BTPLC Annual Report 2006 - Report of the directors

The directors submit their report and the audited financial statements of the company, BT Group plc, and the group, which includes its subsidiary undertakings, for the 2006 financial year.
     It is BT’s policy to achieve for all our operations best practice in our standards of business integrity. This includes a commitment to maintaining the highest standards of corporate governance and ethics throughout the group.
     The directors consider that BT has, throughout the year, complied with the provisions set out in section 1 of the 2003 Combined Code on Corporate Governance and that the Operating and financial review has been prepared in accordance with the principles in the Reporting Statement on the Operating and Financial Review issued by the Accounting Standards Board.

INTRODUCTION
BT Group plc is the listed holding company for the BT group of companies.
     The Operating and financial review and the Report of the Audit Committee, the Report of the Nominating Committee and the Report on directors’ remuneration form part of this report. The audited financial statements are also presented.

PRINCIPAL ACTIVITY
The group’s principal activity is the supply of communications solutions and services and includes: networked IT services; local, national and international telecommunications services; and broadband and internet products and services. In the 2006 financial year, approximately 87% of revenues were derived from operations in the UK. The group’s key performance indicators can be found in the Operating and financial review.

THE BOARD
Directors
The names and biographical details of the directors of the company are given in the Board of directors and Operating Committee. All served throughout the financial year, with the exception of Matti Alahuhta and Phil Hodkinson, who were appointed on 1 February 2006. Lou Hughes served as a director until 31 March 2006.

Election and re-election

All directors are required by the company’s articles of association to be elected by shareholders at the first AGM after their appointment, if appointed by the Board. A director must subsequently retire by rotation at an AGM at intervals of not more than three years. The director may seek re-election.
In accordance with the articles of association, Matti Alahuhta and Phil Hodkinson, having been appointed as directors by the Board, retire at the forthcoming annual general meeting (AGM) and will be proposed for election. Sir Anthony Greener, Maarten van den Bergh and Clayton Brendish retire by rotation and will be proposed for re-election. Details of these directors’ contracts of appointment are included in the Report on directors’ remuneration.

Composition and role

The Board, which operates as a single team, is currently made up of the part-time Chairman, the Chief Executive, four other executive directors and eight non-executive directors. All of the non-executive directors during the 2006 financial year met, and continue to meet, the criteria for independence set out in the Combined Code and are therefore considered by the Board to be independent. In line with BT’s policy, the Board comprised a majority of independent non-executive directors throughout the 2006 financial year.
     The Board’s principal focus is the overall strategic direction, development and control of the group. In support of this the Board approves the group’s values, business practice policies, strategic plans, annual budget, capital expenditure and investments budgets, larger capital expenditure proposals and the group’s overall system of internal controls, governance and compliance authorities. It also has oversight and control of the group’s operating and financial performance and reviews the risk register. These responsibilities are set out in a formal statement of the Board’s role. The Board has agreed the group’s corporate governance framework, including empowering the company’s key management committee, the Operating Committee, to make decisions on operational and other matters. The roles and powers of this committee are set out here. Their powers and the authorities delegated to individual members of the Operating Committee are available to everyone in the group on the group’s intranet site.
     Historically the Board met every month, except in August. The standard Board cycle changed in the 2006 financial year to nine meetings each year. The Board met 11 times during the 2006 financial year including two ad hoc meetings to consider time-critical matters.
     The roles of the Chairman and the Chief Executive are separate. They are set out in written job descriptions, approved by the Nominating Committee. In addition to chairing the Board, the Chairman is responsible for consulting the non-executive directors, particularly the Deputy Chairman, on corporate governance issues, matters considered by the Nominating Committee, which the Chairman chairs, and the individual performances of the non-executive directors. The Chairman and the non-executive directors hold regular dinners at which they discuss matters without the executive directors being present. With the Chief Executive and the Secretary, the Chairman ensures the Board is kept properly informed, is consulted on all issues reserved to it and that its decisions are made in a timely and considered way that enables the directors to fulfil their fiduciary duties. The Chairman ensures that the views of the shareholders are known to the Board and considered appropriately. He represents the company in specified strategic and Government relationships, as agreed with the Chief Executive, and generally acts as the bridge between the Board and the company’s executive team, particularly on the group’s broad strategic direction. The Chief Executive has final executive responsibility, reporting to the Board, for the success of the group. The Chairman’s other current significant commitments are shown in the Board of directors and Operating Committee.
     The Secretary manages the provision of timely, accurate and considered information to the Board for its meetings and, in consultation with the Chairman and Chief Executive, at other appropriate times. He recommends to the Chairman and the Chief Executive, for Board consideration where appropriate, the company’s corporate governance policies and practices and is responsible for their communication and implementation. The appointment and removal of the Secretary is a matter for the whole Board. He advises the Board on appropriate procedures for the management of its meetings and duties (and the meetings of the company’s principal committees), as well as the implementation of corporate governance and compliance within the group.

