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Introduction

I n response to the Nolan Committee (Nolan,1996) recommendations and concerns, the

Local Government Act of 2000 (LGA 2000) provided for the establishment of a NationalStandards Board for England supported by theappointment of local Standards Committeesacross a wide range of local authority bodiesand committees. The range includes over 388 local authorities, 8000 parish councils, 43police authorities and 31 fire and civil defenceauthorities, and “others” including passengertransport authorities, the Greater LondonAuthority, the Broads Authority and theNational Parks Authority. The rationale for

this system of a National Standards Board forEngland, supplemented by Standards Com-mittees for each of the authorities, was one ofseeking to promote ethical conduct in com-mittee decision making both at a collective andat an individual level. It was a response to theNolan concerns and sought to contribute to arestoration of confidence in local democracy.The Standards Board for England is quiteexplicit in declaring its role to be one ofseeking “to promote the highest standards ofbehaviour from representatives in a way thatensures everybody can have confidence inlocal democracy and that a bond is developedbetween the community and those that repre-sent the community” (SBE Guidance, 2001).

© Blackwell Publishing Ltd 2003. 9600 Garsington Road, Oxford,OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.Volume 11 Number 3 July 2003

Corporate Governance andGatekeeper Liability: the lessons from public authorities*

James Kirkbride** and Steve Letza

(1) Under the requirements of the Local Government Act 2000, a system of promoting and reg-ulating good governance in public authorities was introduced. The system involved the estab-lishment of a Standards Board with agreed codes of conduct and enforcement mechanismthrough monitoring officers. All authority codes of conduct had to be approved by May 2002.The system was introduced under the headline of: “Reconnecting with the people – promot-ing good governance and ethical behaviour”. (2) In the mid-1980s, the concept of “gatekeeperliability” was beginning to be promoted as a method of enhancing the regulation of boardsof directors. The most influential work was that of Kraakman. Kraakman was concerned thata system of regulation was brought forward to respond to enforcement insufficiency in thearea of corporate control. A notion of “gatekeeper” liability is one response.

This paper explores the system of controlling governance in public authorities (1 above)and its relationship to the gatekeeper response advocated for private corporations (in 2 above).Through this analysis, a series of reflections and signposts are presented as lessons for theprivate sector and for the enhancement of good governance in that sector.

Keywords: Corporate governance, regulation, public authorities, gatekeeper liability, Stan-dards Board, independent directors

*This paper was presented atthe 5th International Confer-ence on Corporate Governanceand Direction, 8–10 October2002, at the Centre for BoardEffectiveness, Henley Manage-ment College.**Address for correspondence:Faculty of Business and Law, Liverpool John Moores University, 98 Mount Pleasant,Liverpool L3 5UZ; E-mail:j.kirkbride@livjm.ac.uk

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This need to restore confidence and to seek topromote good ethical governance is notunique to the public local authority sector.Enron and WorldCom are recent instances ofcorporate failures demonstrating conduct thatundermines confidence in the democracy ofcompanies and the openness and transparencyexpected from good ethical governance and itsregulation. Similarly, the Modern CompanyLaw Review in its final report (MCLR, 1999a,1999b, 2000) identified the possibility of anational body known as a Standards Boardwho would contribute to moving governancefrom the private sphere or private initiatives,to one of central and national standards andpublic deliberation and development. This hasbeen confirmed in a more recent White Paper(2002). This paper reflects on the developmentof this National Standards Board and the localdevelopment of Standards Committees in theirattempt to restore confidence in local democ-racy and to promote and achieve ethical gov-ernance. In doing so, this paper intends toidentify whether there might be any messagesfor reflection in the corporate sphere from theapproaches that have been advanced in thepublic authority arena.

Local Standards Committees – termsof reference and “positioning”

The specific functions of the Standards Com-mittee are laid down by legislation (LGA 2000)and include the following:

• Give the relevant authority advice on theadoption of a local Code of Conduct.

• Monitor the effectiveness of the Code.• Train members of the authority on the Code

or arrange for such training.

The general functions are to:

• Promote and maintain high standards ofconduct for members.

• Help members observe and understand theCode of Conduct.

These functions must be adopted by all Stan-dards Committees and set out in their Termsof Reference, as a minimum. Standards Com-mittees can also adopt such functions that therelevant authority considers appropriate. In allcases a copy of the agreed Terms of Referencemust be sent to the Standards Board forEngland. A recent consultation paper (DTLR,2002) seeks to extend the functions of the Standards Committee to include, inter alia, aninvestigatory and enforcement role. A matterthat we will return to later.

