T HE RISE OF SHAR E H O L D E R P O W E R : LEGISLATION TRIED AND TESTED BY MARKET PRACTICES AND SHAREHOLDER ACTIVISM

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1 Panel Discus sion 3 T HE RISE OF SHAR E H O L D E R P O W E R : LEGISLATION TRIED AND TESTED BY MARKET PRACTICES AND SHAREHOLDER ACTIVISM Carole Uzan Executive Officer, Legal Affairs LES ENTRETIENS DE L

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3 Introduction Corporate governance can be defined as the process of preparing and overseeing management decisions in companies. Consequently, corporate governance principles shape the balance between the respective powers of shareholders and managers, and underpin the oversight mechanisms available to shareholders. The founding principle of corporate governance is to meet and protect the interests of shareholders. To be effective, therefore, those shareholders must exercise all the rights attaching to the shares they own. In recent years, lawmakers and regulators have made efforts to achieve that end. In France, the 2003 Financial Security Act laid down the principle that investment management companies must exercise the voting rights held by their funds "in the exclusive interest of [ ] shareholders or unitholders". Failing this, they are required to explain why they have not exercised those rights and "report on their practises" in this area1. Pursuant to these measures, Articles et seq of the AMF General Regulation2 require investment managers to prepare a voting policy document explaining how they intend to exercise their voting rights, together with an annual report on the conditions in which they have exercised them. These and other legislative amendments, reviewed below, are part of a shift towards diversified share ownership. French companies, for example, whose ownership structure is traditionally divided between "retail" and "institutional" shareholders, have seen the arrival of new and often powerful investors that are as keen to influence strategic policy as to maximise their return on investment. This new situation has not only led to a strengthening of shareholders' prerogatives and greater transparency in companies' operating conditions but also to the introduction of tools for revealing the rise of shareholder power. 1 Act of August 2003 on financial security (Monetary and Financial Code, art. L ) 2 Version prior to 1 November

4 1. Legislation as a tool for shareholder activism: greater transparency and stronger powers for general meetings The law provides two key tools for shareholder activism: greater transparency in companies' operating conditions and stronger powers of oversight for shareholders. Recent rule amendments have reinforced these tools and brought them into widespread use Widespread transparency Considerable progress has been made in this area in recent years, with confirmation of the principle that the offices of chairman and chief executive are separate (although they may be held concurrently) and the requirement for listed companies to prepare a report on internal control and corporate governance, which the AMF then uses as the basis for its own annual report on this subject. Moreover, the AMF encourages issuers to refer to the guidelines laid down by AFEP/MEDEF3 and ANSA4 covering the principles and procedures for preparing the chairman's report. The critically important issue of executive compensation has been a focal point of discussion, especially since the passage of the 2001 New Economic Regulations Act5. The legislature has constantly raised the level of transparency concerning both the amounts paid out to corporate officers and directors and the procedures used to determine them. For example, under the 2005 Economic Confidence and Modernisation Act6, commitments made by companies whose securities are listed on a regulated market to pay remuneration, compensation or benefits to a senior executive when he or she steps down from or changes office are now subject to the same rules as are related party agreements. The Act has also enhanced shareholder disclosures. It demands that the fixed, variable and exceptional components of remuneration and benefits be identified separately and described in the management report, along with the criteria used to calculate the amounts paid or the circumstances for which they are awarded. The report must also give details of any commitments that the company has made to directors and officers and that correspond to remuneration, compensation or benefits due or likely to be due on account of the taking-up, termination or change of these functions, or subsequently thereto. Furthermore, statutory auditors are required to certify specifically in their report that the information about executive compensation contained in the management report is truthful and precise. More recently, the Act of 30 December amended the rules applicable to grants of options and bonus shares to senior managers. The board of directors of a joint stock company must either bar executives from exercising their options while still in office or, where an option has already been exercised, require them to hold some or all of the resulting shares in registered form until they relinquish their functions. The chosen alternative must be specified in the management report submitted to the general meeting of shareholders. Similar measures have been introduced for bonus shares. 3 AFEP/MEDEF recommendations on the chairman's internal control report, published on 17 December 2003 under the title L application des dispositions de la loi de sécurité financière concernant le rapport du président sur les procédures de contrôle interne mises en place par la société 4 ANSA legal committee memo, 5 November 2003, no Act of 15 May 2001 on new economic regulations 6 Act of 26 July 2005 on economic confidence and modernisation 7 Act of 30 December 2006 on the development of profit sharing and employee share ownership, pursuant to sundry social and economic provisions 2