BT’s non-executive directors

The Nominating Committee has agreed and periodically reviews the combination of experience, skills and other attributes which the non-executive directors as a whole are to bring to the Board. This profile is used by the Committee when the appointment of a non-executive director is being considered to assess the suitability of candidates, who are put forward by the directors and outside consultants. Short-listed candidates meet the Committee, which then recommends to the Board a candidate(s) for appointment.
     The non-executive directors provide a strong, independent element on the Board. Between them, they bring experience and independent judgement, gained at the most senior levels, of international business operations and strategy, finance, marketing, technology, communications and political and international affairs.
     Sir Anthony Greener, the Deputy Chairman, is the senior independent director. He chairs the Audit and Remuneration Committees. In his capacity as the chairman of the Remuneration Committee, he meets with BT’s major institutional shareholders. The Deputy Chairman also continues to be available to discuss matters with institutional shareholders where it would be inappropriate for those discussions to take place with either the Chairman or the Chief Executive.
     Non-executive directors are appointed initially for three years, subject to three months’ termination notice from either BT or the director. At the end of the first three years the appointment may be continued by mutual agreement. Each non-executive director is provided, upon appointment, with a letter setting out the terms of his or her appointment, including membership of Board committees, the fees to be paid and the time commitment expected from the director. The letter also covers such matters as the confidentiality of information and the company’s share dealing code.

Principal Board committees

The Operating Committee, the company’s key management committee, meets weekly and is chaired by the Chief Executive, Ben Verwaayen. The other members are the Group Finance Director and the Chief Executives of BT Retail, BT Wholesale and BT Global Services. The Secretary attends all meetings. The Group Strategy and the Group HR Directors normally attend each meeting. The Committee has collective responsibility for running the group’s business end-to-end. To do that, it develops the group’s strategy and budget for Board approval, recommends to the Board the group’s capital expenditure and investments budgets, monitors the financial, operational and customer quality of service performance of the whole group, reviews the group’s risks register, allocates resources across the group within plans agreed by the Board, plans and delivers major cross-business programmes and reviews the senior talent base and succession plans of the group. Within the group’s corporate governance framework, approved by the Board, the Operating Committee is empowered to approve, up to limits after which Board approval is required, capital expenditure, disposals of fixed assets, the making of investments by the group and divestments. It is authorised to delegate these approvals, up to its own limits, to senior executives.
To meet best corporate governance practice, the Audit Committee, the Remuneration Committee and the Nominating Committee have long been an established part of BT’s system of governance. Each committee has written terms of reference, which are available on the company’s website. The Report of the Audit Committee, the Report of the Nominating Committee and the Report on directors’ remuneration.
The Equality of Access Board (EAB) was established on 1 November 2005, as part of the Undertakings given by BT to Ofcom following Ofcom’s Strategic Review of Telecommunications, to monitor, report and advise BT on BT’s compliance with these Undertakings. The EAB is a committee of the BT Group plc Board, which formally approved its formation and its terms of reference. As required by the Undertakings, the EAB comprises five members: Carl Symon, a BT Group plc non-executive director and chairman of the EAB; a BT senior executive, Sally Davis, Chief Portfolio Officer; and three independent members: Sir Bryan Carsberg, Stephen Pettit and Dr Peter Radley. The EAB reports regularly to the Board.

Meetings attendance

The following table shows the attendance of directors at meetings of the Board and Audit, Remuneration and Nominating Committees during the 2006 financial year.