The Standards Board for England was estab-lished in March 2001. Its main roles are to

provide guidance to authorities on standardsissues and to manage investigations into alle-gations of member misconduct. It must alsoreceive and approve the Codes of Conductthat were required to be adopted by all rele-vant authorities by May 2002.

Independent representatives

The relevant regulations stipulate that at least25 per cent of the members of a StandardsCommittee must be independent of theauthority. In its guidance (SBE Guidance,2002) the Standards Board makes it clear thatthe reason for having an independent repre-sentative is to help increase public confidenceand to provide a clear signal that the Com-mittee is fair. It also identifies the fact that the independent representative should seek to bring a wider perspective from outsideexperiences.

The Standards Committee Regulations of2001 provide that the nature of independencemust be secured by the requirements that theindependent representative must not be amember of the authority or any other author-ity, “that the independent member must nothave been a member or employee of the rele-vant Authority within the past five years”, andthat, at the time they are appointed, theycannot be a relative or close friend of amember or employee of that authority. Theguidance from the Standards Board (SBEGuidance, 2001) indicates that the determina-tion of the length of appointment is up to therelevant authority, with the expectation thatthe appointment would be not less than a two-year period. The expectation is that this will belong enough for them to gain an understand-ing of the Standards Committee and theauthority and its workings. The length ofappointment is also guided by the fact that anoverlong appointment could trigger a loss ofindependence.

The Standards Committee Regulations 2001also outline the process for the appointment ofindependent representatives. They seek toensure that independent representatives areelected in a fair and open way. This includes arequirement that there has been a formalapplication for the position (rather thansimply a formal or informal invitation) andthat the independent representative has beenapproved by the majority of members of theauthority and that the position has beenadvertised in at least one newspaper distrib-uted in the authority’s area. In other words,unlike the corporate world, the public author-ity world is concerned that there is trans-parency and openness in the process of

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application and appointment of independentsto the board, unlike the corporate world whichoften relies on invitations or the whims andwishes of dominant managing directors orCEOs.

Relevant authorities are guided on the qual-ities they should look for in an independentrepresentative. The guidance (SBE Guidance,2002) includes the following:

• The independent representative must befamiliar with ethical dilemmas.

• He/she must have experience with Committee work.

• He/she must have questionning skills.• He/she must be assertive.• He/she must be independent of local

government.

Freedom is, however, given to the authoritiesto decide the remuneration of the independentmembers.

If we compare this with the corporateworld, then we note initially that there is norequirement for a Standards Committee to beappointed by a board of directors – unlike theboard of a public or relevant authority. (In aslightly different way, it could be suggestedthat nomination and remuneration commit-tees perform aspects of the functions of a Stan-dards Committee). Nevertheless, there is arecognition of best practice contribution ofindependent non-executive directors in thecorporate world. The position of a non-executive director is central to the market-based system of corporate governance in theUK. The best practice recommendation1 for thegovernance of public companies is that one-third of the board should comprise non-executive directors; of these, the majorityshould be independent of management andfree from business or other relationships thatcould materially interfere with the exercise oftheir independent judgement. The first thingwe must note in relation to this corporate posi-tion is that it is a recommendation rather thana statutory requirement that non-executiveindependent directors be appointed. The bestpractice recommendation has been dissemi-nated through a series of reports, initiallyCadbury (1992), then Greenbury (1995) andHampel (1998), and these led to the adoptionby the London Stock Exchange of a CombinedCode which brought together the recommen-dations from these early reports. The status ofthe Combined Code was that of beingappended to the Listing Rules and did notform part of the Rules themselves. There isnow a monitoring role for the Financial Ser-vices Authority under the Financial Servicesand Markets Act of 2000. The significance ofthe structure is that, unlike the statutory

requirement for independence under thepublic authority regime, under the corporateregime non compliance with the best practicerecommendation does not in itself jeopardisethe company’s listing. There is a low levelreporting requirement that in their annualreports and accounts, listed companies mustinclude statements on compliance (or other-wise) with the Combined Codes.

Similarly, differences appear in relation tothe process of appointment and declaration offunction of independent representatives. Inthe early 1990s, it was widely reported that theprevailing practices in relation to selection andappointment of non-executive directors wasunsatisfactory (Pro Ned, 1992). It seemed thatin many instances non-executive directorsowed their position to personal relationshipsand acquaintance with the chairman ormembers of the executive board (Cosh andHughes, 1987). Attempts have been made toimprove the processes for the appointment ofnon-executive directors, including the princi-ple of the Combined Code that the procedureof the appointment of new directors to theboard of a company should be formal andtransparent (Charkman, 1995). In addition,there is a requirement for the establishment ofa nomination committee to make recommen-dations on all new board appointments (Com-bined Code, A.5). A majority of this committeeshould be non-executive directors (CombinedCode, A.5.1). Despite these attempts toimprove the process of appointment andensure independence in selection, it has beenreported (Financial Times, 1997) that there aresome concerns over the extent to which inde-pendent non-executive directors continue toremain independent outsiders.

