduciary duties?

Certainly, I am not saying that the entire team of Sime Board should resign. For then there will,

on the practical side, not be continuity of remaining board members with sufficient knowledge to

organise (with or without) new directors the conduct and oversight of these investigations by

external investigators and task force. However those whose oversight over these divisions losing

huge sums, including the Chairman and independent directors and whoever independent director

serving as chairman of the Boards Committee chairman (Audit committee) should have their

roles immediately evaluated to determine they are prima facie accountable to resign in accord

with the very “principles of corporate governance” that the Bursa/Securities Commission have

been preaching. At least those accountable should been seen tendering their resignations.

According to Tun Dr Mahadhir, the former Prime Minister, he claimed that the cost overruns in

the Bakun project were almost RM1.8bil and said that responsibility for the Sime Darby Fiasco

should be shared. The former prime minister said action should be taken not just against chief

executive officer Datuk Seri Ahmad Zubir but also all who were involved in the debacle.

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Q4. On hindsight, if you were one of the directors on the main board of Sime Darby,

what would you have done back in 2005?

I would like to see a change in the perception that GLC (government-linked company) is a dirty

word. It is the common perception that GLCs get what they want and are allowed to get away

with poor performance, at best, and utter incompetence if not blatant corruption, at worst.

I would like to see Sime Darby be regarded as a bastion of leadership in ability, innovation and

execution. I would like to see Sime Darby be regarded as a multinational corporation that has

actually competed internationally without any support from anyone and has won contracts and

projects.

In line with the corporate objectives highlighted above, some considerations would have done in

2005 are:

i) To appoint directors equipped with related and relevant skills and the knowledge to

perform task-specific duties, such as the evaluation of the firm‟s internal control and

accounting procedures, to enhance the quality of information gathered, of the solutions

to problems, and of the views held and judgments made during the decision-making

process. Also, outside directors with a variety of specialist knowledge will be

valuable to the creation of a strong and informed board, in particular, in justifying their

views on and concern with management propositions.

ii) From the report, it can be concluded that the huge loss incurred was due to the problem of

cost overrun and probably the mismanagement in the power and utility division of the

conglomerate that led to failure of completion projects as scheduled. The issue here is

about efficiency and within the context of corporate governance there are a lot of

loopholes in the company and they are serious enough as to cause this serious problem

concerning the figures of the company. In relation to that, long-term structural

management problems shall be identified and the board will involve itself in a special

exercise to look at these structural issues. The need to cite about management structure,

staff qualifications, procedures, feedback channels and checks and balances as examples

of these governance issues in the company.

iii) To initiate a review of the organization and reporting structure of the Sime Darby Group

with the aim of providing and promoting a culture of ownership and accountability across

the Group, strengthening the level of control and enhancing the Board‟s oversight of the

Division‟s operation.

iv) A common code of conduct is written for employees of a company, which protects the

business and informs the employees of the company's expectations. It is ideal to form a

document containing important information on expectations for employees.

v) The setting up of a „whistle-blower‟ policy so that the staff can facilitate the free flow of

opinions, for the negative or positive.

vi) Remediation actions at the Energy & Utilities which include:

a) Realignment of the organization chart to improve risk management

b) Initiation of operational improvement including project bidding processes, tightening

of control over project costs and strengthening of project management

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vii) To scrutiny the role of organisation play in society to ensure that in the quest for profit, the

organisation does not exploit the environment and respect human right of the citizen in the

society.

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Q5. What do you understand by the duty of 'skills, care and diligence''? How is it

different from the duty to act in good faith in the interest of the company?

The directors of a company would typically hold some degree of expertise as such a higher

standard of competence is expected of them in managing the affairs of the company. Modern

company legislation applies an objective standard which judges a director's actions in the context

of what a reasonably prudent person would do in comparable circumstances. As such, to act

honestly and in good faith with a view to the best interests of the company and display the care,

diligence and skill that a reasonably prudent person would exercise in comparable circumstances.

These duties are owed to the company itself. But they protect present and future shareholders,

present and future creditors of the company, employees and even the public at large.

The duty of care imposes on directors a duty of competence or skill - i.e., a requirement to act

with a certain level of skill; and a duty of diligence. The duty of skill and diligence must be

performed to a certain "standard of care". A director in discharging the duties of his office must

act honestly and must exercise such degree of both care and skill and diligence as would amount

to the reasonable care which an ordinary man might be expected to take in the circumstances on

his own behalf. Directors must exercise their powers with reasonable skill and care. If a director‟s

actions fall below the basic standard of care and skill, he or she may be held personally liable for

compensation to the company. At common law, directors will not be liable for errors of

judgement but they will be liable for gross negligence.