		Board^c	Audit Committee	Remuneration Committee	Nominating Committee

	(Attendance shown for committee member)
Number of meetings		11	4	4	4

Sir Christopher Bland		11			4
Matti Alahuhta^a		2
Maarten van den Bergh		9	4	4	3
Clay Brendish		9	4
Andy Green		11
Sir Anthony Greener		8	2	4	3
Phil Hodkinson^a		1
Lou Hughes^b		6	3	3
Margaret Jay		10		4
Hanif Lalani		11
Ian Livingston		11
John Nelson		9	4		4
Paul Reynolds		10
Carl Symon		9	4	4
Ben Verwaayen		11

^a	Appointed a director on 1 February 2006
^b	Granted unpaid leave of absence by the Board from 1 September 2004 to 30 June 2005 to lead the civil reconstruction effort for the US Government in Afghanistan. Resigned as a director on 31 March 2006
^c	Includes two ad hoc meetings

Service agreements

The Chairman and executive directors have service agreements, which are approved by the Remuneration Committee. Information about the periods of these contracts is in the Report on directors’ remuneration.

Independent advice

The Board has a procedure for directors, in furtherance of their duties, to take independent professional advice if necessary, at the company’s expense. In addition, all directors have access to the advice and services of the Secretary.

Training and information

On appointment, the directors take part in an induction programme when they receive information about BT, the role of the Board and the matters reserved for its decision, the terms of reference and membership of the principal Board committees, and the powers delegated to those committees, the company’s corporate governance policies and procedures, including the powers reserved to the group’s most senior executives, and the latest financial information about the group. This is supplemented by visits to key BT locations and meetings with members of the Operating Committee and other key senior executives. Each year, Directors participate in BT’s ‘Back to the floor’ programme, an activity that demonstrates commitment to our customers and the people who serve them. Throughout their period in office the directors are continually updated on BT’s business, the competitive and regulatory environments in which it operates, technology and corporate social responsibility matters and other changes affecting BT and the communications industry as a whole, by written briefings and meetings with senior BT executives. Directors are also advised on appointment of their legal and other duties and obligations as a director of a listed company, both in writing and in face-to-face meetings with the Secretary. They are reminded of these duties each year and they are also updated on changes to the legal, accounting and governance requirements on the company and themselves as directors. During the 2006 financial year, for example, they have attended presentations on BT’s 21CN Investment Programme, on the effects of the introduction of International Financial Reporting Standards on the group’s results and on the US Sarbanes-Oxley Act of 2002, which affects BT because its securities are registered with the US Securities and Exchange Commission (SEC); and received briefings on changes to UK company law and various corporate governance proposals from the European Commission. The Chairman also sends a weekly e-mail to non-executive directors with topical sector highlights.
Guidelines are in place concerning the content, presentation and delivery of papers for each Board meeting, so that the directors have enough information to be properly briefed sufficiently far ahead of each Board meeting and at other appropriate times.

Directors’ and officers’ liability insurance and indemnity

For some years the company has purchased insurance to cover its directors and officers against their costs in defending themselves in civil legal proceedings taken against them in that capacity and in respect of damages resulting from the unsuccessful defence of any proceedings. At the date upon which this report was approved, and throughout the 2006 financial year, the company’s wholly-owned subsidiary, British Telecommunications plc, has provided an indemnity in respect of all the company’s directors. Neither the insurance nor the indemnity provides cover where the director has acted fraudulently or dishonestly.

Interest of management in certain transactions

During and at the end of the 2006 financial year, none of the company’s directors was materially interested in any material transaction in relation to the group’s business and none is materially interested in any presently proposed material transactions.

SUBSTANTIAL SHAREHOLDINGS
At 17 May 2006, the company had received notifications from Legal & General Investment Management Limited, Barclays PLC and Brandes Investment Partners LLC, under Part VI of the Companies Act 1985, in respect of holdings of 318,525,417 shares, 369,832,178 shares and 413,832,977 shares respectively, representing holdings of 3.8%, 4.3% and 4.9% of the company’s issued ordinary share capital.

POLICY ON THE PAYMENT OF SUPPLIERS
BT subscribes to the Better Payment Practice Code for all suppliers, the four principles of which are: to agree payment terms at the outset and stick to them; to explain payment procedures to suppliers; to pay bills in accordance with any contract agreed with the supplier or as required by law; and to tell suppliers without delay when an invoice is contested and settle disputes quickly. The normal payment terms are 42 calendar days from date of receipt of a due and valid invoice. BT will make payment to the supplier on the next payment run following expiry of this term.The ratio, expressed in days, between the amounts invoiced to the company by its suppliers in the 2006 financial year and the amounts owed to its trade creditors at the end of the year was 39 calendar days.