This question of independence extendsbeyond simply the process of appointment toinclude consideration of the expected role ofindependents and their ability to devote timeand skill to that role. Unlike the independentmembers of Standards Committees, the inde-pendent members of boards of directors arenot subject to a common process of appoint-ment, nor to a common list of desirable skills.Nevertheless, the skills must relate to the func-tion and this is where we find the best practicecodes as seeking to influence the functions androle of the non-executive director. No longer is the non-executive director perceived as afigurehead following an appointment basedon reputation. The code of best practice forlisted companies specifies the following:

Non executive directors should bring an inde-pendent judgement to bear on issues of strategy,performance, resources, including key appoint-ments, and standards of conduct. (The Stock

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Exchange, Listing Rules, appendix, “Principlesof Good Governance and Code of Best Practice”).

Thus it can be seen that non-executive direc-tors must possess skills to support a wide role,including both a monitoring function as wellas a strategic function. Unlike the defined roleof the independents on the relevant authorityStandards Committee, the role of non-executive directors in companies is not confinedto pursuing good governance, improvingethical conduct and the monitoring of stand-ards of behaviour. The inherent conflictsbetween performing both a monitoring and astrategic advisory role can cause problems andmight distort from effective independent gov-ernance. Similarly, when one considers thetime given and available to non-executivedirectors, one can begin to understand thequestions over the effectiveness of this dualfunction. This has been compounded furtherby the special role that non-executive directorshave assumed as arbiters of executive remu-neration. This role has attracted much atten-tion and some hostile criticism (Forbes andWatson, 1993, Main and Johnson, 1993). Theextent to which non-executive directors withexpertise and background in the same sectorcan be effective arbiters of remuneration levels within that sector becomes debatable.Similarly, unlike the independent members of Standards Committees, the dual function of non-executive directors often requires adegree of expertise and relevance in respect ofbusiness background or sector-specific knowl-edge of the business operation. The effectivestrategic advisory role appears to demandthis. Yet, this type of relationship, connectionand experience is specifically disallowed inthe appointment of independent members ofStandards Committees. The narrowness andfocus of function of the latter facilitates the actof disallowing such relationship and experi-ence. Through this process and definition offunction one can acknowledge that a greaterdegree of objectivity is permitted and securedin relation to the public assessment of ethicalbehaviour and proper conduct. It certainlyavoids any danger of regulatory capture(Peacock, 1983).

The “new ethical framework” – theCode of Conduct

Under the local authority regime, the ModelCode of Conduct was detailed in the StandingInstrument Order of 2001. The approach is oneof seeking to encourage an ethical environ-ment and the development of an ethical organ-isation through the adoption of a detailedprescription of content supported by a general

framework for the operation of the Code (SBEGuidance, 2001).

Before looking at the detail of the Code, it isimportant to understand when the ModelCode of Conduct will apply to a member.Under the general provisions, it is clear that amember must observe the authority’s code ofconduct whenever he or she:

(a) conducts business with the authority;(b) conducts business of the office to which he

has been elected or appointed;(c) acts as a representative of the authority.

The Code contains a number of general dutiesas well as detailed rules on the registra-tion and declaration of interests. The generalduties include a positive obligation onmembers to:

• Promote equality by not discriminatingagainst others.

• Respect confidential information.• Listen to the advice of the authority’s moni-

toring officer and Treasurer when it relatesto possible legal decisions or spending.

• To inform the Standards Board if they rea-sonably believe another has broken a localcode (“a whistleblower duty”).

Within the general duties there are also anumber of negative obligations which statethat members must not:

• bring their authority or office into disrepute;• misuse their official position to their own

advantage or to give advantage, or disad-vantage to others;

• unduly influence any person who works forthe authority;

• stop somebody seeking or getting copies ofdocuments they are allowed to have;

• misuse the authority’s resources or author-ise their mis-use.

In addition to these general duties there existsa Register of Interests. This is a public registerof members’ interests, including financial andother interests (such as the receipt of gifts andhospitality). There is a requirement to registerinterests with the authority’s monitoringofficer within 28 days. These interests includedeclarations of the following:

• Who you work for and what you do.• Any business you may have.• Any firm in which you are a partner or paid

director.• Anyone other than the authority who has

paid towards the cost of your election or thecarrying out of your duties.

