Who’s Who Legal has brought together Claudia Allen of Katten Muchin Rosenman, Derk Lemstra of Stibbe, Lisa Chung of Slaughter and May, Vassily Rudomino of ALRUD Law Firm and Gareth Roberts of Herbert Smith Freehills to discuss shareholder activism, disclosure requirements, board diversity and future trends.
Katten Muchin Rosenman
WWL: Shareholder activism has remained a key trend of the past year, with some lawyers in the US describing it as having become “mainstream”. What extent of shareholder activism do you see in your jurisdiction? And what has been its impact on your clients and the type of work you are seeing?
Claudia Allen: As traditional institutional investors have increasingly allied themselves with activists, and corporate defences (such as classified boards and poison pills) have been repealed, activism has gained acceptance in the US. In essence, activist investments have become a new asset class. Most commonly, activists who are not able to effect desired changes through dialogue with a company, mount “short-slate” director election campaigns, by nominating one or more candidates. These campaigns are increasingly successful and often end in a settlement before the stockholders’ meeting. Companies in the US, including even the largest, are aware that they are not exempt from activist approaches. One of the best ways for a board to deal with activism is by proactively considering potential vulnerabilities in the same way that an activist would, and then, if the board believes it is in the best interests of the company, making appropriate changes.
Derk Lemstra: If you define shareholder activism as shareholders becoming more active and more vocal, I agree that this has become mainstream. In continental European jurisdictions shareholders have become more active, both individually and through industry organisations. This applies both to smaller retail investors and to large institutional investors and is likely to stay and will become mainstream. The more aggressive form of shareholder activism seen mainly in the US is taking less hold in our jurisdictions, in part because of the notion that a board should look at all interests, not just those of shareholders.
Lisa Chung: There is generally a lack of shareholder activism in Hong Kong. This is largely due to two factors: first, cultural norms in Asian society tend to be more deferential and less confrontational than in North American and European society (reflecting a general reluctance to criticise openly); and second, the dominance of family ownership structures that prevail in Hong Kong. It tends to fall to a handful of determined individuals to lead the charge on shareholder activism in Hong Kong.
Vassily Rudomino: I would name shareholder activism among the key trends in Russia as well. As we can see from our practice a lot of clients’ requests are related to protecting minority shareholders’ rights. Decisions issued by the state courts upon consideration of cases on infringement of minority shareholders’ rights form a new law enforcement practice. For instance, practice of the Supreme Arbitration Court was consolidated in the extremely important Ruling No. 62 On Some Issues Related to Compensation of Damages by Persons Being Part of the Legal Entity’s Governing Body, adopted in July 2013. This Ruling is aimed to introduce significant changes in the practice of recovering damages by shareholders from general directors (CEOs), members of the boards of directors and supervisory boards, and other members of governing boards.
Gareth Roberts: In the UK, the term “activism” traditionally meant activity designed to impose itself in one way or another upon the operation of the company – very often by seeking, via the requisitioning of a shareholders’ meeting, either to make changes to the board of directors or to pressurise the incumbent board in its strategic direction. That tended to be driven by shareholders who sought such opportunities to generate value where they perceived management failure and undervalued equity. What we now see, in addition to that, which is always going to be comparatively rare, is a more widespread willingness amongst shareholders as a whole to engage with boards and to exercise their votes to register concern. This has, to date, focused heavily on remuneration, with several high-profile scalps having been taken following the so-called shareholder spring of 2012, but we are increasingly seeing engagement on other governance issues such as independence of non-executive directors, succession planning and relationships with controlling shareholders. Stewardship is now positively expected of institutional shareholders, and is firmly a mainstream concept.
WWL: Many of those we spoke to mentioned increasingly onerous disclosure requirements with regard to corporate governance. How has this affected your clients and your practice?
Claudia Allen: In response to corporate scandals, the United States Congress enacted the Sarbanes-Oxley and Dodd-Frank Acts, each of which has had a major impact on corporate governance and disclosure. The rules required by those Acts have required increasing amounts of dense disclosure, some of which can be confusing and arguably unhelpful to investors. To address the “disclosure overload” problem, which has been acknowledged by the chairman of the United States Securities and Exchange Commission, many companies are employing summaries and graphics to guide investors to key facts. Some plaintiffs’ attorneys have used the additional disclosures, particularly those relating to executive compensation, as the basis for filing lawsuits which are primarily intended to result in the payment of attorneys’ fees. We work with clients to ensure that their disclosure satisfies legal requirements, clearly communicates key points and takes into account litigation risk.