CHARITABLE DONATIONS
Details of charitable donations made by the group can be found in Business review – Community investment.

POLITICAL DONATIONS
The company’s continuing policy is that no company in the group shall make contributions in cash or kind to any political party, whether by gift or loan. Arrangements are in place to implement this policy. However, the definition of political donations used in the Companies Act 1985 is very much broader than the sense in which these words are ordinarily used. It covers activities such as making MPs and others in the political world aware of key industry issues and matters affecting the company, which make an important contribution to their understanding of BT. These activities are carried out on an even- handed basis related broadly to the major UK political parties’ electoral strength. The authority we are requesting at the AGM is not designed to change the above policy. It will, however, ensure that BT acts within the provisions of the Companies Act 1985 requiring companies to obtain shareholder authority before they can make donations to EU political organisations (which includes UK political parties) as defined in the Act. During the 2006 financial year the company’s wholly-owned subsidiary, British Telecommunications plc, made the following payments to cover the cost of hosting briefing meetings about the company’s activities with MPs and MEPs: Labour Party £9,956; Conservative Party £10,867; Liberal Democrats Party £1,747; Scottish National Party £1,200; Plaid Cymru £88. No loans were made to any political party by any company in the BT group.

FINANCIAL INSTRUMENTS
Details of the financial risk management objectives and policies of the group and exposure of the group to interest risk, foreign exchange risk, credit risk, liquidity risk and price risk is given in the Financial review and in the Consolidated financial statements.

AUDITORS
Resolutions to reappoint PricewaterhouseCoopers LLP as auditors of the company and to authorise the directors to settle their remuneration will be proposed at the AGM.

AUTHORITY TO PURCHASE SHARES
The authority given at last year’s AGM of the company held on 13 July 2005 for the company to purchase in the market 850 million of its shares, representing 10% of the issued share capital, expires on 12 October 2006. Shareholders will be asked to give a similar authority at the AGM.
     During the 2006 financial year, 166 million shares of 5 pence each were purchased under this authority (1.9% of the share capital) for a total consideration of £360 million, at an average price of £2.17 per share. The shares were purchased in an on-market programme of buying back the company’s shares, initiated in November 2003, as part of the company’s shareholder distribution strategy. 290 million shares have been retained as treasury shares. At 17 May 2006, 22 million treasury shares had been transferred to meet the company’s obligations under its employee share plans.

RELATIONS WITH SHAREHOLDERS
Senior executives, led by the Chief Executive and the Group Finance Director and including, as appropriate, the other executive directors, hold meetings with the company’s principal institutional shareholders to discuss the company’s strategy, financial performance and specific major investment activities. The Deputy Chairman also attends, at his discretion and in consultation with the Chairman and the Chief Executive, meetings with shareholders during the year. All non-executive directors have an invitation to attend investors’ meetings if they wish. The company also maintains contact with investors, when appropriate, through the chairman of the Remuneration Committee and other senior executives to discuss overall remuneration policies and plans. Contact with institutional shareholders (and with financial analysts, brokers and the media) is controlled by written guidelines to ensure the protection of share price sensitive information that has not already been made generally available to the company’s shareholders. The directors are provided with either full or summarised reports and other written briefings from the company’s major shareholders and analysts and are regularly informed by the Secretary about the holdings of its principal shareholders. The Secretary also surveys the company’s retail shareholders about the quality of the company’s shareholder communications and share registration services.
     We are continuing our policy that shareholders vote on the annual report at the AGM. Shareholders will also again be asked to vote separately on the Report on directors’ remuneration.
     It is part of our policy to involve shareholders fully in the affairs of the company and to give them the opportunity at the AGM to ask questions about the company’s activities and prospects. We also give the shareholders the opportunity to vote on every substantially different issue by proposing a separate resolution for each issue.
     The proxy votes for and against each resolution, as well as abstentions, will be counted before the AGM and the results will be made available at the meeting after the shareholders have voted on each resolution on a show of hands and at the end of the meeting. It is our policy for all directors to attend the AGM if at all possible. Whilst, because of ill health or other pressing reasons, this may not always be possible, in normal circumstances this means that the chairmen of the Audit, Nominating and Remuneration committees are at the AGM and are available to answer relevant questions. All the directors attended the 2005 AGM.
     The Annual Review and Notice of Meeting 2006 and, if requested, the Annual Report and Form 20-F, are sent to shareholders in the most cost-effective fashion, given the large number of shareholders. We aim to give as much notice as possible and at least 21 clear days, as required by the company’s articles of association. In practice, these documents are being sent to shareholders more than 20 working days before the AGM.
     Established procedures ensure the timely release of share price sensitive information and the publication of the company’s financial results and regulatory financial statements. All external announcements are also reviewed for accuracy and compliance requirements by a committee of senior executives, the Disclosure Committee, which is chaired by the Secretary.