5 The Act of 21 August amends the rules on deferred compensation for officers and directors. It prohibits a listed company from granting this type of compensation unless the beneficiary is subject to performance-related conditions, assessed in light of the company's own conditions. No payment may be made until the board of directors has established, when or after the person ceases or changes functions, that these conditions have been met. Any payment made in breach of these rules is automatically void. The new law also requires the general meeting of shareholders to pass a special resolution for each deferred compensation package awarded to a director or officer, as established by the board. Similarly, the legislature has mandated greater transparency in areas other than executive compensation. Regarding takeover bids, the Act of 31 March imposes transparency by requiring that any measures likely to affect the bid price should be published in the management report10. Likewise, with the transposition of the Transparency Directive11, periodic and ongoing disclosures concerning companies listed on a regulated market must now be disseminated Europe-wide. This makes it even simpler for investors to obtain information about the company they invest in, regardless of where its registered office is located Greater powers of oversight Giving shareholders greater powers of oversight encourages them to take part in general meetings, wherever they live. In February 2005, the AMF set up a working group chaired by Yves Mansion, a member of its Board, to look into ways of improving shareholders' rights in this regard. In its report, titled "Improving the exercise of shareholder voting rights at general meetings in France", the group put forward a set of recommendations based on four high-level principles: improved access to information, efficient processing of votes, investor accountability, and quality of the meeting proceedings. In particular, it recommended adopting a system of record dates on the grounds that the French system of temporary share-blocking is seen by shareholders especially non-residents as a hindrance to voting, even when the requirement is revocable. Further to these proposals, the decree of 11 December eliminated share blocking and provided that the right to participate in general meetings of companies whose shares are listed on a regulated market or admitted to a central depositary is evidenced by the book-entry of shares in the name of the shareholder or the intermediary registered on its behalf. The entry must be made on the third business day before the meeting, either in the registered share accounts held by the company or in the bearer share accounts held by the authorised intermediary. The EU Directive of 11 July 2007 on shareholder rights is framed in the same spirit13 but goes further by allowing shareholders to appoint any person or legal entity to represent them as a proxy holder at a general meeting. This eliminates the barriers to proxy voting that sometimes arise because of the holder's status. That said, in the event of potential conflicts of interest between the proxy holder and the shareholder, national legislation can force the holder to reveal the existence of such conflicts or restrict the holder from exercising voting rights if he has not received specific instructions for each resolution. 8 Act of 21 August 2007 on encouraging work, employment and purchasing power 9 Act of 31 March 2006 on takeover bids 10 For example, measures set forth in the company's articles to restrict the exercise of voting rights, share transfers or shareholder pacts; the list of holders of any security with special voting entitlements and a description of those rights; and a non-exhaustive list of agreements entered into by the company that would be modified or terminated following a change of control, except where such disclosures would materially compromise the company's interests (and excluding instances of mandatory disclosure). 11 Directive 2004/109/EC of the European Parliament and the Council of 15 December 2004 on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market 12 Decree of 11 December 2006 amending decree of 23 March 1967 on commercial companies 13 Directive 2007/36/EC of the European Parliament and the Council of 11 July 2007 on the exercise of certain rights of shareholders in listed companies 3