The duty to act in good faith of the company requires a director acts honestly and in good faith of

the company. The duty of loyalty is a personal duty and cannot be delegated (the "no-delegation

rule"). Among other implications, it means that a director is not allowed to profit from his or her

office (the "no-profit rule") and must avoid all situations in which his or her duty to the

Corporation conflicts with his or her interests (the "no-conflict rule").

In this case, the Chief Executive Officer and top management of Sime Darby Group may not

have the proper or right attitude. They may conduct unethical practices which contradict the best

practices of corporate governance. The management may also trespass their power and do not

comply with the board‟s decision. Due to non-compliance with the duties and responsibilities of

boards of directors, troubled conglomerate Sime Darby Berhad filed a lawsuit against former

chief executive officer Datuk Seri Ahmad Zubair and four other key officers over the losses

incurred in three projects. The Sime Darby claimed that, the defendants, inter alia, restitution for

monies wrongfully paid out, damages for losses suffered, profit reduction , aggravated damages

and costs. In its statement of claim, Sime Darby alleged that the accused had been grossly

negligent for allowing Sime Darby Engineering to pursue engineering, procurement,

construction, installation and commissioning (EPCIC) project in which it had no prior

experience. Furthermore, the defendants also accused of awarding EPCIC jobs to similar

inexperienced subcontractors and for failing to pursue claimed for the work not done.

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Q6. Based on the case, what grounds can be used to justify the claim made by Datuk Sri

Zubair that the directors had breached the duty of skills, care and diligence in his

counter suit?

Datuk Sri Zubair filed a counter suit against 22 directors, including Tun Musa Hitam, Tun

Ahmad Sarji Abdul Hamid, Tan Sri Ahmad Tajuddin Ali and Datuk Seri Andrew Sheng. Datuk

Zubair claimed “selective prosecution” of the defendants for collateral purpose and abuse of

process, without regard of the “collective responsibility” of the main board in Sime Darby's

losses. In his statement of defence then, Datuk Zubair had explained that Sime Darby's main

board “retained control over the management and ultimate decision-making process of the Sime

Darby Group”.

There are two grounds can be used to justify the claim made by Datuk Zubair, the directors had

breached the duty of skills, care and diligence:

1) In the cases mentioned above there was a strong likelihood that some of the independent

directors were not independent in mind and had structural bias towards their colleagues on

the Board especially for those directors who have been working for 28 years. It is also

likely that „group think‟ resulted in the selection of directors who were less inclined to be

suspicious of people like them. The majority of the Board of Sime Darby, comprise of

former civil servants or government investment agency appointees. Many members of the

Board moved in similar social, work and political circles and were possibly inclined to

accept the assurances of the CEO or Chairman who came from the same background, that

there was no financial mismanagement in spite of red flags raised by the auditors. It is

difficult for them to demand higher level of accountability when the Chairman or CEO is a

person with strong political connections which raises the issue of power distance. Many of

the Board members in government linked companies are Malays and in Malay culture,

criticisms and challenges against those in authorities or from a higher social hierarchy are

considered rude and causing loss of face is often avoided. Criticisms if any, is only

tendered in mild language and often after showering the powerful person with praises.

Power distance may also inhibit directors from criticising founders of the Board to whom

they may owe their position. Furthermore in-group collectivism results in directors‟

tendency to sweep matters under the carpet as pursuing controversial issues may

compromise their loyalty to their in-groups. There is a strong tendency to defend in-groups

even in the face of overwhelming evidence that someone in that in-group has committed a

wrong. This is because loyalty is highly valued.

2) An increase in the number of independent directors under such conditions may result in

greater assertiveness as they would be able to put forward their views as a group.

Nevertheless this will not always ensure independent and vocal boards as half the Board of

Sime Darby comprised independent directors, but this did not prevent its financial losses.

So where is the role of independent directors in Sime Darby? Usually the conflict of

interest happens in this field where the independent directors failed to ensure that the

financial information was accurate and satisfied all the stakeholders in the organization. In

the case of Sime Darby, none of the independent directors in the board had enough business

experience such that they depended more on the advice of Datuk Zubair rather than

overseeing his business decisions. Indeed as an independence director, he or she must

strengthen the responsibilities of audit committees, and improving the quality of financial

and shareholders disclosures.

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