House of Commons - Dairy Farmers of Britain - Environment, Food and Rural Affairs Committee

Dairy Farmers of Britain - Environment, Food and Rural Affairs Committee Contents

3 Governance and accountability

43. The governance structure of DFB comprised a Board, an Executive Team and a Members Council. The Members Council were elected from among the farmer members and acted as their representatives. The Members Council voted on Board proposals on members' behalf. A group from the Members Council commented: "The relationship between the board, executive and council appears to have been dysfunctional."[83] When we began the inquiry, it was not, as we have explained, our intention to discuss in detail the behaviour or personalities of individuals. However, it is difficult to comment on the governance of DFB without at least touching on personalities. We heard various and sometimes conflicting accounts from those who had been involved in the governance of DFB. Feelings clearly still run high—understandably, given what happened to the business in the end. Some conflict is to be expected when running a business; indeed, some tension may be beneficial. However, there also comes a point when such antagonisms are in danger of becoming a distraction and an obstruction to the effective operation of a business. In pursuing a challenging vertical integration strategy, with limited capital-raising ability, DFB's difficulties were compounded by a governance structure that did not function as well as its members were entitled to expect.

The Board and the Executive Team

44. DFB's Board initially consisted of five farmer directors and three non-farmer, non-executive directors.[84] Later, the ratio changed to six to four.[85] Unlike Milk Link and First Milk—the two remaining large UK dairy co-operatives—DFB did not have any executive directors on its Board. Mr Knight, the former Chairman of DFB, stated that the relationship between the Board and the Executive Team was "excellent", describing it as "professional, courteous, friendly and testing".[86] Mr Oakes, a farmer director on the Board, characterised the relationship as "challenging"—by which he seemed to mean that the Board expected the Executive Team to deliver and if they did not, the Board wanted to know why. He commented that the Board had "got rid of one chief executive relatively soon after we had taken over ACC".[87]

45. The Chief Executive in question, Mr Malcolm Smith, stated that, in the course of his career, he had been a CEO "for a lot of years" and that he had "never not been on the board". He described the lack of executive directors on the Board as one of the problems with DFB.[88] Mr Knight commented that the reason why executives were not on the Board "is because it was not actually provided for within the constitution or the rules of the business".[89] While Mr Smith may have overstated the case when he commented that his absence from the Board "was a major and fundamental reason why the company went down", it is hard not to agree with him that DFB's governance would have been improved by the presence of executive directors on the Board.[90] The lack of executive directors on DFB's Board was a weakness and should have been addressed, even if this meant a rule change. It is important for members of the Executive Team to be represented on the Board in farmer-owned co-operatives, as in other businesses.

FARMER DIRECTORS

46. Mr Stephen Yates explained that it was the Members Council, of which he was the Chairman from October 2006 until June 2009, that wanted a majority of farmer directors on the Board, to protect the interests of the farmer members. However, he said that, with hindsight, he thought that the Members Council would have become less concerned about the balance between farmer and non-farmer directors.[91] He commented: "The key strength the farmer directors have is that they are the key communication tool because they can stand up in front of a meeting of farmers and deliver the good, the bad and the ugly in a robust manner."[92]

47. Others were concerned about the farmer directors on the Board: one former DFB member described them as "out of their depth".[93] The NFU emphasised the "need for Farmer Directors be properly supported, trained, highly skilled and have the ability to manage large and complex businesses". It commented: "These requirements are not easy to find when most farmers are accustomed to running single operations or sole trading businesses."[94] When we asked Mr Oakes, one of the farmer directors, how he was prepared for his role, he commented: "We did spend quite a bit of time with the non-execs on the board. [...] We learned from them."[95] He also mentioned going on a risk management course and attending relevant conferences.[96] Mr Knight, the former Chairman of the Board, said that he sat down with each of the directors on an eight-weekly basis to "talk about progress and areas that they were feeling confident about or less confident about".[97]

48. Mr Bill Mustoe, the Chairman of First Milk, told us that he was considering a different approach to choosing farmer directors. At present, farmer directors are elected to First Milk's Board. He commented that to be successful in the process, you had to be two things: "you have to be a dairy farmer [...] and you have to know how to win local elections." He suggested a system under which half the directors were elected and the other half were selected. Selection would involve members nominating other farmer members with "proven business acumen" who might not necessarily have come forward under the election system. He stated that this would involve a rule change and would need to be put to the AGM.[98]

49. Farmer directors have a valuable part to play on the Boards of farmer-owned businesses, although we are not convinced that they need necessarily make up the majority of the directors. It is vital that both they, and the non-farmer directors, receive regular and appropriate training—from both internal and external sources. The annual reports of agricultural co-operatives should contain a section detailing what steps have been taken to ensure that farmer directors are properly trained and supported for the important job they undertake.