Derk Lemstra: There is indeed a risk of form over function. Or to put it differently, corporate governance should not become a box-ticking exercise. By its very nature it should be principle-based rather than rule-based. Boards should accept their responsibility and have room to exercise it. Dynamics now sometimes create more focus on proper file keeping rather than on thorough analysis and decision-making.
Lisa Chung:The Hong Kong Listing Rules, which include the Corporate Governance Code (the Code), were amended in 2012 and 2013 to take account of two global trends in corporate governance. The first change was to include an Environmental, Social and Governance Reporting Guide (the ESG Guide) in the Listing Rules, which issuers are encouraged to follow. The second change was to introduce a new Code Provision in the Code requiring issuers (on a “comply or explain” basis) to have a policy regarding diversity in the board of directors. Although these requirements are new to the Hong Kong Listing Rules, they were introduced after a market consultation process and reflect international trends. Clients have been keen to understand how they should adopt these new requirements and how other companies have addressed them in overseas markets.
Vassily Rudomino: Russia is not an exception in this respect. For our clients, the increase of onerous disclosure requirements is also a major issue of concern. Shareholders and beneficial owners are mainly concerned with disclosure requirements when they acquire a new business or change their interest in the existing business. General directors, members of the boards of directors and management boards, as well as shareholders holding 20 per cent or more shares in a company, are bound by disclosure obligations when executing interested or related-party transactions on behalf of a company. So-called Insider Trading Law, adopted in 2010, imposes additional obligations on shareholders and companies’ management dealing with insider information. Moreover there are certain laws that set out additional disclosure requirements to such forms of entities as credit organisations, companies of strategic importance and others. The regulation is becoming more and more comprehensive; therefore, we regularly receive clients’ requests related to clarification of some general or industry-specific disclosure requirements.
Gareth Roberts: This is, I fear, a universal problem. With the question of corporate performance, risk management and executive reward having been forced into the spotlight following the financial crisis, there is an understandable and justified need to scrutinise the issues and to seek to improve communication and transparency. Unfortunately, what comes with that is the instinct to require more and not less by way of disclosure. The consequence of that is that the volume and level of detail involved can make it harder for investors to assess the important issues. The laudable objective in the UK of moving to improved narrative reporting with a separately identified strategic report has in its early days seen corporate reports lengthening, as have the new directors’ remuneration reporting requirements. Whilst there is a stated objective of cutting clutter, the individual elements do not naturally lead to that result.
WWL: Board diversity, notably in relation to gender, has been a hot topic in recent years. Have there been any regulatory requirements in your jurisdiction addressing this issue? How, in practice, are regulations being implemented within the necessary time frame?
Claudia Allen: While US public companies generally must have a majority of independent directors, there are no other mandates regarding board composition. The securities laws only require that public companies disclose whether they consider diversity in identifying board nominees, and leave the term “diversity” undefined. Some large institutional investors have been pressing the case for more women directors, and have cited studies arguing that boards with women directors demonstrate superior financial performance. Achieving diversity of gender, ideas, professional skills and background is complicated by the long-tenure of many sitting directors and the sharply lower number of public companies, as compared to the late 1990s. Notably, proxy advisers and some institutions are beginning to factor extended director tenure into voting recommendations and decisions.
Derk Lemstra: The Netherlands has introduced soft quotas in the sense that at least 30 per cent should be female and 30 per cent should be male. The remaining 40 per cent can be either. The quotas are soft because a company can deviate by providing the reasons for any deviation. Diversity is relatively high on the agenda but the speed with which board composition changes is too low.
Lisa Chung: As mentioned in response to the second question, Hong Kong-listed companies are now required to have a policy regarding diversity in the board of directors – or, if they do not, to explain why not. As explained in the Code, diversity can be achieved through various factors, including gender, but also with respect to age, cultural and educational background, or professional experience. The new requirements on board diversity were introduced in Hong Kong after a market consultation process and listed companies had a reasonable amount of lead time to prepare for their introduction.
Vassily Rudomino: I would say that in Russia gender diversity of corporate government bodies is not a hot topic yet. For the moment there are no regulatory requirements prescribing board diversity in relation to gender. It would be fair to say that the number of women participating in the state government in Russia is constantly increasing; for instance, the Federal Assembly, the upper chamber of the Russian Parliament and the Central Bank of Russia are currently chaired by women. I believe that a similar tendency can be seen in corporate governance as well.
