Pirelli & C.

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10. The committee for internal control, risks and corporate governance

10.1 Composition.

The Board of Directors established 62 the “Committee for Internal Control and Corporate Governance”, renamed the “Committee for Internal Control, Risks and Corporate Governance” with effect from 1 September 2009, which is charged with fact-finding and advisory functions, from amongst its members in 2000.

In line with the best corporate governance practice, and going beyond the recommendations of the Self-Regulatory Code, the Committee, appointed by the Board of Directors in its meeting on 29 April 2008 (composed of Carlo Angelici, Franco Bruni and Carlo Secchi) and subsequently extended in its meeting on 29 July 2009, effective from 1 September 2009 (with the appointment of directors Cristiano Antonelli and Luigi Roth), is composed solely of independent Directors, two of whom considered by the Board of Directors to be in possession of adequate experience of accounting and finance matters 63.

At the Date of the Report, the Committee for Internal Control, Risks and Corporate Governance had the following members:

  • Carlo Secchi (Chairman);
  • Carlo Angelici;
  • Cristiano Antonelli;
  • Franco Bruni;
  • Luigi Roth.

The Secretary to the Board of Directors, Anna Chiara Svelto, acts as Secretary to the Committee.

10.2 Tasks assigned to the Committee.

The Board of Directors that convened on 29 April 2008 confirmed the tasks - of a fact-finding and advisory nature – assigned to the Committee for Internal Control and Corporate Governance in line with those specified in the Self-Regulatory Code, and also specified that the Committee should continue to maintain the corporate governance prerogatives that have characterised it since its establishment.

In particular, the Committee for Internal Control and Corporate Governance:

  • assists the Board of Directors:
    • in the definition of policies for the internal control system, so that the main risks for the Company and its subsidiaries are correctly identified and adequately measured, managed and monitored, and also in the determination of criteria for the compatibility of these risks with healthy and correct management of the business;
    • in the identification of an executive director (normally a Managing Director) charged with supervising the operations of the internal control system;
    • in the evaluation, at least annually, of the adequacy, efficacy and effective operation of the internal control system;
    • in the description of the essential elements of the internal control system in the corporate governance report, expressing its evaluation of the system’s overall adequacy;
  • expresses an opinion on proposals to appoint, revoke or assign tasks relating to the internal control officer;
  • with the appropriate Company managers, the officer responsible for preparing the company accounting documents and the auditors, evaluates the correct use of accounting principles and their homogeneous application inside the Group and for the purpose of drawing up the consolidated financial reports;
  • at the request of the executive manager with specific responsibility, expresses opinions on specific aspects of the identification of the main company risks and on the design, implementation and management of the internal control system;
  • reviews the work plan prepared by the internal control officers and their periodic reports;
  • evaluates the proposals formulated by external auditors in order to obtain the commission, as well as the audit plan and the results set out in the auditors’ report and in the letter of suggestions, if produced;
  • monitors the efficacy of the audit process;
  • monitors the respect of the principles that the Company has formulated for execution of transactions with related parties;
  • reports to the Board of Directors, normally in the first available meeting, on the activity carried out and in general on the adequacy on the internal control system when the annual and half-yearly financial reports are being approved;
  • monitors compliance with the rules of corporate governance and their periodic updating, and respect for any rules of conduct adopted by the Company and its subsidiaries. It is also responsible for proposing the methods for and times at which the Board of Directors should perform its annual self-evaluation.
  • if an independent Director should be replaced, it proposes candidates for co-opting to the Board of Directors;
  • performs the further tasks assigned to it by the Board of Directors, also in relation to the monitoring of procedural correctness and of the substantial fairness of operations.

In line with the “Procedure for information flows to Directors and Statutory Auditors”, the Committee has the right to consider, on a case by case basis, the following correlated parties:

  1. companies in which the natural persons indicated in the procedure mentioned above hold strategic management roles, and the companies controlled by these companies;
  2. companies which share a majority of directors with Pirelli.

After the approval of a new model of risk assessment and risk management in the company, the Committee was assigned consultation and/or advisory tasks in relation to the new model of risk assessment and risk management. See the section entitled “Risk assessment system” for further details.

10.3 Operation

The Committee – which may also request the assistance of external consultants in fulfilling its mandate – meets whenever its Chairman deems it appropriate or a meeting has been requested by another member of the committee or by a Managing Director.

The Board of Statutory Auditor 64 and, if deemed appropriate, other Company and/or Group representatives and representatives of the External Auditors, attend the meetings of the Committee.

The internal control Officer (who is functionally answerable to the Committee for Internal Control, Risks and Corporate Governance) reports on his work and on the arrangements by which risk management and compliance with plans of defined content occur;

The internal control Officer also reports, at least once a year, to the Board of Directors, either directly or through the Committee for Internal Control and Corporate Governance, and to the Board of Statutory Auditors.

