MEMO/03/112. General. What will this Action Plan do for the average European? Won't all this just mean more red tape for businesses?

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1 MEMO/03/112 Brussels, 21st May 2003 Commission Action Plan on "Modernising Company Law and Enhancing Corporate Governance in the European Union" - Frequently Asked Questions (see also IP/03/716) General What will this Action Plan do for the average European? In short, good company law and good corporate governance practices throughout the EU will enhance the "real" economy by encouraging investment. That means better prospects for growth. It means more jobs. It means higher real incomes and more resistance in Europe to downturns in the global economy. A dynamic and flexible company law and corporate governance framework is essential to protect investors from fraud and malpractice and make sure investors or those representing them have the information enabling them to make the right investment decisions. Most Europeans are investors in one way or another, not only through direct shareholdings but also through pension funds, savings accounts, life assurance etc. Their livelihoods are tied up in the proper, responsible performance and governance of listed companies in which they invest. A modern European company law framework is also a key to deepening the Internal Market and building an integrated European capital market, further motors for growth. What is more, it will help maximise the benefits of enlargement for citizens of all the Member States, new and existing. Won't all this just mean more red tape for businesses? Far from it. An effective approach will increase the efficiency and competitiveness of businesses in the EU. Well managed companies, with strong corporate governance records and sensitive social and environmental performance, outperform their competitors. Europe needs more of them to generate employment and higher long-term sustainable growth. What is more, the proposals in the Action Plan will make it much easier for businesses to operate across borders, in some cases by further harmonising divergent national regulations through a few essential European rules, in others by encouraging co-operation between Member States and convergence of their laws. There are also proposals to facilitate cross-border mergers and transfers of "seat" (a company's centre of activities and/or its registered office), as well as to allow businesses to operate under a single European statute.

2 An effective approach will help to strengthen shareholders' rights and protection of third parties, and will contribute to rebuilding European investor confidence in the wake of a wave of recent corporate governance scandals. All that is good news for responsible businesses. The Financial Services Action Plan (FSAP) has not been completed yet. Do we really need another action plan? Yes! Without a modern European company law framework, we cannot complete the Internal Market. But the proposals in the Company Law Action Plan are carefully prioritised over the short, medium and long-term. Many need further thought. Major initiatives will be consulted upon. It is essential to avoid hasty legislation which creates more problems than it solves. The Company Law Action Plan complements the FSAP. Both are necessary to help maximise both opportunities and protection for companies, investors and consumers active in the Internal Market. Both will help restore confidence in the financial markets, help ensure genuine integration of European economies, make it easier for businesses to operate across borders and boost investment, growth and jobs. To what extent does the Action Plan follow the recommendations of the High-Level Group of Company Law Experts chaired by Jaap Winter Frits Bolkestein, the Internal Market Commissioner, has already made clear how much he appreciated the excellent work of the Group (see IP/02/1600)? In most respects, the Action Plan follows the Group's recommendations. However, there are certain differences, for example: The High Level Group, in its report, saw a case for setting up a permanent structure which could provide the Commission with independent advice on future regulatory initiatives in the area of company law. The Action Plan does not exclude this in the future but for now proposes instead, in addition to wide consultation, a "European Corporate Governance Forum" to meet once or twice a year. The High Level Group made proposals aimed at obliging listed companies to facilitate electronic access by the general public to relevant company information via company websites, the creation of national central electronic filing systems and the establishment of links between the various registries containing formal company information. These are not addressed in the Action Plan, because they are already partly covered by the proposed Transparency Directive (see IP/03/436, MEMO/03/68 ) and because the need for further EU intervention will depend upon forthcoming national initiatives. On corporate governance, the High Level Group felt that the nomination and remuneration of directors of listed companies and the supervision by the board of the audit of accounts should be decided upon by exclusively non-executive or supervisory directors, a majority of whom would be independent. The Action Plan differs from this as far as the nomination of directors is concerned as the Commission considers that executive directors are best placed to know the qualities required for a board position and to assess candidates. However, the Plan proposes that non-executive directors ought to be included and specific safeguards should be put in place to deal with any conflicts of interest. 2

