Mandatory and Indicative Articles and the “Comply or Explain” Principle

Classification of Regulation Articles, the Comply or Explain Philosophy, and Practical Application

First: Introduction

The Corporate Governance Regulations are characterized by a unique hybrid approach: most articles are mandatory, and a limited number are indicative. This division is not random but reflects a deep philosophy in governance: what touches fundamentals is mandatory, and what needs flexibility in application is indicative with the “Comply or Explain” principle. This approach achieves balance between regulatory discipline and practical flexibility, suiting the diversity of companies in size, sector, and complexity.

Understanding this division is essential for proper compliance. A company that deals with indicative articles as if they were mandatory burdens itself unnecessarily. A company that deals with mandatory articles as if they were indicative violates the law. The smart company understands the difference, complies with the mandatory, studies the indicative, and chooses wisely what to apply or disclose the reason for not applying. This article reviews this division in detail, its philosophy, and practical application.

💡  Key Insight The “Comply or Explain” principle does not mean “comply or exempt yourself.” It is an approach that respects company diversity but demands transparency in choices. A company that discloses non-application of an indicative article must explain the reason convincingly, present alternatives, and specify how it achieves the basic purpose by another means. Good disclosure may be harder than compliance.

Second: Mandatory Articles

1. Definition and Nature

1.1 Concept

• Articles with no choice in application.
• Must be fully complied with.
• Without exceptions.
• Violations require penalties.

1.2 Philosophy

Why these are mandatory articles:

• To achieve minimum governance.
• To protect shareholders and parties.
• To ensure basic transparency.
• To prevent bad practices.

2. Main Categories

2.1 Shareholder Rights

• Most are mandatory.
• To ensure protection.
• Without exceptions.

2.2 Board Composition

• Minimum independent members.
• Separation between Chairman and CEO positions.
• Membership duration.
• Legal quorum.

2.3 Audit Committee

• Composition.
• Responsibilities.
• Meetings.

2.4 Financial Disclosure

• Periodic financial statements.
• Reports.
• Immediate disclosures of material information.

2.5 Related Party Transactions

• Disclosure.
• Approvals.
• Procedures.

2.6 Internal Control

• Internal audit (since 2021).
• Appointment and dismissal (since 2024).
• Sufficient resources.

3. Consequences of Violation

3.1 Gradual Procedures

The Authority proceeds gradually:

• Warning.
• Request for remediation.
• Fine.
• Suspension.

3.2 Financial Fines

• Up to SAR 5 million.
• In serious cases: higher.
• Doubling illicit profits.

3.3 Administrative Penalties

• Suspension from work.
• Banning from holding positions.
• Listing suspension.

3.4 Referral to the Prosecution

• In cases of forgery.
• Fraud.
• Insider trading.
• Financial crimes.

Third: Indicative Articles

1. Definition and Nature

1.1 Concept

• Articles whose compliance is left to the company.
• Within the “Comply or Explain” principle.
• Application is not mandatory.
• But disclosure of non-application is mandatory.

1.2 Philosophy

Why these are indicative articles:

• To provide flexibility in application.
• To suit company diversity.
• To avoid imposing practices that may not suit all companies.
• To develop practices gradually.

2. Examples

2.1 Advanced Practices

Some advanced practices are indicative:

• Additional optional committees.
• External Board evaluations.
• Some remuneration details.
• Some stakeholder practices.

2.2 Sectoral Practices

• Some practices pertain to certain sectors.
• Indicative for others.
• Flexibility in application.

3. Transition from Indicative to Mandatory

3.1 General Trend

The Regulations evolve:

• Gradual conversion of articles to mandatory.
• Raising general governance level.
• Keeping pace with international standards.

3.2 Examples of Conversion

• 2021: Internal audit articles (76, 77, 78) from indicative to mandatory.
• 2024: Article 37 (training) from indicative to mandatory.
• Other developments.

3.3 Signals

• Smart companies pay attention to trends.
• Anticipate the transition.
• Apply indicative articles before they become mandatory.

Fourth: “Comply or Explain” Principle

1. Origin and Evolution

1.1 British Origin

• Cadbury Report (1992).
• Combined Code.
• UK Corporate Governance Code.
• Global model today.

1.2 Global Adoption

• OECD Principles.
• ECoDa (European Confederation of Directors Associations).
• Most governance regulations in emerging markets.

1.3 In Saudi Arabia

• Since issuance of the Regulations in 2017.
• For indicative articles.
• Mandatory requirement in the annual report.