• Any corporate body with land or a place ofbusiness in the authority’s area in whichyou hold more than 1 per cent of the total

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shares or shares with a nominal value ofover £25,000.

• Any contract for services between yourauthority and you or a firm you are a partnerof, a paid director, or in which you have ashareholding that requires registration.

• Any land in the authority’s areas which youown or rent, or for which you have a licence.

• The location of any property in the area ofwhich the authority is the landlord and thetenant is a firm in which you are a partner,a company of which you are a paid director,or a company in which you have a share-holding which requires registration.

In addition, there is an obligation to declaremembership, management or position ofgeneral control in:

• Any body on which you represent theauthority.

• Any public authority.• Any company, industrial or provident

society, charity or body with a charitablepurpose.

• Any body primarily intended to influenceopinion or policy.

• Any Trade Union or professional association.

You must also inform the monitoring officerabout any gift or hospitality you receive whichis, or might be, connected with your role as amember, and is worth more than £25.

In addition to these specific requirements ofdeclaration and public notice, there exist controls on members’ abilities to remain atmeetings in which the authority’s business isconducted. These controls relate to the pres-ence of personal or prejudicial interests. Per-sonal interests are interests that affect members’ability to participate in a meeting. Membersare obliged to disclose the personal interestand to take part and then vote in the meeting.This is regarded as a “disclose and stay” pro-vision. A personal interest is one that mightreasonably be regarded as affecting individ-ual, family, friend, employer or partner, etc.more than any other people in the area. It issignificant that it is a member’s judgement asto whether a personal interest has beenaffected and should be disclosed. It should benoted that the concept of personal interestextends beyond interests which affect you,your partner, relative, friend or employer butalso includes interests in organisations inwhich you, relatives or friends hold a positionof control or management.

Prejudicial interests on the other hand areknown as “disclose and go” provisions. Onceagain you declare the interest, but in this caseyou withdraw from the meeting and do not

participate in any discussion or voting thattakes place. The concept of a prejudicial inter-est is an objective argument of a potential con-flict of interest: “if a member of the public,who knows all the relevant facts would viewyour personal interest in the issue being dis-cussed to be so great that it is likely to preju-dice your judgement of the public interest,then you must leave the meeting” (SBE Guid-ance, 2001). It is an interest that is so signifi-cant that a reasonable person would regard itas likely to prejudice judgement.

How does this relate to the corporate world? Inrespect of the general obligations in dealingwith others and dealing with colleagues thenthere exists no similar requirement except thegeneral position of employment law and anti-discrimination legislation. Similarly, any activ-ity of disrepute may affect your position as anexecutive or non-executive, but the situation isnot absolute or as clear as that detailed in theethical framework applying to members of relevant authorities and their Standards Committees. In the corporate world, it is oftenleft to individual judgement and, on occa-sions, the collective judgement of shareholdersand interested parties. There is no commonapproach operating across the corporate sectorsimilar to that found under local authoritygovernance rules. In the public companycontext, however, there are controls on accessto public documents that must be adhered toin the corporate context.

In respect to the range of prejudicial andpersonal interests, then directors in companiesare subject to both statutory, common law andequitable controls. The most significant of thelatter are the duties of honesty, propriety andloyalty developed through the categorisationof directors as fiduciaries. These include thebroad duties of acting in good faith in theinterests of the company; exercising theirpowers for proper purpose; and not delegat-ing their powers. It has also been establishedthat an improper exercise of a fiduciary power may form the basis of a petition underThe Companies Act 1985, Section 459 for relief from “Unfairly Prejudicial Conduct”.2However, for specific relief in the areascovered by the Ethical Code on Local Author-ities, one needs to look to the fundamentalduty of a fiduciary. This is a duty of loyalty tothe person on whose behalf the fiduciary acts.It is from this fundamental duty that a numberof rules stem which are intended to precludea fiduciary from being swayed in his actionsby considerations of personal interests orinterests of a third party (Finn, 1992). This iswhere one would hope to find some correla-tion between the personal and prejudicialinterest controls on local authority members

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and the control of company directors. In a corporate context, the specifics include therequirement that a director may not personallyenter into a contract with the company or holdinterest in any of the company’s contracts, forexample by being a partner in or by holdingshares in another company with which thecompany contracts. However, in a commercialcontext this rule is qualified to allow the ruleto operate practically. The qualification is thata director can contract or have an interest in acontract with a company where he is author-ised by the company’s articles or the interesthas been properly disclosed to the companyand the company has consented to a director’sparticipation. The company for the purposesof disclosure and consent means a share-holders and general members meeting. Thisrequirement can be and normally is modifiedby the articles to provide for the board to actinstead of the general meeting for thispurpose. Hence, Table A provides that a direc-tor is permitted

(a) to be party to or otherwise interested in, atransaction or arrangement with the companyor in which the company is otherwise interested,and (b) to be a director, officer or employee of anybody corporate promoted by the company or inwhich the company is otherwise interested, thedirector may also be a party to, or interested in,any transactional arrangement with any bodycorporate. Provided that in either case the direc-tor has disclosed to the directors the nature andextent of any material interest. (Table A, Com-panies Act, 1985).