The information and documents available and required for informed deliberation of the topics submitted to the committee have always been circulated to all members reasonably in advance.

The meetings of the Committee for Internal Control and Corporate Governance are regularly minuted by the secretary and the minutes are transcribed into a specific
register 65.

The Committee has adequate financial resources for the performance of its duties with independent expenses.

In accordance with the provisions of the Self-Regulatory Code 66, the Committee also has the right to access company information and departments as necessary for the execution of the tasks assigned to it, making use of the support of the Secretary of the Board of Directors.

10.4 Activity during the financial year.

During 2009, the Committee for Internal Control and Corporate Governance met 6 times (with two of these meetings held after its renewal) and all members participated in these meetings. The average duration of the meetings was about two and a half hours.

In the 2010 financial year to the Date of the Report, the Committee met twice.

Corporate Governance activities

The Committee made real contributions to the process of implementing and updating the new Company corporate governance instruments, in particular, during the year, the Committee submitted to the Board of Directors some modifications to the Group Code of Ethics, which, while the values that inspire it remain substantially unchanged, has been supplemented and enriched with new instances which were concrete expressions of the action of the Pirelli Group, and which, with the modifications approved first by the Committee and then by the Board, are expressly reflected in the Code.

During the year, the Committee approved some modifications to the procedure for managing information (which were already partially reported on in the 2008 Corporate Governance Report). In particular, the Committee considered whether or not the mechanisms that permit processing of confidential information should be extended, while at the same time guaranteeing the confidentiality of the information processed.

The Committee submitted to the Board (which consequently approved, in its meeting on 10 March 2009) a proposal to reconsider the preceding assessments carried out on the absence of direction and coordination activities on Pirelli RE (a circumstance reported on in the 2008 Corporate Governance Report).

During the financial year, the Committee examined the results of the board performance evaluation 2008 (which was previously extensively reported on in the Corporate Governance Report for the 2008 financial year), and started the self-evaluation process for the 2009 financial year, examining the results of this during 2010. In this respect, please see the section entitled “Board performance evaluation”. The Committee then proposed that a new model for risk assessment and management should be adopted, and its implementation subsequently monitored. This was approved by the Board in its meeting on 29 July 2009. For a more extensive description of the new “risk management” system, see the section entitled “Risk assessment system”.

The Committee then examined in depth the position of Pirelli in terms of “sustainable development” taking note of the many acknowledgements received in the international indices.

Again on the subject of “corporate governance”, the Committee oversaw the investigation to ascertain the continuing possession by directors of the requisites for independence, and respect for the Policy on the maximum accumulation of offices considered compatible with serving as a director of Pirelli. The results of the examination undertaken in the 2009 Financial year are indicated in the Corporate Governance Report for the 2008 financial year, while those obtained during the 2010 financial year are reported in the sections entitled “Independent Directors” and “Maximum number of offices held in other companies”.

The Committee expressed a preventive positive assessment of the reorganisation process resolved by the Board of Directors on 16 September 2009 described in the “Delegated Bodies” section. The Committee also proposed that the following be identified as “managers with strategic responsibilities in the business”: Francesco Gori (General Manager Tyre & Parts), Francesco Chiappetta (Assistant to the Chairman and Group General Counsel) and Francesco Tanzi (Director of Finance, and Officer responsible for the preparation of the company accounting documents).

The Committee approved a procedure to report violations of laws, regulations and principles sanctioned in the Code of Ethics and in internal procedures to the Internal Audit Division (a so-called “Whistleblowing” procedure).

Finally, the Committee submitted the Half Yearly Corporate Governance Report, published in a single document with the Half-Yearly Financial Report at 30 June 2009 to the Board for approval.

The Committee also took note of the flattering results on corporate governance achieved in the GMI Governance Metrics International report, explained in the 2009 half-yearly report on Corporate Governance.

Internal Control activities

During 2009, the internal control Officer of the Company (identified as the head of the Internal Auditing Department, Mr. M Bonzi) attended the meetings of the Committee, reporting on his activities every three months.

The Committee monitored the work carried out by the Internal Audit Department, and, in particular, examined the shortcomings identified in the audits completed by the department, monitoring the implementation of the related action plans for the corrective measures needed to continuously improve the system.

At the start of the 2009 financial year, the Committee approved the final results of the activities carried out in implementation of the 2008 Audit Plan, and approved the Audit Plan for 2009. Similarly, in 2010 the Committee examined the final results of the 2009 Audit Plan and approved the Plan for the 2010 financial year.