3 In the light of the views of the sectors concerned and of the European Parliament, the Commission has given a higher priority than the Group to the creation of a European Association Statute, a European Mutual Society Statute, and a possible European Foundation Statute. Finally, there is one element in the Action Plan that was not explicit in the Group's report. The Action Plan notes that there is a strong medium to long term case for aiming to establish a real shareholder democracy many corporate governance codes tend to support the one share/one vote principle, although many codes favour some flexibility in this respect. The Commission intends to undertake a study on the consequences of such an approach. Do the European Parliament and the Council have to ratify this action plan? No. The Commission is, however, submitting it for consultation and will give adequate consideration to any comments made. Of course, the individual legislative proposals arising from the Plan will have to be adopted by the Parliament and the Council in the usual way. How does the Commission intend to consult on the Action Plan before starting to put it into effect? This Action Plan has not appeared in a void. It aims to put into effect a lot of things the business community and other interested parties have asked for over the last few years. It follows many of the recommendations of the High-Level Group; a broadly based group of experts from various backgrounds which itself held extensive consultations. The Action Plan also constitutes a considered response to recent corporate scandals, following discussions with Member States, notably at the Oviedo informal meeting of Ministers in April 2002 (see MEMO/02/72 and IP/02/584) But the Commission is committed to further consultation. First, the Action Plan itself will be open for consultation until 31 August Responses should be sent to Markt-COMPLAW@cec.eu.int With respect specifically to corporate governance, a European Corporate Governance Forum will be convened once or twice a year to contribute to coordinating the corporate governance efforts of Member States. Corporate governance Isn't this Action Plan an admission that EU corporate governance is not currently up to US levels post Sarbanes-Oxley? No. It is not helpful to look at this in terms of a race: neither side is "ahead" of the other. Clearly a lot of work is being done and will continue to be done on both sides of the Atlantic. The EU and the US have identified broadly the same problems and broadly share the same goals. Both recognise the importance of good corporate governance both for investors and for the economy as a whole. On the US side the passing of the Sarbanes-Oxley Act is not the end of the story. The SEC and other regulators are assessing how to implement it. 3

4 Unfortunately the Act creates a series of problems due to its outreach effects on European companies and auditors, and the Commission is engaged in an intense regulatory dialogue with a view to negotiating acceptable solutions with the US authorities, in particular the Securities and Exchange Commission (SEC). Those solutions should avoid imposing double regulation on business already adequately regulatedintheeu. In Europe, a one-size-fits-all solution is not feasible or desirable given the many different national models. That is why the Action Plan proposes combining harmonising a few essential rules with closer co-ordination between national codes. The Commission sees the Action Plan as an opportunity for the EU to help shape international regulatory developments, strengthening its influence in the world with good, sensible corporate governance rules to be a potential model for other countries in the future. Do the proposals on corporate governance go far enough, given that some Member States already have or are in the process of preparing tougher rules? The proposals on corporate governance are far-reaching and based on best practice and on extensive consultation, in particular by the High Level Group of Company Law Experts, with investors, issuers and other interested parties. If some Member States wish to go further, that is their prerogative. The Commission is not aiming for total harmonisation but to implement a few essential principles and rules. Recent debates in the OECD, which is in the process of updating its 1999 corporate governance principles, confirm that the EU Action Plan will address the key issues at stake. Some of the proposals for now stop short of formal legislation but aim to create strong moral and market pressure on companies to improve their corporate governance act and on Member States and regulators to enforce that improvement. The Commission believes this approach will be effective and that the Action Plan will greatly improve transparency, reinforce shareholder rights and enhance corporate responsibility. Why is the Commission only proposing Recommendations on reinforcing the role of non-executive directors, on disclosure of Directors' remuneration and shareholder approval of Director share options? What will happen if these are ignored? The High Level Group advocated Recommendations as these can take effect much more quickly than Directives or Regulations. And speed is important here. We need to reinforce investor confidence quickly. The Commission is confident Member States will give effect to the Recommendations in national law and that the spread of best practice will take on a momentum of its own. It is clearly in companies' own interests to ensure their corporate governance framework is worthy of investor confidence. A recent study by Deminor (for details see found that well governed companies perform up to 3 % better than less well-governed rivals. It is also clear that investors are paying increasing attention to governance issues in making their investment choices. By requiring full reporting by companies of their corporate governance practices, the Action Plan will help them do that. 4