This is a compromise between “disclose andstay” and “disclose and leave” in that thedirector who has disclosed such an interestmay stay and attend the meeting, but is notcounted in the quorum and may not vote atany important meeting where the matter isconsidered.

In addition to these rules, a director maygive a general notice of interest and an inter-est of which a director is unaware is deemednot to be his interest, provided it was unrea-sonable to expect a director to have thatknowledge.

Legislation places a further disclosure obli-gation on directors where they have interestsin company contracts. Section 317 of theCompany’s Act 1985 imposes a duty on direc-tors to declare to a meeting of the directors the nature of any interests that they have inany contract or proposed contract with thecompany. The disclosure must be made at ameeting of the board and, with some excep-tions, it must be at the time when the questionof entering into a contract is first considered.

Under Section 317, the disclosure obligationdoes not limit itself to a material interest.

Unlike the public authority regime, wherebreach results in a focus on the position of theauthority member, in the corporate regimebreach initially focuses on the status of thecontract and the transaction. In the former, thefocus on the member results in a full range ofpersonal penalties being available, includingthat of removal from office. The range alsoincludes the full extent of criminal liability ifthe conduct was one of seeking to confer a per-sonal benefit to the detriment of the publicauthority. In the corporate context, the focus isupon the transaction whereby the transactionis avoidable and may be set aside at the insis-tence of the company provided that the conditions for avoidance are satisfied. The corporate context also includes the ability torender the director liable to make good anycompany’s loss represented by the transactionentered into. The statutory regime through theCompanies Act 1985, Section 317, can lead toa fine, although there is some debate throughrecent court decisions as to whether a techni-cal breach of Section 317 would be sufficient tosupport a fine.3 Despite this uncertainty, it isclear that the corporate and public authorityregimes that support strict disclosure areproper in that they provide, through the com-mittee or board meeting minutes, a record forsubsequent controllers of the organisation tobe aware of interests and activities of membersand directors and also supports the opennessand transparency required in contributing toconfidence in local authority and in corporatedemocracy.

The issue of prejudicial interest is not onethat is specifically addressed in the corporatefield through the statutory or common law ofduties of directors. It could be said to beimplicit in the requirement to act in thecompany’s best interests. Nonetheless, there isno strict requirement of disclosure or with-drawal as in the public authority regime.Despite this, there might be an indirectrequirement to disclose and withdraw, if oneseeks to carefully construct an action andremedy under the Companies Act 1985,Section 459, for unfairly prejudicial conduct.There have been instances of success underSection 459, where the involvement of keydirectors in influencing decision making wereheld to be unfairly prejudicial.4 But in relyingupon this aspect, the corporate regime is at adistinct disadvantage in that few litigants cansupport the financial uncertainties of a Section459 action and the scope of Section 459 seemsto increase in uncertainty on a daily basis. Torely upon the general requirement of acting inthe company’s best interests with the back up

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position of an obligation not to act unfairlyprejudicial to the interests of members (and nowider interests) is insufficient in controllingthe conflict of prejudicial interests and fallsbelow the level of control of similar conflictsand interests of members of public authorities.

Standards Board vs Standards Board

In the public authority context, the creation ofa Standards Board for England was deemedessential in order to receive both the Codes ofConduct from the various Standards Com-mittees, but also to be a source for judging and approving those Codes of Conduct andfor conducting, investigating and imposingpenalties for breach. It is a body that is clearlyindependent from the Standards Committeesthemselves and is one that can promote anational commonality of expectation andenforcement. Since its creation, it has beenvery open in terms of its discussions and nego-tiations with interested parties and in itsattempts to seek to support and advise thoseappointed to Standards Committees. In the UScorporate context, we have seen a recentresponse to public concerns over both directorconduct and reporting mechanisms in thestrengthening of the regulation and the pro-motion of common standards and expecta-tions through the introduction of a “PublicCompany Accounting Oversight Board”(Shlaes, 2002).

