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National

June 25, 2018

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Governance and privatisation of state-owned enterprises

Good governance is commonly understood to embody the characteristics of accountable, transparent, participatory, responsive, effective, and efficient; to minimize corruption; to take into account the views of minorities; and finally, and perhaps most importantly, to follow the rule of law. This paper presents and examines governance issues related to the privatization of state-owned enterprises (SOEs).

JUDICIAL RESTRAINT: ACTIVISM OR ADVENTURISM?

In Pakistan, the judiciary enjoys a very significant position. It is fiercely independent and has been the guardian and custodian of the Constitution. Recent judicial activism in Pakistan has made the judiciary a watchdog against the violation of fundamental rights guaranteed under the Constitution. The challenge, in the case of the Supreme Court, is to strike the right balance when it comes to the tightrope of equity, justice, and good conscience.

The question will always be when, how, and to what extent the Supreme Court should exercise its activism. Generally, the approach of the judiciary in Pakistan has been that while it may be appropriate that the courts show due deference to the opinion formed by the executive, any state action that violates fundamental rights must invariably be subject to judicial scrutiny that passes the test of fairness and impartiality.

Indian judgments are followed and relied upon in Pakistan, and they have persuasive value. An important milestone in India’s privatization was the landmark 2001 judgment of its Supreme Court in a case titled Balco Employees Union vs. Union of India and others. The Court laid down the principle of judicial restraint in relation to the matter of privatization. It was held that in a democracy, it is the prerogative of each elected government to follow its own policy. A change in government may often result in a shift in focus or change in economic policies. Any such change may result in adversely affecting some vested interests. Unless any illegality is committed in the execution of the policy or the same is contrary to law or mala fide, a decision bringing about change cannot per se be interfered with by the Court. It is neither within the domain of the courts nor the scope of the judicial review to embark upon an enquiry as to whether a particular public policy is wise or whether better public policy can be evolved. Nor are the courts inclined to strike down a policy at the behest of a petitioner merely because it has been urged that a different policy would have been fairer or wiser or more scientific or more logical.

In other words, according to this Indian Supreme Court judgment, it is not for the courts to consider the relative merits of different policies. For testing the correctness of a policy, the appropriate forum is parliament and not the courts.

Pakistan has judicial precedents in public interest litigation where on the one hand the Supreme Court has exercised judicial restraint, and on the other hand where the courts have felt justified to intervene. Such intervention can be regarded as judicial activism. In some cases, judicial activism has bordered on being classified as judicial adventurism. However, the courts do not and should not operate in the framework of these concepts. For the Supreme Court, as a guardian and interpreter of the Constitution, the only concept that matters is the rule of law.

Public interest litigation is a weapon that has to be used with great care and circumspection. Indeed, the judiciary has to be extremely careful. It must ensure that ugly private malice, vested interests, and publicity-seeking do not lurk behind the beautiful veil of public interest. Indeed, the attractive brand name of public interest litigation should not be used for suspicious products of mischief.

THE CHALLENGES OF PRIVATIZATION

For decades, Pakistani politicians have invoked hollow slogans focused around economic upliftment, poverty alleviation, and the overall improvement of the lives of the toiling masses. If politicians understood real economics and linked their politics to the same, we Pakistanis may not find ourselves where we are today and be envious of the gloss and shine of the Indian economy and businesses. For years, Pakistan has declared an economic war on itself through the manner in which its budget is allocated.

In Pakistan, privatization suffers from, or has to face, the following challenges:

• It is not and has not been an economic ideology for successive governments.

• Government ownership of privatization is for the wrong reasons. It is rooted in either the desire to use the proceeds of sales for financing the budget deficit, or simply to meet the deadline for publishing the Expression of Interest imposed as a consequence of International Monetary Fund (IMF) or other conditions.

• Country ownership is limited. To the public at large, it is a change from one shareholder (the government) to another (the private sector). Privatization will be effective and popular only if private managers act in the public interest.

• The political opposition (in complete disregard for its own election manifestos) criticizes the incumbent government’s privatization plans. It brings in slogans such as “selling the country’s silver.” The loss-making SOE becomes the vanity of the nation. For example, in the case of Pakistan International Airlines (PIA), the opposition has argued that the airline is an embassy with wings transporting culture, commerce, and goodwill around the world. The sovereignty of the country, so goes the opposition narrative, is being compromised by selling such national symbols—as loss-making as these supposed national icons may be.

• The impression among employees in SOEs that the public sector has an advantage over the private sector in terms of job security, working conditions, and fringe benefits.

