The Amended Shareholders’ Rights Directive

EU Directive 2017/828 has now been published in the Official Journal and will come into force on the 9th June 2017. The Directive serves to amend Directive 2007/36/EC, which is more commonly known as the Shareholders’ Rights Directive (‘SRD’). The SRD was passed in 2007 ‘with a view to enhancing shareholders’ rights in listed companies.’ The financial crisis revealed that many shareholders supported management’s excessive short-term risk-taking and so, in 2012, the EU Commission published an Action Plan which set out the initiatives the Commission intended to take in order to enhance transparency and engage shareholders. Directive 2017/828 is the result.

The Amendments

The principal amendements to the SRD are:

  • Identification of shareholders: Shares in listed companies are often held through complex chains of intermediaries, which can make it difficult or impossible for a company to identify its shareholders. This, in turn, makes it difficult for companies to contact shareholders, which is an essential feature to facilitating the exercise of shareholder rights. Accordingly, a new Art 3a is inserted which provides that Member States shall ensure that companies have the right to identify their shareholders. To faciliate this, companies will have the right to collect personal data on their shareholders ‘in order to enable the company to identify its existing shareholders in order to communicate with them directly with the view to facilitating the exercise of shareholder rights and shareholder engagement with the company.’ Companies will be able to store this data for as long as they remain shareholders.
  • Institutional investor engagement: A new Art 3g provides that Member States shall ensure that institutional investors and asset managers comply with two requirements, or publicly disclose a reasoned explanation as to why they have not complied. The two requiremrnts are (i) institutional investors and asset managers shall develop and publicly disclose an engagement policy that describes how they integrate sahreholder engagement into their investment strategy, and; (ii) institutional investors and asset managers shall, on an annual basis, publicly disclose how their engagement policy has been implemented.
  • Institutional investor investment strategy: A new Art 3h provides that Member States shall ensure that institutional investors public disclose how the main elements of their equity investment strategy are consistent with the profile and duration of their liabilities, in particular long-term liabilites, and how they contribute to medium to long-term performance of their assets.
  • Transparency of asset managers: A new Art 3i provides that Member States shall ensure that asset managers disclose, on an annual basis, certain information to their institutional investors, such as how their investment strategy and implementation thereof complies with the arrangements in Art 3h and contributes to the medium to long-term performance of the assets of the institutional investor or the fund.
  • Transparency of proxy advisors: A new Art 3j provides that Member States shall ensure that proxy advisors publicly disclose reference to a code of conduct which they apply and report on. If such proxy advisors depart from the recommendations of this code of conduct, they shall explain from which parts they depart, provide explanations for doing so and, where appropriate, any alternative measures adopted. Where proxy advisors do not apply a code of conduct, they shall provide a clear and reasoned explanation why this is the case. All proxy advisors will be required to diclose inforamtion set out in Art 3j(2).
  • Right to vote on remuneration policy: A new Art 9a provides that Member States shall ensure that companies establish a remuneration policy as regards directors, and that shareholders have the right to vote on the remuneration policy at the general meeting. Member States may allow companies, in exceptional circumstances, to temporarily derogate from the remuneration policy, provided that the policy includes the procedural conditions under which the derogation can be applied and specifies the element of the policy from which derogation is possible. The company’s remuneration policy shall contribute to the company’s business strategy and long-term interests and sustainability, and shall explain how it does so. The remuneration policy shall explain how the pay and employment conditions of employees of the company were taken into account when establishing the remuneration policy.
  • Transparency and approval of related party transactions: Transactions with persons related to the company can adversely affect the company and its shareholders, or place the directors in a conflict position. Accordingly, a new Art 9c provides that each Member State shall define what a ‘material transaction’ is. Companies that enter into material transactions with related parties must publicly announce the transaction at the latest at the time the transaction is concluded, and provide specified information relating to the transaction. Member States shall ensure that material transactions with related parties are approved at the general meeting or by the administrative or supervisory body of the company. Where the administrative or supervisory body has approved the transaction, then Member States may require that the shareholders in general meeting then have the right to vote on the transaction.

Implementation

Member States have until the 10th June 2019 in which to implement the amended Directive. Remember that, until the UK formally leaves the EU, it remains bound to implement EU law. Article 50 has now been triggered and if, as expected, the UK leaves by the end of the Art 50 period (i.e. by the 29th March 2019), then the Amended Directive will not apply, unless the UK decides to implement it prior to leaving the EU. Accordingly, it will be interesting to see whether the government decides to begin the process of implementing the Directive.

Further information

The EU Commmission’s factsheet on the SRD can be found by clicking here. The EU Council’s press release on the amendments made to the SRD can be found by clicking here.