In the UK context, a proposal was includedin the Modern Company Law Review FinalReport (MCLR, 2001) for the development ofa Standards Board. This was in response tosome of the concerns over the private natureof initiative and Codes of Best Practice andGovernance. The Standards Board was identi-fied as being central to the proposed regula-tory and institutional framework for companylaw reform and its future development.Included within its terms of reference will bea responsibility for the development, monitor-ing and enforcement of the combined code(MCLR, 2001, para. 5.42). It is envisaged thatthe Standards Board will have responsibilityfor keeping under review the operation andeffectiveness of the Code and will considerwhether at any point a re-examination of theCode is desirable. If there was a general con-sensus that the Code should be revisited, it isenvisaged that the work would be carried outunder the ultimate authority of the StandardsBoard. The Standards Board would also beresponsible for setting the detailed rulesrequiring certain companies to disclose compliance or otherwise with the Code ofConduct. The Standards Board would thus

become the regulatory body charged withensuring proper compliance with the Code ofConduct and generally seeking to enhance theeffectiveness of corporate governance. It isnoted that the Standards Board would beexpected to operate its review proceduresthrough consultation and discussions with awide range of interested parties. A more recentWhite Paper gives further support to the cre-ation of a Standards Board (White Paper 2002).

Thus the monitoring, enforcement anddevelopment role of the Standards Board forcompanies is similar to the role currently per-formed by the Standards Board for England inrelation to local and relevant authorities. Oneof the clear advantages that the StandardsBoard for Local Authorities enjoys is its abilityto converse with Standards Committees,including independent members of StandardsCommittees, and its ability to approve andsupport the enforcement of clear Codes ofConduct for each local authority. The absenceof a Standards Committee in the company lawregime and the absence of an obligation tosubmit for consideration and approval Codesof Conduct is a gap in the approval andenforcement ammunition of a Standards Boardfor companies. It is this narrowness of focusand function that would distinguish such acorporate Standards Board from any generalDepartment of Trade and Industry role.

The monitoring officer andgatekeeper liability

In the corporate context, there has been a longdebate as to how best to tap the private inter-ests of enterprise participants to serve thepublic interest. To a large extent proponentsand critics of structural reform in corporategovernance have remained divided overwhether participants within the enterprise orexternal institutions should define and policeresponsible corporate activity. To an extent,this becomes a question of how external con-trols ought to be crafted and enforced, andwhom they ought to target. For example,should we rely upon liability rules directedsolely at the corporation to assume compli-ance with legal norms or should we imposeabsolute legal duties and sanctions on indi-vidual participants in the firm as well? Thisdebate can be seen in the public sector devel-opment of the Standards Board for local andrelevant authorities. Although the Board ischarged with the development and enforce-ment of good governance and the promotionof local democracy, a recent White Paper(DTLR, 2002) seems to suggest that sanctionswill be imposed upon individuals who will

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have a local responsibility for monitoring and policing compliance with the Code ofConduct. Those individuals are known asmonitoring officers. The White Paper does notreplace the powers (known as Section 66powers) of the Standards Board to investigatealleged breaches of the ethical Codes, but itdoes provide a situation where the StandardsBoard can delegate this power to local Stand-ards Committees. In doing so, it appears thatthe role of the monitoring officer is pivotal andcentral to the local conduct of investigationsand the determination of breach. In the WhitePaper (DTLR 2002) it proposes (paras 41 and42) that the monitoring officers role includesone of providing good advice to members,officers and the public on the operation of theCode, and how alleged breaches should beinvestigated. It also states that monitoring officers will need to be able to conduct inves-tigations into some cases referred to local Standards Committees. They will thereforeneed powers to:

• Arrange for any person to assist him or herin the investigation.

• Make enquiries of any person he or shethinks necessary.

• Obtain advice from any person who he orshe believes is qualified to provide it and topay that person any fee or allowance that heor she sees fit.

Discussions with monitoring officers andStandards Committee members confirm thatmonitoring officers are placed at the heart ofthe local determination of the meaning andapplication of the Codes of Conduct (Work-shop). The White Paper clearly places moni-toring officers in a central position in relationto the investigation of allegations of breachand in determining and advising on remedies.Despite many monitoring officers possessinga professional legal education and back-ground, it is clear that they feel they are placedin a vulnerable position – particularly whenone considers the conflict between their advi-sory role and their investigatory and sanction-ing role. In a sense, they are now becoming the“gatekeepers” of the Code at the local level,while exposing themselves to personal liabil-ity in relation to advising on the interpretationand application of the Code and their conclu-sions on activities and breach by individualmembers. On a positive side, this proposalintroduces a local element and a local cham-pion for the promotion of ethical conduct –albeit that local champion is introduced intothe framework on the basis of potential “gate-keeper” liability.