The post-privatization success of the Balco case and others like it is important in that it demonstrates that labor is not necessarily a casualty of privatization. While it is expected of a reasonable employer to take many matters into consideration, including the welfare of labor, before making a policy decision, that by itself will not entitle the employees to demand a right of hearing or consultation prior to the making of the decision. The workers may have some protections; however, the sole shareholder—the government—does not have to give the workers prior notice of a hearing before deciding to disinvest.

PRIVATIZATION AND JUDICIAL ACTIVISM

A major advantage—or disadvantage—for privatization is judicial activism. Major privatization transactions in Pakistan have been brought before the Supreme Court on the grounds that they relate to public importance or are an enforcement of a fundamental right or public duty. Below are two contrasting cases.

In the 2006 Pakistan Steel Case, the Supreme Court struck down the contract entered into by the Privatization Commission of Pakistan with the successful bidder. This decision ultimately has cost the Pakistani taxpayer billions of rupees.

In this case, the Supreme Court did not pay much attention to the well-established principle of law—namely, that it is not the function of the judiciary to interfere in the policymaking domain of the executive.

The most surprising feature of the judgment was that the Supreme Court appeared to suggest a unilateral demand: Bidders should have furnished a guarantee for the purpose of making future investments with a view to raising production capacity. This was not a condition specified in the bid documents, and no such requirement has been made in any other case of privatization. If such guarantees are made a condition of privatization, no company will ever be privatized.

In the 2011 Habib Bank Case, surprisingly, the first question framed for adjudication was whether privatization was carried out in haste and was undertaken on the desire of the IMF. The assumption here was that the decision was not that of the government of Pakistan, but rather was made due to external pressure. While the Supreme Court held that this logic was twisted and rejected the position, the fact that such a question even made it to the process of adjudication highlights the extent to which any government has to go not only to implement a transparent process but also to manage all kinds of perceptions that make it to the Court.

The Supreme Court further held that while dealing with a case relatable to financial management by the government, it must appreciate that these are either policy issues or commercial transactions requiring knowledge in specialized fields. The Court noted that it lacks the expertise to express any opinion on the soundness or otherwise of such acts and transactions. The Court even went so far as to state that so long as there was “substantial compliance with the relevant provision,” then a minor deviation from the rules or regulations, if any, in the absence of any credible allegation of mala fides or corruption would not furnish a valid grounds for interference in judicial review. Indeed, this portion appears to follow the concept of judicial restraint as enunciated in the Balco case.

For the purposes of privatization, what is the rule of law in terms of a public functionary exercising public authority? The decision of the government should be fair, just, transparent, reasonable, not arbitrary, untainted by mala fide, without discrimination, in accordance with the law, without any deviation of due process, and made while always keeping in view the constitutional rights of citizens. Given the presence of so many criteria, something is bound to go amiss.

The Court can nullify any action of the government where it is established that a decision-making authority acted in violation of the above; exceeded its powers; or committed an error of law or an all-encompassing breach of the rules of natural justice.

Given the judicial activism already seen in public interest litigation, it can be expected that future privatization will be subject to judicial scrutiny. It is unlikely that superior courts will demonstrate restraint or reluctance in this regard, and in fact they are likely to broaden their constitutional authority particularly when state institutions cross their constitutional limits.

CODE OF CORPORATE GOVERNANCE: FIRST PHASE

Lord Acton perhaps made the founding statement on corporate governance with his famous quote that “power tends to corrupt and absolute power corrupts absolutely.”

Democracy through the doctrine of separation of powers divides power and control between the judiciary, the executive, and the legislative, and each must have a separate and distinct autonomy. In a similar vein, the government places an expectation upon business houses that divisions should be created, and the requisite autonomy maintained, within its own business organizations.

The reason to draw this comparison is important. Governments view multinational enterprises as having the economic power of any government. In each case, the government and the private sector have a separation between principal and agent. In the case of the government, the principal is society and in the case of the company the principal is the shareholder. The agent is the public servant for the government whereas for the company it is management. The division between the public sector and the private sector has been increasing, particularly with privatization and corporatization. In Pakistan, we have seen the privatization of the banking system and other previously public services. Indeed, if all the large banks in Pakistan came together, they could yield serious economic power and seek any change that they desire from the government.

All of the above underscores the need to establish corporate governance, or some similar type of division of power and control, in boardrooms. A Code of Corporate Governance was in fact introduced in Pakistan in 2002. Today, the Code derives its strength not from a fear of penalties, but rather from the widespread support and heightened level of expectation it has now introduced.