6 The Act of 31 March 2006 on takeover bids14 is in the same vein. It requires the managers of the target company to seek the approval of the general meeting before taking any measures apart from seeking other offers that might frustrate the bid. Similarly, if the general meeting has delegated such a measure before the offer period, the delegation is suspended during the period, and any decisions taken by management before the period that have not been fully or partly implemented and are inconsistent with the company's regular course of business must be approved or confirmed by the general meeting Legislation as a tool for detecting the rise in shareholder power The emerging power of minority shareholders, who do not necessarily have the same objectives as other shareholders, has prompted a spate of reforms aimed at enabling companies to identify both the composition of its shareholder base and its investors' objectives Detecting the rise in shareholder power The regulations governing the disclosure of major holdings16 have sought to make it easier to identify the ownership structure of a company and thus detect any shareholder that is increasing its stake. Depending on the circumstances, the shareholder in question has to report to the AMF, declare its intentions or even file a proposed tender offer. Article L of the Commercial Code, amended for the purpose of transposing the Transparency Directive,17 provides that "any person coming into possession of a number of shares representing more than one twentieth, one tenth, three twentieths, one fifth, one quarter, one third, one half, two thirds, eighteen twentieths or nineteen twentieths of the capital or voting rights shall inform the company and the AMF of the total number of shares and voting rights it possesses". The purpose of these multiple reporting thresholds, as well as the number of situations deemed equivalent to direct ownership, is to "clarify who actually exercises influence over an issuer"18. The Commercial Code also requires disclosure of the number of shares giving access to a company's capital, making it possible to gauge the influence that a shareholder may ultimately exert. A similar disclosure is provided for in the Transparency Directive and its implementing directive,19 where the major holding notification requirements apply also to a person who holds "financial instruments that result in an entitlement to acquire, on such holder's own initiative alone, under a formal agreement, shares to which voting rights are attached, already issued, of an issuer whose shares are admitted to trading on a regulated market"20. Further, the fact that the Takeover Act 21 recognises actions in concert and extends this concept to defensive actions makes it possible to identify a shareholder's actual influence more clearly. Similarly, the definition of corporate control was amended in 2005 to include the power to appoint and dismiss the majority of the members of a company's board of directors, management body or supervisory board Act of 31 March 2006 on takeover bids 15 However, these arrangements are valid only if they are reciprocal. To derogate from the principle whereby defensive measures cannot be implemented without the authorisation of a general meeting convened during the offer period, the target company can cite the absence of reciprocity if it is targeted by an offeror that does not apply this principle or an equivalent measure. 16 Commercial Code, art. L et seq 17 Directive 2004/109/EC of the European Parliament and the Council of 15 December 2004 on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market 18 Transparency Directive, Recital (20) 19 Directive 2007/14/EC of the European Commission and of the Council of 8 March 2007 laying down detailed rules for the implementation of certain provisions of Directive 2004/109/EC on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market 20 Transparency Directive, art Commercial Code, art. L : "In the case of a takeover bid, persons who have entered into an agreement with the initiator of a public offer to take control of the company targeted by the offer are deemed to be acting in concert. Persons who have entered into an agreement with the targeted company with a view to frustrating the offer are also deemed to be acting in concert." 22 Commercial Code, art. L