2. The Concept

2.1 Options

The company has two options:

• Comply with the article.
• Non-compliance with disclosure.

2.2 Required Disclosure

• Explaining the reason for non-compliance.
• Alternatives followed.
• How the company achieves the basic purpose.
• Future plans (if any).

3. Disclosure Quality

3.1 Poor Disclosure

• “The company does not apply this article” — without explanation.
• General explanation without details.
• Claims without evidence.
• Copy and paste from other companies.

3.2 Good Disclosure

• Detailed and specific explanation.
• Realistic context.
• Alternatives.
• Results.
• Plans.

3.3 Criteria

Good disclosure must be:

• Honest.
• Comprehensive.
• Specific to the company.
• Convincing to the investor.

📌  Note International studies show that disclosure quality under “Comply or Explain” varies greatly. Some companies write a rigid paragraph for each article “the company does not apply.” This approach fails to achieve the purpose. Leading companies make disclosure an opportunity to explain their philosophy, demonstrate their commitment to governance, and earn investor trust. Good disclosure may be stronger than compliance.

Fifth: Practical Application of Compliance

1. Step 1: Evaluating Each Article

1.1 Review

For each article of the Regulations:

• Is it mandatory or indicative?
• Is the company compliant with it?
• If not compliant, why?
• What are the alternatives?

1.2 Documentation

• Worksheet for each article.
• Compliance or non-compliance.
• Reasons.
• Evidence.

2. Step 2: Planning

2.1 For Compliance with Mandatory Articles

• Closing gaps.
• Required resources.
• Timeline.
• Responsibilities.

2.2 For Indicative Articles

• Evaluating benefit.
• Balancing application and disclosure.
• The decision.
• Planning.

3. Step 3: Application

3.1 Actual Compliance

• Applying what was decided.
• With integrity.
• Not just on paper.

3.2 Documentation

• Recording each step.
• Evidence.
• Procedures.

4. Step 4: Disclosure

4.1 In the Annual Report

• Special section for “Compliance with Regulations.”
• For each indicative article.
• With transparency.

4.2 Compliance Table

• Comprehensive table.
• For each article.
• Compliance status.
• Details.

Sixth: Compliance Disclosure Template

1. Structure

Article	Status	Details
Article X	Compliant	How it is applied
Article Y	Partially Non-Compliant	Reason and alternatives
Article Z	Non-Compliant	Reason and plans

2. Details

2.1 For Compliant Article

• How it is applied.
• Evidence.
• Responsible.

2.2 For Partially Non-Compliant Article

• What part is applied.
• What part is not applied.
• Reasons.
• Plans.

2.3 For Non-Compliant Article

• Detailed reasons.
• Alternatives followed.
• How the purpose is achieved.
• Future plans.

Seventh: Common Challenges

1. “Misinterpretation” Challenge

Considering an indicative article as mandatory:

• Solution: precise review of Regulations.
• Legal consultation.
• Clear guide.

2. “Formal Disclosure” Challenge

Disclosures without value:

• Solution: investment in quality.
• Real explanation.
• Specific context.

3. “Updates” Challenge

Transition from indicative to mandatory:

• Solution: following amendments.
• Anticipation.
• Early application.

4. “Balance” Challenge

Between compliance and cost:

• Solution: cost-benefit evaluation.
• Gradual application.
• Priorities.

Eighth: Differences Between Companies

1. By Size

1.1 Large Companies

• Comprehensive compliance.
• Applying all indicative articles.
• International standards.
• Competitive advantage.

1.2 Medium Companies

• Compliance with mandatory.
• Selective application of indicative.
• Balance with cost.

1.3 Small Companies

• Basic compliance.
• Focus on essence.
• In Parallel Market: lighter requirements.

2. By Sector

2.1 Financial

• Additional requirements.
• Strict compliance.
• Dual oversight.

2.2 Others

• Governance Regulations only.
• But according to size.

Ninth: Penalties in Detail

1. Gradual System

1.1 Minor Violations

• Warning.
• Request for remediation.
• Limited fine.

1.2 Medium Violations

• Higher fines.
• Public announcement.
• Specified-duration suspension.

1.3 Serious Violations

• Large fines.
• Referral to the Prosecution.
• Listing suspension.
• Ban on responsible individuals.

2. Famous Cases

2.1 At the Global Level

• Enron: collapse + imprisonment.
• Wirecard: suspension + prosecution.
• Theranos: founder imprisoned.