In a corporate context, Kraakman (1984) hasargued for the introduction of gatekeeper lia-

bility in order to promote good governance.He saw the need for informed local competentindividuals who would be champions of governance through their own position ofabsolute liability should good governance fail.Kraakman developed the possibility of gate-keeper liability in a situation where the legalsystem suffers enforcement insufficiencythrough being unable to detect or prosecute asignificant proportion of offences or wrongdo-ing. A response to this insufficiency is to delegate enforcement to private actors (orgatekeepers) supported by a position ofabsolute liability. This is the preferred systemof gatekeeper liability advocated by Kraak-man. Potential targets of gatekeeper liabilityare identified as including outside directorsand lawyers, accountants and underwriters(Kraakman, 1984, p. 892). The suggestion isthat these outsiders can simultaneously serveas internal monitors of board behaviourbecause they possess privileged informationabout firm operations which is inaccessible topublic enforcement officials or other internalplayers. Enforcement insufficiency existswhere enterprise and individual abilities failto present sufficient compliance, at acceptablecosts. Much of recent debate over directors’duties and enforcement in the ModernCompany Law Review (MCLR, 1988–2001)raises questions over the cost-effectiveness ofenforcement alternatives.

Kraakman’s focus on enforcement insuffi-ciency was centred on the firm’s top partici-pants. The imposition of liability on outsidersor independent directors was seen as beingfacilitative, both in terms of their skills andknowledge, but also in terms of any risksharing through professional indemnity insur-ance. The findings in this area inspired Kraak-man to conclude (1984, pp. 897–898) that onlyone alternative remained, namely the possibil-ity that civil law and liability could inducefirm participants outside the circle of con-trolling managers to discover and preventoffences or wrongdoing. These participantsare potential gatekeepers. The scope of theirliability as gatekeepers would depend on thereach of their duties to monitor for andrespond to corporate wrongdoing. Gatekeeperliability joins the risk of absolute liability withan active duty to monitor for wrongdoing. Itimposes liability on an entirely new class ofinnocent gatekeepers to reduce enforcementcosts, the frequency of wrongdoing or both.True gatekeeping liability is designed to enlistthe support of outside participants in a firmwhen controlling managers and directorscommit wrongdoing or grossly underperform.The issue of scope and duties and incentive tomonitor and act are developed further in

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another paper (Kirkbride and Letza, 2002).Nevertheless, at this stage it is sufficient topoint out that the gatekeeper role (in the cor-porate context) includes the duties of moni-toring and enforcing good behaviour andgovernance, and is similar to the proposedduty imposed upon monitoring officers in thecurrent White Paper (DTLR, 2002) under thepublic authority regime. Those monitoringofficers would not only have a duty to advise,but also to monitor conduct and enforce andinvestigate potential breaches of that conduct.Failure to effectively monitor and enforce,together with any process of negligent adviceexposes the monitoring officer to liability,albeit a situation of professional negligencerather than a situation of absolute strict liabil-ity. It will be interesting to see how the WhitePaper proposals develop into secondary legis-lation under the Section 66 Rule Procedureand how monitoring officers cope with theinherent conflicts of advising boards and individuals while exposing the officer to thepotential of having to investigate and imposepenalties on the same individuals and boardsirrespective of whether that is a consequenceof, or independent from, the advice advancedinitially by the same monitoring officer.

Conclusion

As this paper (and Table 1) illustrate, thepublic authority regime, in response to theconcerns identified by the Nolan Committee,has responded stringently and quickly to therequirement of seeking to restore confidence

in local democracy and to seek to promoteethical governance within the public authorityregime, both at committee operating level andon an individual professional level. It is nowmore advanced than the corporate regime inthat its duties are more explicitly defined bystatute with an over-riding objective duty inrespect of the procedures to be adopted for adefinition of prejudicial interest. Furthermore,it includes the involvement of an independentStandards Board to provide commonality ofindependence across the whole of the 100,000+committee-members’ operations. It is interest-ing to note that the Modern Company LawReview has similarly speculated upon anindependent objective Standards Board toperform the public requirements of, and theprivate initiative of, developing and monitor-ing Codes of Conduct. Similarly, the currentDTLR White Papers proposal for advancingthe public authority regime contains a systemof gatekeeper liability with obligations beingimposed upon the local monitoring officer.Gatekeeper liability has in the past been pre-ferred as being an effective response to therequirements of the corporate world, but hasyet to be introduced. Perhaps reflections on itsoperation and development in the publicauthority world will encourage its develop-ment and introduction in the corporate world.It is clear that both the public and privateauthorities have a shared agenda in terms ofseeking to restore confidence in ethical gover-nance. The consideration of the post Nolandevelopments in the public authorities worldand reflection on those should be used toinform the post Enron debate in the corporatesector.