What is the purpose of the Code of Corporate Governance? Where public investment is sought, the obligation of the state is to protect investors against malpractice. In the case of banking and finance, the twin peaks are confidence and integrity. One complements the other, and each is codependent on the other. The slightest doubt about the integrity of a financial system can erode the confidence that supports it. While Pakistan may not have experienced corporate scandals of the magnitude of Enron and Worldcall, we have still seen financial institutions collapse. Indeed, larger financial institutions could have also collapsed had it not been for the government’s timely privatization of the large state-owned banks that brought back and resurged the confidence of having a safe and well-managed bank. Prior to privatization, in 1997, the government as a first step changed the senior management of the three largest banks in Pakistan, thereby avoiding scandals in these institutions. Even without the formal Code of Corporate Governance, these banks were turned around through major restructuring—particularly in relation to ensuring good governance. This further fortifies the view that discipline and integrity cannot be ensured only with regulation.

All banks are used to limits on equity investment and other requirements meant to protect bank deposits and investments which are placed in the banks’ trust. This fiduciary responsibility is a pillar of corporate governance, and it rests solely with none other then the senior management of the bank and its board of directors.

The most frequently asked question is to whom do the management and the board owe this fiduciary responsibility. Almost 80 percent of bank assets are financed by the depositor’s funds and in some cases less than 5 percent by equity, making banking business a highly leveraged business in an economy. In these circumstances, the message is clear: The primary responsibility of the management of a bank is to depositors, not shareholders.

Another common question is what the responsibilities are. In legal terms, the director’s responsibilities are embodied in the articles of association and in the complex, and at times inaccessible, case law. As a result, directors have often not been clear about their general duties. The Code of Corporate Governance is certainly a step in the right direction toward achieving clarity in this regard.

We have seen corporate governance being introduced in various forms in the case of banks. Examples include directors’ remunerations, the number of meetings that directors have to attend, limitations on the number of directorships each director can hold, the rotation of auditors, restrictions on directors investing in shares, and governance of employee share-owning plans.

While the Code of Corporate Governance requires substantial disclosure, most listed companies—including banks—do not have sufficiently broad-based shareholding to ensure shareholder independence strong enough to demand such disclosures. In a typical general meeting in Pakistan, it is usually a case of one representative of the majority shareholder holding proxy for 51 to 75 percent shareholding and casting the vote on behalf of one or more of the major shareholders.

To conclude, the onus of good governance rests with the directors. No amount of regulation, codes, or standards can replace the integrity, honesty, and responsible conduct of a director in a board room. Moreover, corporate governance can only be implemented in the true sense if the shareholding structure becomes broad based.

The Securities and Exchange Commission of Pakistan (SECP) now has 16 years of experience in enforcing the Code of Corporate Governance. Hence, enforcement of the new rules of corporate governance in relation to SOEs should be effected efficiently and swiftly.

CODE OF CORPORATE GOVERNANCE: SECOND PHASE

Since 2013, the SECP has been implementing SOE corporate governance regulations in order to substantially strengthen the independence, capacity, and roles of boards of directors. These regulations include measures such as the establishment of audit committees, distinguishing between the roles of chairman and CEO, and improving the process for the appointment of directors.

The SECP is now seeking to make amendments to these rules in order to enable SECP to better regulate them. It appears that the amendments are in fact relaxing the rules. The rules are not applicable to SOEs that are not registered under the Companies Act of 2017, are established under their own special enactments, or are operating in a non-corporate form.

RECOMMENDATIONS

Corporatize: Corporatize SOEs by converting them into companies under the Companies Act of 2017. This will bring uniformity and standardization in their legal structures. SOEs include government divisions and departments, particularly entities set up under a special statute (statutory corporations). In this regard, a data bank of independent directors is required for the identification of competent directors. This will require an elaborate mechanism for nominating and inducting independent directors. The Companies Ordinance of 2016, which was struck down by the Pakistan Senate, contained enabling provisions of this sort.

Commercialize: While on the one hand the priority is to convert statutory corporations and divisions into entities under the Companies Act, a task that the Pakistani government has already been successfully implementing, a more difficult task is to give these converted corporate bodies a much-needed commercial mindset and framework. Commercialization of these SOEs requires a cleaning up of balance sheets; a retrenchment of employees; a stop to all non-commercial business and activity; the introduction of modern technology; and a change in mindset and culture.

Privatize: Once SOEs are corporatized and commercialized, the process of privatization is not likely to face resistance, and even if challenged, it should be able to withstand the test of judicial activism or adventurism. (The writer is is Barrister at Law, Senior Partner at Mandviwalla & Zafar, and President of SAARCLAW)

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