2.2 Lessons

• Weak governance is catastrophic.
• No limits to penalties.
• Reputation does not recover quickly.

Tenth: Relationship with International Regulation

1. International Standards

1.1 OECD

• Principles of Corporate Governance.
• Updated 2023.
• Global reference.
• Saudi Regulations are aligned.

1.2 ICGN

• Global Stewardship Principles.
• For institutional investors.
• Higher standards.

1.3 ISO 37000

• Governance of Organizations.
• International standard.
• Comprehensive.

2. Regional Context

2.1 G20/OECD

• Regional cooperation.
• Common standards.
• Commitment to principles.

2.2 GCC

• Gulf Cooperation Council.
• Similar regulations.
• Regulatory cooperation.

Eleventh: Future and Developments

1. Development Initiative 2024-2026

1.1 Objectives

• Comprehensive Regulations development.
• Keeping pace with international standards.
• Greater market attractiveness.

1.2 Expected Trends

• Converting more articles to mandatory.
• Strengthening ESG requirements.
• Updating disclosure requirements.
• Technology and digital governance.

2. Global Trends

2.1 ESG

• Increasing mandatoriness.
• Specific standards.
• Mandatory reporting.

2.2 Diversity

• Board diversity requirements.
• Women’s representation.
• Disclosures.

2.3 Cybersecurity

• Cyber governance requirements.
• Disclosures.
• Responsibilities.

Twelfth: Best Practices

1. At the Philosophy Level

• Self-commitment: to highest standards.
• Anticipation: of developments.
• Full application: of mandatory.
• Conscious choice: for indicative.

2. At the Disclosure Level

• Full transparency: in compliance.
• Substantive disclosures: not formal.
• Updating: annual.
• High quality: in content.

3. At the Development Level

• Following: amendments.
• Training: continuous.
• Consultations: specialized.
• Improvement: continuous.

Conclusion

The division between mandatory and indicative articles in the Corporate Governance Regulations reflects an evolved philosophy achieving balance between discipline and flexibility. Compliance with mandatory articles is not an option, and choice in indicative articles is not exemption but commitment to transparency. The “Comply or Explain” principle is a powerful tool if applied sincerely, requiring companies to explain their choices transparently and leaving the final decision to the investor.

Leading Saudi companies are not satisfied with the minimum compliance, but adopt the highest standards, apply indicative articles as if mandatory, and publish deep disclosures about their choices. This trend builds a strong reputation in the market, attracts the best investors, and places the company in a distinguished position for future developments. With the ongoing Regulations development initiative through 2026, the direction is clear: more articles will become mandatory, and the highest standards will become the minimum. Companies prepared from now, committed to refined governance philosophy, will reap the fruits tomorrow.

🎯  Essential Points to Remember (1) Most articles of the Regulations are mandatory, a limited number are indicative. (2) Mandatory articles: no choice, full compliance, penalties for violation. (3) Indicative articles: applied under “Comply or Explain” principle. (4) Trend: gradual conversion of articles to mandatory (example: internal audit 2021, training 2024). (5) “Comply or Explain” principle requires transparency, not exemption. (6) Disclosure quality: comprehensive, honest, specific, convincing. (7) Penalties are gradual: warning, remediation request, fine, suspension, referral. (8) Differences between companies by size and sector are natural. (9) Following developments: 2024-2026 initiative will transform much. (10) Best practice: adopting higher standards, anticipating developments.

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FAQS

What is the difference between mandatory and indicative articles in the Corporate Governance Regulations?

It is a principle originating from the UK's Cadbury Report in 1992, giving companies two options for indicative articles: comply with the article, or disclose a justified, detailed reason for non-compliance, including the alternatives followed and how the company achieves the basic purpose by another means.

What are some examples of articles that transitioned from indicative to mandatory?

In 2021, internal audit articles (76, 77, and 78) shifted from indicative to mandatory, and in 2024, Article 37 related to training shifted from indicative to mandatory, reflecting a general trend toward gradually raising governance standards.

References and Sources

• Corporate Governance Regulations issued by the CMA and its amendments.
• CMA Strategic Plan 2024-2026.
• UK Corporate Governance Code — Comply or Explain Principle.
• Cadbury Report (1992).
• OECD Principles of Corporate Governance (2023).
• ICGN Global Stewardship Principles.
• ISO 37000 — Governance of Organizations.
• FRC — Comply or Explain Reporting.
• ECoDa — European Confederation of Directors Associations.
• Certified Governance Institute — Compliance Guides.