7 Not only are shareholders required to report certain major holdings; they must also declare their intentions in certain cases. When the shares of a company are admitted to trading on a regulated market, any person acquiring one tenth or one fifth of the capital or voting rights must state his intentions for the coming twelve months. The acquirer must issue a statement specifying whether it is acting alone or in concert, whether or not it intends to continue its purchases, and whether it plans to take control of the company or to seek the appointment of one or more persons as directors or members of the executive or supervisory boards. In the case of a change of intention permissible only in the event of "material changes in the environment, situation or shareholder base of the persons concerned" another statement must be drawn up. Similarly, since the passage of the Act of 31 March 2006 on takeover bids, supplemented by Articles to of the AMF General Regulation, a person can be required to publicly state his intentions if there are reasonable grounds for believing that he is preparing a takeover bid, particularly where there have been significant price swings or unusual trading volumes in an issuer's financial instruments. This is notably the case if the issuers concerned are holding talks or have appointed advisors with a view to preparing a bid. This system has a binary mechanism. If the person states that he intends to launch a bid, he must inform the public and then file an offer within a time period set in accordance with the AMF. If not, he cannot file an offer for a period of six months from the statement date or until the period specified in the last paragraph of Article has elapsed, unless there are material changes in the environment, situation or shareholder base of the persons concerned Action taken further to the report on the exercise of voting rights at general meetings The legal basis for a shareholder's rights is that he bears the economic risk associated with the shares and may therefore need to control the actions of management. The law has traditionally recognised that relationship through concepts such as affectio societatis, the prohibition of unconscionable clauses (leonina societas) or the prevention of vote trafficking. Concerns about whether stock lending is justifiable during general meeting periods were voiced in the Mansion report, "Improving the exercise of shareholder voting rights at general meetings in France", on the grounds that these transactions can transfer some of the meeting's decision-making powers to borrowers who, although they have legal title to the shares, do not bear the economic risk on a long-term basis. In such cases, the voting rights attached to borrowed shares could be used to back selective moves by some types of investors to influence the course of the general meeting, or even the value of the shares themselves, without assuming the actual risk of ownership. The working group did not adopt a policy position on this issue but recommended "transparency in stock lending" and also proposed that "asset management companies [should] recall lent stock when general meetings are held". Securities lending during general meetings and, more broadly, the possibility of using various methods to temporarily separate the legal ownership of a share from the underlying economic risk, has once again become a critical and hotly debated issue at the international level. Codes of practices 23 have been published in some Member States to prevent misuse of stock lending and to regulate this practice during general meetings. In a consultation paper published on 30 April , the European Commission also raised the question of whether stock lending should be regulated at the European level. It also initiated a debate about the proportionality between capital and control in listed companies, generally known as the "one man, one vote" issue, and commissioned the consultancy Institutional Shareholder Services Europe, the law firm Shearman & Sterling, and the European Corporate Governance Institute to review compliance 23 For example, Code of the International Corporate Governance Network, 15 October Fostering an appropriate regime for shareholders rights 5

8 with the principle of proportional allocation of capital and control of European listed companies. The report on this review was published on 4 June In light of these developments, initiatives may be needed to find solutions and to prevent abusive practices that may arise because of the uncoupling of legal ownership and economic risk. However, such initiatives should not undermine the efficiency of the existing stock lending arrangements, which are of undisputed value to financial markets, especially in terms of liquidity. 6

9 Conclusion The AMF's remit as a regulator is to ensure orderly markets and protect savings and investments in financial products. This means guaranteeing that companies can remain keenly competitive while maintaining a high level of protection for wholesale and retail investors alike. Strengthening measures to enhance transparency and improve the conditions for exercising shareholders' voting rights is certainly a step in this direction because it allows investors to compare the performance of companies and, where appropriate, to penalise their managers. For these same reasons, the AMF cannot disregard market practices, especially when they result in transferring a shareholder's rights to a market participant who, despite owning the shares at the time of the general meeting, does not assume the associated risks on a long-term basis. In such cases, there is a serious risk that the affairs of a company may be disrupted, without the market necessarily realising that the practice is improper. How should the regulator assess such practices? The question is a thorny one because it involves finding ways to raise ethical standards for takeover bids and the exercise of shareholder voting rights without calling into question legal procedures, such as stock lending and derivatives, that have proven their worth in the marketplace. Is it sufficient and sufficiently dissuasive to rely more heavily on transparency measures? Or should the regulator go further and outlaw certain techniques for separating ownership from economic risk in the run-up to the annual meeting season? Or take measures to bring economic and legal ownership into line simply for the purpose of exercising voting rights? These issues need to be analysed in depth, having regard to stakeholder expectations. 7