Gareth Roberts: Board diversity is a high-profile issue in the UK. Attention has very largely centred to date on gender diversity. But we do not have hard regulatory requirements in the form of, for example, targets or quotas. The government commissioned a report from Lord Davies to review the obstacles for women in reaching the boardroom, and Davies reported back in 2011. Amongst his recommendations was one that FTSE 100 boards should aim for a minimum of 25 per cent female representation by 2015. The Companies Act was amended to require listed companies to disclose the proportion of women on their boards, in senior executive positions and in the whole workforce in their strategic reports. And the Corporate Governance Code requires listed companies to describe their diversity policy (including gender diversity), with any measurable objectives and progress against them. It does not require such a policy to exist. There remains potential for further change here from Europe, including possible targets (not quotas) for listed companies of 40 per cent female non-executives by 2020.
WWL: Looking to the future, what changes or developments are you expecting to see in this area of law? Will experienced outside counsel continue to be in demand? Are you expecting any changes to the legal market where you are?
Claudia Allen: The combination of heightened regulation, activist investing and demands from socially oriented investors means that corporate governance will remain a central issue for US public companies. Additionally, many rules mandated by the US Congress under the Dodd-Frank Act have yet to be written. To navigate this increasingly complex playing field, where missteps can result in litigation, regulatory action, negative publicity and economic consequences, companies will continue to require experienced corporate governance counsel. Such expertise is critical in connection with mergers and acquisitions, fiduciary litigation, regulatory and internal investigations, evaluating transactions (such as spin-offs) proposed by activists and responding to crises.
Derk Lemstra: I believe that we may be seeing the end of the number of corporate governance requirements but will see a further refinement. The one area for which this does not apply is executive compensation. Here, more rules are likely to follow.
As a general note, I truly hope that the pendulum will swing somewhat back to a more overall principle-based approach, leaving boards more room to do what they are supposed to do – which is make informed business decisions. Whatever the development, however, this is an area of law where the view of outside counsel is frequently sought. As long as shareholders are active, so are corporate governance counsel.
Lisa Chung: In the area of ESG reporting, the Hong Kong Stock Exchange has indicated that it may consult the market again to raise the obligation in the Code from a recommended best practice to “comply or explain” by 2015.
The Exchange also recently carried out a market consultation on proposed changes to the connected transaction rules. These rules are quite onerous (in the opinion of overseas companies in particular) but reflect the prevalence of family-owned companies among listed issuers in Hong Kong. As explained in Rule 14A.01 of the Hong Kong Listing Rules, the connected transaction rules are intended to ensure that adequate safeguards are in place to protect minority shareholders. The proposed amendments to the rules, if adopted, will introduce certain relaxations to the regime and, in that respect, will be welcomed by issuers.
In addition, on 3 March 2014, a new Companies Ordinance came into operation in Hong Kong. One of the key aims of the new legislation was to enhance corporate governance in Hong Kong, for example through the codification of the directors’ duty of care, skill and diligence.
In all of these respects, experienced Hong Kong counsel have been and will continue to be in high demand – particularly those lawyers who have a long-standing presence in the market and good contacts with the key regulators.
Vassily Rudomino: As important developments I would identify expected changes in regulation of corporate control and affiliation issues. A draft law covering these questions has been developed by the Russian government last year. Our law firm took part in the legal expertise of the subject law and I can say that the law introduces some significant novellas in regulation, like vesting the state courts with the right to acknowledge the fact of affiliation (for instance, between a company and its shareholder or between two legal entities) or division between public and non-public companies. We assess such changes in general as a positive and progressive step in regulation. However the amendments have not been supported by the business, therefore the process of adoption of a new law is not likely to be fast. A more distant initiative relates to the possible appointment of several directors for management of operational activity of a company (similar to the system that currently exists, for instance, in Cyprus).
All the above-mentioned developments are expected to increase the transparency of the whole corporate governance system in Russia; the market situation in general will stay positive. Demand for experienced external counsel and law services providers will continue to grow.
Gareth Roberts: I believe that corporate governance is a topic that will continue to develop. There was a huge acceleration in regulation and guidance following the analyses of the causes of the financial crisis, the results of which have affected all companies in the listed arena, even though the root of many of the themes lay within the financial services industry. It is clear in the UK that there will be evolution both in revising the requirements which have been introduced and in examining different areas. There has, for example, been a major exercise concerning risk management, internal control and the going concern basis of accounting, on which the Financial Reporting Council has consulted. Risk, in the broadest sense, is now back at the top of the agenda, and the relationship between the audit process and the board’s approach to corporate risk is a very significant topic. We have commented elsewhere in the past that prudent risk-taking is at the core of successful commercial activity, and the way in which boards assess their approach to this, particularly in a climate which seeks first to ascribe blame, is in our view a key challenge. Given the extent of the requirements, the large number of other interested parties (investors, regulators and media) who monitor outcomes, and the importance of keeping an eye on best practice in the market, it is – we believe – inevitable that the role of the experienced external adviser will become more, rather then less, necessary.