SPECIFIC CONCERNS

50. In addition to the more general points that were raised about the Board of DFB, two very specific issues were drawn to our attention by individual farmer members and farmers on the Members Council. First, there was concern about the fact that Mr Knight took on the role of Chief Executive in addition to his role as Chairman, during 2005, after the acquisition of ACC and the dismissal of Mr Malcolm Smith. One former director of DFB who wrote to us referred to "major powers" being placed in the hands of one individual.[99] A group from the Members Council commented that the dual role was "substantially financially rewarded with over £400,000 paid to the executive-chair in the financial year 2005-2006".[100] Mr Knight confirmed that his remuneration was "of that sort of order". He stated that he was "employed right from the outset on a daily rate" and that when he took on the post of Chief Executive, this daily rate, "happened to be then for a full-time period".[101]

51. We asked Mr Knight why he had taken on both roles and whether the Board had discussed the matter. He stated that it was "absolutely at the board's request", commenting: "when we started to look at the issues we were facing with ACC and the different skill sets which we would need to control a business of that sort of size, that was when we decided to modify and change the people that were in the business at the time".[102] When we put it to him that it was not recommended practice to combine the roles, he replied: "That is why it was for a short period of time."[103] On being asked how long he held both posts, he told us that it was "nine months to a year, perhaps".[104] A period of nine months to a year does not strike us as a particularly short time. Nor is it clear to us why DFB could not appoint an outside Chief Executive to fill any perceived skills gap, as it did eventually. Moreover, when the daily rate Mr Knight was paid to act as a non-executive Chairman was originally agreed, it was presumably not envisaged that this rate would ever be paid on a full-time basis. We accept that the rate was approved and published in the annual accounts, but we do not accept that paying a Chief Executive at a daily rate—a rate that was originally agreed for a different and part-time post—offered value for money.

52. The second specific issue that was raised with us concerned Mr Moody. A group from the Members Council commented that there was concern "that there was a board level conflict of interest". It stated: "DFB board director Philip Moody was also a Director of Smith [and] Williamson Corporate Finance who evaluated proposals and advised in these areas providing support to the chairman and board for considerable financial reward."[105]

53. Mr Moody told us that he was originally approached to join the Board of DFB in July 2003, at a time when he was already working for Smith and Williamson, because DFB's acquisition-driven strategy meant that there was a need "to have corporate finance skills on its board". [106] He stated that, whereas larger businesses tended to have their own mergers and acquisitions teams, DFB chose instead to ask him to join the Board and to invite his team "effectively to be an outsource of that M&A [mergers and acquisitions] project management capability that would be done in-house in a larger business".[107] He commented: "we could not act as independent advisers to the board because that would be in clear conflict with my position as a board director."[108] Thus when DFB was purchasing ACC, Smith and Williamson were project managers, rather than corporate financial advisers—a role which was taken on by Rabobank. However, Mr Moody said that, in the case of smaller acquisitions, such as the Lincoln dairy, Smith and Williamson did offer advice "because the transactions were of much less significance and it was believed that there were fewer judgmental issues and more process issues involved".[109]

54. Mr Moody stated that he "was not personally involved in either securing work for Dairy Farmers of Britain or in delivery" and that "All of the services delivered by Smith & Williamson were headed up by somebody other than me", but he added:"of course, in my role as strategic director for Dairy Farmers of Britain, I worked very closely with my team that were engaged to do work for DFB."[110] When we put it to him that he stood to gain financially from the work Smith and Williamson did for DFB, he replied that he was a fixed share partner in Smith and Williamson and stated: "What that meant was that my personal remuneration was not influenced by one penny as a result of the fees paid to my firm."[111] When pressed about the perceived conflict of interest he replied: "I am not denying that there was a conflict. What I am saying is that the role of my firm was completely transparent; it was well governed in terms of its corporate finance process."[112] He added: "I am completely satisfied in my own mind that my judgment in acting as a director of Dairy Farmers of Britain was not at any time impaired by the conflict to which you allude."[113]

55. We have no reason to believe that, in practice, Mr Moody's judgment as a director of DFB was impaired or influenced by his role at Smith and Williamson. However, it is not difficult to see why, to the wider membership, this relationship must have appeared, as one farmer member put it, "very cosy".[114] The perception of a conflict of interest can cause damage, even if the individual concerned is satisfied that they have behaved responsibly. For this reason, we believe that advice and assistance, including project management, is best provided by companies and individuals that have no other connection with the directors of the business to which they are providing the service.