Notes

1. This best practice recommendation is based onthe Combined Code, which is appended to theListing Rules of the London Stock Exchange.

2. An improper exercise of a fiduciary powerformed the basis of a petition under The Com-panies Act 1985, s.459 for relief from unfairlyprejudicial conduct in Re DR Chemicals Ltd(1989) 5 BCC 39.

3. There is a difference of view in first instancecases on this point. See Neptune (Vehicle WashingEquipment) Ltd v. Fitzgerald [1995] BCC 474; andRunciman v. Walter Runciman plc [1992] BCLC1084.

4. An example can be found in Re DR ChemicalsLtd (1989) 5 BCC 39.

References

Cadbury (1992) Report of the Committee on the Finan-cial Aspects of Corporate Governance. London: Gee.

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Table 1: Differences between public and privatesector non-executive/independent directors

Public Privatesector sector

Legal code ✓ ✗Voluntary code ✓ ✗Standards Committee ✓ ✗Nomination Committee ✗ ✓Full, open & transparent ✓ ✗

appointmentGenuine independence ✓ ✗Focused remit ✓ ✗Declaration statement ✓ ✗Monitoring officer ✓ ✗Appointee familiar with ✓ ✗

ethical issuesGatekeeper liability ? ✗

CORPORATE GOVERNANCE AND GATEKEEPER LIABILITY 271

Charkman, J. (1995) “Keeping Good Company”.Oxford: OUP, 268–271.

Cosh, A. D. and Hughes, A. (1987) The Anatomy ofCorporate Control: Directors, Shareholders andExecutive Remuneration in Giant US and UKCorporations, Cambridge Journal of Economics, 11,285.

DTLR (2002) Conduct of Councillors – Local Investiga-tion and Determination of Misconduct Allegations, AConsultation Paper. London: HMSO, May.

Financial Times (2002) Non Executives Fill 50% ofBoard Seats, Financial Times, 15 May 2002.

Finn, P. D. (1992) Fiduciary law and the moderncommercial world. In E. McKendrick (ed.) Com-mercial Aspects of Trusts and Fiduciary Relationships.Oxford: OUP.

Forbes, W. and Watson, R. (1993) Managerial Remu-neration and Corporate Governance: A Review ofthe Issues, Evidence and Cadbury Committee’sProposals, Accounting and Business Research, 91A,331.

Greenbury (1995) Directors’ Remuneration: Report ofa Study Group chaired by Sir Richard Greenbury.London: Gee.

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Kirkbride, J. and Letza, S. (2003) Gatekeeping theCEO: The Role of Law, Self-Regulation and Inter-nal Mechanisms. 54 Northern Ireland Legal Quar-terly, 1–24.

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Main, B. E. M. and Johnston, J. (1993) RemunerationCommittees and Corporate Governance,Accounting and Business Research, 91A, 351.

MCLR (1998) Modern Company Law for a CompetitiveEconomy. DTI, London.

MCLR (1999a) Modern Company Law for a Competi-tive Economy – Developing the Framework. London:DTI.

MCLR (1999b) Modern Company Law for a Competi-tive Economy – The Strategic Framework. London:DTI.

MCLR (2001) Modern Company Law for a CompetitiveEconomy – Final Report. London: DTI.

Nolan (1996) First Report of the Committee on Standards in Public Life. Cm 2850. London: HMSO.

Peacock, A. (1983) The Regulation Game. Oxford:Basil Blackwell.

Pro Ned (1992) Research into the Role of the Non-Executive Director. London: Pro Ned.

SBE Guidance (2001) Guide to Part III of the LocalGovernment Act 2000. The Standards Board forEngland.

SBE Guidance (2002) Guidance on Standards Com-mittees. The Standards Board for England.

Shlaes, A. (2002) The Danger of Holding a Profes-sion to Account, Financial Times, 2 July.

White Paper (2002) Modernising Company Law. Cm5553. London: HMSO.

James Kirkbride is Dean of the Faculty ofBusiness and Law at Liverpool John MooresUniversity and Professor of International Business Law. His research interests includecorporate law and governance, regulation andcompetition controls.Steve Letza is Professor of Corporate Governance at Leeds Law School, Leeds Metropolitan University. He is a foundermember of the Research Forum on Opera-tional Risk, which advises bodies such as theBank of England and the Financial ServicesAuthority on policy. His research interestsinclude corporate governance and perfor-mance management.

© Blackwell Publishing Ltd 2003 Volume 11 Number 3 July 2003