During the year the Committee met the Responsible Officer, who reported on the suitability of the means and powers attributed to him, and on the activities he carried out in relation to the financial statements for the year to 31 December 2009; this has already been reported in the Corporate Governance Report for the 2008 financial year. After the reorganisation decided within the Company, the Committee met the new Responsible Officer, Mr. Tanzi, to confirm the information flows established in the past with Mr. De Conto.

In the meeting that preceded approval of the draft financial statements at 31 December 2009, it met the Responsible Officer to check the suitability of the means and powers attributed to him, and to receive a report on the activity he had carried out. See the section entitled “Responsible Officer” for more detail.

The Committee then examined and formulated a positive opinion of the External Audit Plan for the 2009 financial year submitted by the external auditors, Reconta Ernst&Young.

The Committee, in concert with the external auditors and the Responsible Officer, emphasised some issues inherent to the use of the accounting principles, with particular reference to the treatment of shareholdings in affiliated companies. The Company then took note of the effective implementation of the procedure adopted pursuant to article 36 of the Regulations of the Markets and examined the joint Bank of Italy/CONSOB/ISVAP document dated 6 February 2009, noting no problems of critical issues.

The Committee maintained adequate flows of information with the Committee for Internal Control of Pirelli RE.

The Committee then examined some transactions with related parties, although they were typical and usual and/or at market conditions (in particular, the sale of the holding in Vittoria Capital N.V. representing 5% of the capital) and agreed the contents of the shareholder agreement between Pirelli and the Camfin Group to regulate their relations as shareholders in the companies owned 51% by the Company and 49% by Cam Partecipazioni S.p.A., a Camfin Group company, active in the environment and sustainable mobility business. The Committee noted that the agreement grants a purchase option to the Company, and, to Cam Partecipazioni S.p.A., an option to sell, if either party should cancel the shareholder agreement on its expiry on 30 June 2012 and subsequently every three years. If the purchase or sale option should be exercised, the price will be determined based on the discounted cash flow method, and specifies the application of the market multiples of comparable companies as corrective, if necessary.

A sale option in favour of Cam Partecipazioni S.p.A. is also specified if there should be disagreement on significant issues.

In the light of the activities carried out and the checks made, and the information and documents received and examined, the Committee confirmed its positive opinion of the adequacy of the internal control system and governance of the Company and the Group of which it is part 67 and has provided a report on its activities through its Chairman to the first useful meeting of the Board, and reported on its activities to the Board at half-yearly intervals.

It is considered appropriate to provide an account of the development of the actions, legal and otherwise, that involved two ex-heads of Company Security that were reported in the corporate governance report for 2006 , 2007 and 2008 and have been the subject of an investigation by the Committee for Internal Control and Corporate Governance, the Board of Statutory Auditors and the Supervisory Body.

In particular, as already made public, during the year the Company joined the proceedings against all the persons accused of the crimes which have caused damage or offence to the company as civil part. The Company has been allowed to joint the criminal proceedings for embezzlement and money laundering as civil part.

The only civil action that has been permitted to be brought against the Company, the legal person accused pursuant to leg. Decree 231/2001, is that brought by the Avvocatura dello Stato (the pool of specialised jurists who defend state and other public bodies) in the interest of the Office of the Prime Minister and the Ministries to which the public officials involved in the corruption proceedings belong, and the suit certain parties allegedly damaged by the conduct of the company’s ex-employees.

Such compensatory action is in fact founded in the legal provision by virtue of which the employer, irrespective of its culpability, is answerable financially for the illicit acts committed by its employees. So Pirelli would be called on the answer only for its objective liability.

Subsequently the Board of Directors of the Company, as proposed by the Committee for Internal Control, Risks and Corporate Governance, with the advice of highly qualified professionals, carefully assessed and then approved the decision to petition for the application of the penalty at the request of the parties, since it had in any event reached an agreement with the Government Departments involved so as to completely define all responsibilities.

The Procura (Criminal Court) issued a favourable opinion of the petition submitted by the Company, and the Judge reserved the right to pronounce his/her decision.

It should be noted that the Company is proceeding with the civil actions started against the security service suppliers involved in the investigations in order to be compensated for services that were not contractually fulfilled or were even illegal.

62 Also in line with the provisions of the Self Regulatory Code. Principle 8.P.4.

63 Specifically, Mr Bruni and Mr Secchi.

64 Also going beyond the recommendations of the Self Regulatory Code: Criterion of application 8.C.4. This circumstance characterises the corporate governance rules adopted by the Company, and offers the Board of Statutory Auditors, in its own interest, the possibility of directly following the activities of the Committees so as to more effectively execute the control function assigned to it.

65 Also in line with the provisions of the Self Regulatory Code. Criterion of application 5.C.1, lett. d).

66 Self Regulatory Code: Criterion of application 5.C.1, lett. e).

67 Cf. Paragraph on “Internal control system and governance system” in the section entitled “Role of the Board of Directors”.