The Members Council

56. Mr Yates, the former Chairman of the Members Council, outlined the Council's principal role and powers as follows: "the selection and election of the board, the appointment of the auditors, the authorising of any rule changes, [and] the authorising of the business's ability to borrow money and to spend that money". The initial ceiling on the Board's borrowing—that is to say the amount the Board could borrow without the approval of the Members Council—was £100 million, but this was raised to £200 million two years after DFB's formation.[115]

57. These are significant responsibilities. Opinion about how successful the Members Council was in discharging them varied, but was largely positive. Mr David Wilkinson, a director of DFB, commented: "Ultimate company governance lay with the council, and it is my opinion they undertook this well."[116] He commented favourably on the amount of external advice that was available to the Members Council.[117] Mr Oakes, a director of DFB, told us that DFB "invested a lot of money in training the council".[118]

58. One farmer member who wrote to us, however, stated: "the council just rubber stamped any decisions taken by the board. [...] The members of the council did not recognise any of the warning signs that indicated that the company was in trouble."[119] A significant occasion on which the Members Council clearly did not simply rubber stamp decision-making by the Board was on 27 March 2009, when it turned down a Board proposal to raise £20 million of new equity via retention from members' milk cheques.[120] However, comments made by Mr Yates himself suggest that there were a few times, particularly in the early days of DFB, when the Members Council was not quite as robust as it might have been. Mr Yates believed that, to start with, the Council was "too large". Membership was subsequently reduced from 82 to 62 and then to 35.[121] Mr Yates also told us that, when DFB was initially formed, "the non-exec directors at that stage were gifted to us by the interim board" and that the Members Council simply formally elected them.[122] This was a decision he seemed to regret in hindsight. Speaking about the appointment of Mr Knight, he commented: "Last night I read through what we were told, the fact file on the new appointments, and I am aghast that we accepted it then".[123]

59. In carrying out its responsibilities effectively, the Members Council depended on communication from the Board. Mr Oakes said the Members Council "could access the board very easily".[124] Mr Yates's comments about the relationship between the Board and the Members Council back this up, although they also make it clear that it was sometimes difficult for the Members Council to obtain the information it needed, particularly in relation to DFB's banking arrangements. Mr Yates commented that, in addition to formal Council sessions, he met the Chairman of the Board privately "probably once a month" but added: "He was not a man who liked to share information with us."[125] He told us: "The area that they [the Board] never took us into was the banking, the key area."[126] When we asked why the Council did not press for such information, particularly when changing the ceiling on borrowing limits, Mr Yates replied: "I think it was made pretty clear to us that that was an area of detail that we were not entitled to."[127] Mr Knight stated in contrast that the Board were "very open with the council", but that "the decision and the judgment always was about information that was confidential, that could have been damaging to the business if it got out into the wider world, that was customer sensitive, all sorts of information like that".[128]

60. While a Members Council can be a useful part of the governance structure of a co-operative, its ultimate effectiveness depends on its willingness to use its powers, and on regular and, so far as is possible, frank communication from the Board. The Council should not have to press the Board for information: sometimes the Council will not be in a position to know what information to seek. The presumption should be that the Board will actively share information with the Members Council unless it is prevented from doing so by the need to preserve commercial confidentiality. It is hard to see how a Members Council could be in a position to approve changes to the ceiling on borrowing if it did not feel that it could ask detailed questions about banking arrangements.

Communication with members

61. Related to the issue of communication between the Board and the Members Council is communication with the wider membership. The Farmers Union of Wales commented that in the months leading up to DFB's collapse, it had been contacted by farmers who had concerns:

Foremost amongst these was the concern that projections and assurances made by DFB officials regarding the financial wellbeing of DFB were unfounded, and that a lack of transparency regarding such matters was restricting the ability of DFB members to make balanced business decisions.[129]

Mr Brown, a DFB member who sat on the Members Council until 2008, commented: "If I relied upon what had come from Council meetings, what had come through on the official channels, I would have had a completely erroneous view of the business."[130]

62. As with communication between the Board and the Members Council, commercial confidentiality is clearly a factor when communicating with the wider membership. Mr Oakes, a Board member, commented: "You wanted to tell the membership as much as you can about where the business was. [...] You feel they have a right to know but there is confidential information and there is commercial information there."[131] There is also a balance to be struck between maintaining members' confidence in their business and pointing to potential problems. However, there is a danger that guarded communication only encourages speculation about what the true position of the business might be. As Mr Jones, the NFU's National Dairy Board Chairman, commented: "if you do not communicate effectively others will do it for you, and that is what happened."[132]Lord Grantchester told us that he tried to improve communication when he became Chairman in November 2008.[133]

63. We recognise that it is difficult to strike a balance between providing an accurate picture of the state of a co-operative to its members and not revealing commercially sensitive information. However, we consider that the Board of DFB failed to strike this balance and that DFB members did not receive the quality of information that they were entitled to expect. This breakdown in communication encouraged speculation about the future of DFB and can only have contributed to the business's difficulties.