The Corporate Governance Review

Today, the Department for Business, Energy & Industrial Strategy launched a corporate governance review, accompanied by a Green Paper on corporate governance reform. The need for a review was set out by the Prime Minister in the Green Paper’s introduction:

‘for people to retain faith in capitalism and free markets, big business must earn and keep the trust and confidence of their customers, employees and the wider public. Where this social contract breaks down and individual businesses decide to play by their own rules, faith in the business community as a whole diminishes – to the detriment of all. It is clear that in recent years, the behaviour of a limited few has damaged the reputation of the many. It is clear that something has to change.’

Although the title of the Green Paper (‘Corporate Governance Reform’) indicates a broad, wide-ranging discussion, the Paper does not provide a review of corporate governance in general, and instead focuses on three specific issues, with a very brief ‘other issues’ category at the end of the Paper. The Paper does stress that the Paper is designed to ‘stimulate a debate on a range of options for strengthening the UK’s corporate governance framework’ and that ‘[t]he Government does not have preferred options at this stage.’ Accordingly, this Paper is merely the first step on what may prove to be a lengthy reform process (especially as large parts of the government and civil service will be preoccupied with Brexit). These areas and the suggested potential reforms will be set out.

Executive pay

The first governance issue discussed is one of the more controversial, namely executive remuneration. The Paper notes that ‘there is a widespread perception that executive pay has become increasingly disconnected from both the pay of ordinary working people and the underlying long-term performance of companies.’ The Paper discusses five areas where the regulation of executive remuneration in quoted companies could be reformed:

  1. Shareholder voting and other rights: The Paper puts forward a number of possible options for reform, namely (i) increasing the scope of the binding vote; (ii) introduce stronger consequences for a company losing the advisory vote; (iii) requiring or encouraging quoted companies to set an upper threshold for annual pay and requiring a binding vote if pay exceeds that threshold; (iv) requiring the binding vote to be held more frequently than the current three-year period, and; (v) strengthening the UK Corporate Governance Code to provide greater specificity on how companies should engage with shareholders on pay.
  2. Shareholder engagement on pay: The Paper discusses several reforms aimed at improving shareholder engagement on pay issues, namely (i) mandatory disclosure of fund managers’ voting records at AGMs and the extent to which they made use of proxy voting; (ii) establishing a senior shareholder committee to engage with executive remuneration arrangements, and; (iii) considering ways to facilitate or encourage individual retail shareholders to exercise their rights to vote on pay and other corporate decisions.
  3. The remuneration committee: The Paper notes the existence of concerns that ‘remuneration committees are not sufficiently or visibly pro-active in consulting formally with shareholders and with the company’s workforce. There are concerns too, that some lack the authority or inclination to take positions that may not align with the CEO or wider executive team’s expectations.’ Accordingly, the Paper suggests potential reforms, namely (i) requiring the remuneration committee to consult shareholders and the wider company workforce in advance of preparing its pay policy, and; (ii) requiring the chairs of remuneration committees to have served for at least 12 months on the remuneration committee before taking up the role.
  4. Transparency: The Paper states that ‘[t]he Government wants to explore whether there is additional information which companies could provide which would make shareholders more effective in holding boards to account on their executive pay arrangements.’ The suggested potential reforms are (i) requiring companies to publish ratios comparing CEO pay to that of the wider workforce, and; (ii) whether existing requirements regarding the disclosure of performance targets that trigger bonuses need to be strengthened.
  5. Long-term executive pay incentives: The Paper looks at possible reforms either replacing or amending practice regarding long-term incentive plans.

Strengthening stakeholder voice

The second major issue the Paper focuses on is strengthening the employee, customer, and wider stakeholder voice. The Paper notes that ‘[m]any companies and their boards recognise clearly the wider societal responsibilities they have and the enormous benefit they gain through wider engagement around their business activities.’ However, it then goes on to state that ‘some have said that companies need to do more to reassure the public that they are being run, not just with an eye to the interests of the board and the shareholders, but with a recognition of their responsibilities to employees, customers, suppliers and wider society.’ To that end, suggested potential reforms include (i) creating stakeholder advisory panels; (ii) designating existing non-executive directors to ensure that the voices of key interested groups, especially that of employees, is being heard at board level; (iii) appointing individual stakeholder representatives to company boards, and; (iv) strengthening the reporting requirements relating to stakeholder engagement.

Corporate governance in private companies

The recent BHS scandal has focused attention on corporate governance and private companies (see blog post here on this). The Paper notes that private companies ‘are not expected or required to meet the same formal corporate governance and reporting standards as publicly listed companies, yet the consequences when things go wrong can be equally severe for other stakeholders.’ Accordingly, several suggested reforms include (i) extending the UK Corporate Governance Code to private companies, or developing a new Code aimed at such companies, and; (ii) extending the scope of certain reporting requirements to cover certain private companies.

Other issues

The final major section of the Paper is entitled ‘other issues’, but it only really focuses on one issue, namely whether the UK’s comply or explain system remains effective in providing the right combination of high standards and low burdens.