STATEMENT OF BUSINESS PRACTICE
To reinforce our commitment to achieve best practice in our standards of business integrity and ethics, BT has had in place a written statement of business practice (The Way We Work) for nearly seven years. The statement covers all our operations. A copy of the statement has been sent to every employee and is available in eight languages. Copies are also sent to the employees of newly acquired subsidiaries.
     These high-level principles are supported by a continuing and comprehensive communications programme and online training. A confidential helpline and dedicated e-mail facility are also available to employees who have questions about the application of these principles. The helpline number is published externally as part of the statement of business practice. We also continue to require our agents and contractors to apply these principles when representing BT. BT’s new Undertakings code of practice (It Matters) forms part of BT’s statement of business practice and is consistent with it.

PENSION FUNDS
BT’s two main pension funds – the BT Pension Scheme and the BT Retirement Plan – are not controlled by the Board but by separate trustees who are company and union nominees, under independent chairmen. The trustees look after the assets of the funds, which are held separately from those of the company. The pension funds’ assets can only be used in accordance with their respective rules and for no other purpose.

INTERNAL CONTROL AND RISK MANAGEMENT
The Board is responsible for the group’s systems of internal control and risk management and for reviewing the effectiveness of those systems, which it does annually. Such systems are designed to manage, rather than eliminate, the risk of failure to achieve business objectives; any system can provide only reasonable and not absolute assurance against material misstatement or loss.
     The Board also takes account of significant social, environmental and ethical matters that relate to BT’s businesses and reviews annually BT’s corporate social responsibility. The company’s workplace practices, specific environmental, social and ethical risks and opportunities and details of underlying governance processes are dealt with in the Business review – Motivating our people and living the BT values and Our commitment to society.
     BT has processes for identifying, evaluating and managing the significant risks faced by the group. These processes have been in place for the whole of the 2006 financial year and have continued up to the date on which this document was approved. The processes are in accordance with the Internal Control: Guidance for Directors on the Combined Code first published in the UK in September 1999.
     Risk assessment and evaluation takes place as an integral part of the group’s annual strategic planning cycle. The group has a detailed risk management process, culminating in a Board review, which identifies the key risks facing the group and each business unit. This information is reviewed by senior management as part of the strategic review. The group’s current key risks are summarised in Business Review – Group risk factors.
     The key features of the risk management process comprise the following procedures:

•	senior executives, led by the Secretary, review the group’s key risks and have created a group risk register describing the risks, owners and mitigation strategies. This is reviewed by the Operating Committee before being reviewed and approved by the Board.
•	the lines of business carry out risk assessments of their operations, have created registers relating to those risks, and ensure that the key risks are addressed.

•	senior management reports regularly to the Group Finance Director on the operation of internal controls in its area of responsibility.

•	the Chief Executive receives annual reports from senior executives with responsibilities for major group operations with their opinion on the effectiveness of the operation of internal controls during the financial year.

•

the group’s internal auditors carry out continuing assessments of the quality of risk management and control. Internal Audit reports to the management and the Audit Committee on the status of specific areas identified for improvement. Internal Audit also promotes effective risk management in the lines of business operations.

•

the Audit Committee, on behalf of the Board, considers the effectiveness of the operation of internal control procedures in the group during the financial year. It reviews reports from the internal auditors and from the external auditors and reports its conclusions to the Board. The Audit Committee has carried out these actions for the 2006 financial year.