Registration and regulation

64. The Financial Services Authority (FSA) registers industrial and provident societies, but does not regulate them. It explained its role as follows:

Our main functions under the [Industrial and Provident Societies] Act are twofold: to register societies which provides them with corporate status; and to register their rules (and subsequent changes to those rules) and other relevant documents; we have no duty to regulate these societies under the Act, nor do we monitor their compliance with their rules.[134]

The FSA also has a duty to make documents, such as accounts, available for public inspection. Mr Joe Egerton told us that it is "far slower and more cumbersome" to obtain documents relating to co-operatives from the FSA than it is to obtain the same information on companies from Companies House.[135] Documents filed by industrial and provident societies should be as easily obtainable as documents filed by companies. We urge the Financial Services Authority to improve the way in which it makes such documents available to the public.

65. The FSA commented: "On the basis of the facts as we currently understand them, we do not consider that the collapse of DFB could have been prevented by any proportionate, additional powers being conferred on the FSA under the Act."[136] In response to the question of whether it thought that there was a need for a regulatory authority for IPSs, the FSA expressed the view that: "Conferring regulatory powers over Industrial and Provident societies on a new, or existing, regulatory authority could undermine control of these societies by their members and prejudice the co-operative principles of autonomy and independence."[137]

66. Even as a registering authority, rather than a regulatory authority, there is scope for the FSA to encourage best practice. The FSA stated that it was working with stakeholders to develop codes of practice to "represent our guidance to co-operatives on the standards that we expect as a condition of continued registration under the 1965 Act".[138] It is also part of a group "established to identify the weaknesses in the co-operative model that have come to light since the collapse of DFB".[139] The group, which also involves English Farming and Food Partnerships and Defra, is looking at matters such as skills and training for Board members, governance, and the provision to members of regular trading statements. It plans to publish its conclusions as a code of practice in September 2010.[140]

67. The Financial Services Authority has an important role to play in relation to the effective functioning of industrial and provident societies. We welcome the fact that it is developing codes of practice to clarify what is expected of industrial and provident societies.

68. We look forward to reading the conclusions of the group on the co-operative model to which the Financial Services Authority and Defra are contributing. The code of practice developed by this group should aim to create the best possible environment for decision taking whilst providing maximum protection for members' interests. Attention should be paid in the code of practice to the information requirements of structures such as Members Councils and of ordinary members if they are to be able to act as a check and balance mechanism on decision making by the Board.

Auditing

69. DFB's auditors were Ernst and Young. They were first appointed in 2002 and issued their last audit opinion on DFB on 31 July 2008. This opinion related to the financial year ending 31 March 2008. No audit opinion was issued for the financial year ending 31 March 2009, because the audit was incomplete.[141] Ernst and Young commented that the directors of DFB concluded that the group was a going concern when the 2008 accounts were signed, and stated that it was "satisfied that management's evaluation was appropriate".[142] Under the going concern assumption "an entity is ordinarily viewed as continuing in business for the foreseeable future with neither the intention nor the necessity of liquidation, ceasing trading or seeking protection from creditors pursuant to laws or regulations".[143] Before agreeing with the going concern evaluation, Ernst and Young performed a number of procedures which are set out in full in its written evidence. The issues taken into account include the fact that, although DFB made a loss in 2008, the losses were broadly in line with DFB's three year forecasts, which assumed that DFB would break even in 2009 and return to profitability in the year ending 31 March 2010.[144]

70. Ernst and Young commented that although DFB was an IPS and was not required to comply with the more prescriptive accounting requirements that apply to listed companies, "the Board of DFB sought to adopt practices that were more akin to those of a listed entity wherever practical" and "this resulted in greater disclosures in the 2008 accounts than would otherwise be required by an Industrial and Provident Society".[145] It continued: "For example, DFB included within the 2008 accounts a Business Review, a Statement of Corporate Governance and a Remuneration Report."[146]

71. DFB's decision to adopt some of the auditing standards that apply to listed companies was a move in the right direction. As the case of DFB illustrates, applying these standards cannot prevent the collapse of a business, but it is another way of ensuring that industrial and provident societies are subject to more rigorous evaluation. We recommend that agricultural co-operatives voluntarily adopt such standards wherever possible.

83 Ev 224 Back

84 Q 657 Back

85 Q 672 Back

86 Q 522 Back

87 Q 414 Back

88 Q 743 Back

89 Q 522 Back

90 Q 743 Back

91 Q 672 Back

92 Q 672 Back

93 Ev 218 Back

94 Ev 20 Back