Conclusion

The Green Paper is a welcome development and it contains a raft of reforms that deserve wider discussion. However, it does only focus on a few specific areas of corporate governance (admittedly those that have drawn most ire in recent years). Governments and businesses will regularly talk of the importance of having strong governance standards, but reforms in this areas have tended to be rather tepid. It will be interesting to see how committed the government is to governance reform, especially if Brexit does cause the UK to become a more unattractive place to do business.

Company law and a new Prime Minister.

Today, Andrea Leadsom MP dropped out of the Conservative leadership contest, and Theresa May MP was shortly thereafter confirmed as the Conservative Party leader. David Cameron has stated that he will resign as Prime Minister on Wednesday the 13th July, meaning that Theresa MP will likely become Prime Minister later that day.

From  a company law point of view, the significance of this is that, on the 11th July 2016, Theresa May gave a speech launching her campaign to be party leader and Prime Minister. That speech contained a number of company law-related pledges – below are the relevant quotes:

  • ‘And I want to see changes in the way that big business is governed. The people who run big businesses are supposed to be accountable to outsiders, to non-executive directors, who are supposed to ask the difficult questions, think about the long-term and defend the interests of shareholders. In practice, they are drawn from the same, narrow social and professional circles as the executive team and – as we have seen time and time again – the scrutiny they provide is just not good enough. So if I’m Prime Minister, we’re going to change that system – and we’re going to have not just consumers represented on company boards, but employees as well.’
  • ‘The fourth way in which I want to make our economy work for everyone is by getting tough on irresponsible behaviour in big business…. The FTSE, for example, is trading at about the same level as it was eighteen years ago and it is nearly ten per cent below its high peak. Yet in the same time period executive pay has more than trebled and there is an irrational, unhealthy and growing gap between what these companies pay their workers and what they pay their bosses.’
  • ‘So as part of the changes I want to make to corporate governance, I want to make shareholder votes on corporate pay not just advisory but binding. I want to see more transparency, including the full disclosure of bonus targets and the publication of “pay multiple” data: that is, the ratio between the CEO’s pay and the average company worker’s pay. And I want to simplify the way bonuses are paid so that the bosses’ incentives are better aligned with the long-term interests of the company and its shareholders.’

Here are a few initial thoughts on some of the reforms proposed by Theresa May:

  • The most radical reform proposed is to have employees represented on company boards. Of course, there is currently nothing to stop companies having board-level employee representatives, but hardly any companies do so. The UK is in a minority amongst EU states in that it does not provide for a legislative system of employee representation. 18 of the 28 EU Member States provide for some form of employee representation on the board, with the vast majority mandating employee representation for certain companies. Employee representation has been advanced on multiple occasions in the UK, with the most notable attempt being the publication of the Bullock Report in 1977. That report recommended a system of board representation in companies with over 2,000 employees. That central recommendation of the report received very little support and the election of a Conservative government in 1979 meant that employee representation fell firmly by the wayside. Attempts to resurrect the issue since have not met with success. It will be interesting to see how Theresa May’s proposal will be received.
  • I suspect that binding shareholder votes on remuneration will have little effect. A binding vote was introduced by the Enterprise and Regulatory Reform Act 2013, which introduced a new s 439A into the Companies Act 2006 which provides members of quoted companies with a binding vote on the company’s remuneration policy. This reform has had little impact. It will be interesting to see if Theresa May proposes extending the binding vote to other remuneration issues (e.g. payments for loss of office, golden hellos).
  • Oddly enough, the reforms relating to remuneration disclosure right be more useful. Disclosure of pay ratios has been argued for for a long time (see, for example, this report from the High Pay Centre) and it could be argued that media pressure has been a better regulator of remuneration than the general meeting (see, for example, the foregoing of bonuses by Bob Diamond and Stephen Hester following intense media pressure). Moves that place more pay information in the public arena may allow further public pressure to be placed upon excessively paid directors. However, there is a downside. Remuneration disclosures are already significant and the details of a director’s remuneration package can be very complex. Increasing disclosure obligations will, accordingly increase the length and complexity of annual reports (anyone who has read the annual reports of a FTSE company will attest that such reports are already way too long) and will, of course, impose additional costs. Theresa May’s proposals to simplify bonus structures could help this, but we will need to see the details.

Perhaps the most surprising thing about the above proposed reforms is that they are being advanced by a Conservative MP. If one did not know that these proposals were being advanced by Theresa May, one would be forgiven for assuming that they were the proposals of a Labour MP – a number of these proposals have been advanced by Labour MPs or those on the left left of the political spectrum, and were opposed by the Conservatives at the time. Indeed, in some notable respects, Theresa May’s proposals go further. Labour’s 2015 manifesto only pledged to provide for employee representation on remuneration committees, whereas Theresa May appears to favour employee board representation.

The devil will, of course, be in the detail and only time will tell the extent to which these proposals are actually implemented. The extent to which company law reform will be a priority to a Prime Minister who has to negotiate the UK’s exit from the EU remains to be seen. But it is an interesting development to see a Tory Prime Minister designate speaking in such terms.