     New subsidiaries acquired during the year have not been included in the above risk management process. They will be included for the 2007 financial year. Material joint ventures and associates, which BT does not control, outside the UK have not been dealt with as part of the group for the purposes of this internal control assessment.
     The Board has approved the formal statement of matters which are reserved to it for consideration, approval or oversight. It has also approved the group’s corporate governance framework, which sets out the high level principles by which the group is managed and the responsibilities and powers of the Operating Committee and the group’s senior executives. As part of this framework the development and implementation of certain powers relating to group-wide policies and practices are reserved to identified senior executives.

US SARBANES-OXLEY ACT OF 2002
BT has securities registered with the US Securities and Exchange Commission (SEC). As a result, BT is obliged to comply with those provisions of the Sarbanes-Oxley Act applicable to foreign issuers. BT complies with the legal and regulatory requirements introduced pursuant to this legislation, in so far as they are applicable to the group.
     With the appointment of Phil Hodkinson, it is the opinion of the Board that the Audit Committee now includes a member who is an ‘audit committee financial expert’, and who is independent (as defined for this purpose). The Board considers that the Committee’s members generally have broad commercial and business leadership experience, having held various roles in accountancy, financial management and supervision, treasury and corporate finance and that there is a broad and suitable mix of business, financial and IT experience on the Committee.
     The Chief Executive and Group Finance Director, after evaluating the effectiveness of BT’s disclosure controls and procedures as of the end of the period covered by this Annual Report and Form 20-F, have concluded that, as of such date, BT’s disclosure controls and procedures were effective to ensure that material information relating to BT was made known to them by others within the group. The Chief Executive and Group Finance Director have also provided the certifications required by the Sarbanes-Oxley Act.
     There were no changes in BT’s internal control over financial reporting that occurred during the year ended 31 March 2006 that have materially affected, or are reasonably likely to materially affect, BT’s internal control over financial reporting. Preparations are well advanced for BT to be able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act. BT is required to report under Section 404 in the 2007 Annual Report and Form 20-F.
     The code of ethics for the Chief Executive, Group Finance Director and Director Group Financial Control and Treasury, adopted for the purposes of the Sarbanes-Oxley Act, is posted on the company’s website at www.bt.com/ethics

THE NEW YORK STOCK EXCHANGE
The company, as a foreign issuer with American Depositary Shares listed on the New York Stock Exchange (NYSE), is obliged to disclose any significant ways in which its corporate governance practices differ from the corporate governance listing standards of the NYSE.
     The company has reviewed the NYSE’s new listing standards and believes that its corporate governance practices are consistent with them, with the following exception where the company does not meet the strict requirements set out in the standards. The standards state that companies must have a nominating/corporate governance committee composed entirely of independent directors and with written terms of reference which, in addition to identifying individuals qualified to become board members, develops and recommends to the Board a set of corporate governance principles applicable to the company. BT has a Nominating Committee chaired by the Chairman Sir Christopher Bland. It does not develop corporate governance principles for the Board’s approval. The Board approves the group’s overall system of internal controls, governance and compliance authorities. The Board and the Nominating Committee are made up of a majority of independent, non-executive directors.
     The Sarbanes-Oxley Act, the SEC and NYSE introduced rules on 31 July 2005 requiring the company to comply with certain provisions relating to the Audit Committee. These include the independence of Audit Committee members and procedures for the treatment of complaints regarding accounting or auditing matters. The company is fully compliant with these requirements.

FINANCIAL STATEMENTS
So far as each of the directors is aware, there is no relevant information that has not been disclosed to the company’s auditors and each of the directors believes that all steps have been taken that ought to have been taken to make them aware of any relevant audit information and to establish that the company’s auditors have been made aware of that information.
     A statement by the directors of their responsibilities for preparing the financial statements is included in the Statement of directors’ responsibility. The directors’ statement on going concern is included in the Operating and financial review – Financial review – Capital resources.

AGM RESOLUTIONS
The resolutions to be proposed at the AGM at the Barbican Centre, London, on 12 July 2006, together with explanatory notes, appear in the separate Annual Review & Notice of Meeting 2006 sent to all shareholders.

By order of the Board
Larry Stone
Secretary
17 May 2006