5 But this is not a closed book. The Commission will monitor carefully how the Recommendations work in practice and assess the need for further action, perhaps including binding legislation. How would the proposal in the Action Plan on Directors' remuneration reinforce shareholders' power to veto excessive executive pay, as we saw in the UK with Glaxo Smith Kline? One of the key objectives of the Action Plan is to increase transparency and control for shareholders across the EU. They should be able to refuse excessive remuneration packages. It proposes a Recommendation putting forward four specific measures in this regard - the disclosure of remuneration policy of directors' remuneration in annual accounts - the annual disclosure of the remuneration of individual directors - prior approval by the shareholder meeting of share and share option schemes in which directors participate - proper recognition of the costs of such schemes for the company in profit and loss accounts (and not just in notes to the accounts) As previous examples have shown, once disclosure is required, the moral pressure shareholders can exert is considerable. It would be very difficult for a board to adopt a remuneration structure against the clearly expressed disapproval of shareholders. If it proves necessary, however, the Commission will consider following up the Recommendation with binding action. Why is the introduction of a special investigation right for shareholders, of personal responsibility for wrongful trading by directors and of EU wide director- disqualification only for the medium-term? Not everything can be done at same time. And it is important to get measures right. Knee-jerk responses can do more harm than good. But already in the short term, effective measures are proposed reinforcing directors' responsibility. For example, the Commission intends in short-term to confirm through a Directive the collective responsibility of Directors for financial statements and for key non-financial statements such as the annual corporate governance statement proposed in the Action Plan. Traditionally sanctions for corporate or individual malpractice have been an exclusive competence of Member States. The Commission is not advocating altering that general principle. But clearly it is undesirable for a director banned in one country to be able to start up a company in another. So in the case of director disqualification, there is a clear need to balance subsidiarity against protection of investors and the public and against the needs of the Internal Market. But that will require careful consideration. 5

6 The Winter Group recommended independent directors should sit on nomination committees. But the Action Plan recommends a key role for executive directors. Why? The Commission believes that those on nomination committees need to know the company from the inside. That does not mean independent directors should not have a role. And safeguards need to be in place to prevent conflicts of interest. But executive directors are best placed to assess the expertise and experience boards need in new members. What exactly would be the role of the Corporate Governance Forum proposed in the Action Plan? Would it have any formal powers? Who would be the members? The exact composition of the Forum remains to be determined. It will have no formal powers or statute. It will be an informal structure set up by the Commission in close consultation with the European Parliament, Member States and interested parties. Issuers, investors, regulators, academics and exchanges will be among those represented. Clearly the Forum itself, once constituted, will have an input into determining its own role. But the objective is clear. It will work to foster convergence of corporate governance codes and the adoption of best practice across the EU. Isn't it unrealistic to propose, even in the long term, shareholder democracy based on one share one-vote when EU governments have repeatedly rejected this in the context of the proposed Takeovers' Directive? The Commission will not apologise for aiming for more shareholder democracy. It's what most investors want and many existing corporate governance codes refer to it as an aim. That said there are clearly tricky issues to be examined. That is why the Action Plan commits the Commission to an in-depth study of this issue in the short to medium term. How will enlargement affect the corporate governance proposals, given the increased diversity of national codes with 25 Member States? Enlargement makes it all the more important to establish essential rules and better co-ordination of national codes. But there is a great deal of agreement on what constitutes good corporate governance within the future EU 25. And several of the new Member States are taking an active role in OECD discussions. 6

7 In a globalised economy, corporate governance is an international issue. What work is taking place in international fora and how does this Action Plan link with that? OECD issued its corporate governance principles in OECD Ministers have decided to adopt an updated version in spring Preparation work started with a meeting in Paris in March The Commission and Member States are making an important contribution to this. In addition, progress at OECD level will be taken into account in implementing the Action Plan. The OECD is discussing many of the same issues, for example enhancing the role of non-executive/supervisory Directors and improved disclosure (including of directors' remuneration) by listed companies to investors. The G8 also made a declaration last week at its meeting of Finance Ministers in Deauville confirming the importance of corporate governance. The issue will be further discussed at its forthcoming summit in Evian on 1-3 June. Of course, the Commission will also continue its detailed discussion with the US government and regulators. It is important to underline that this is a long-established and ongoing co-operation. Occasional areas of disagreement such as the application of Sarbanes-Oxley to EU audit firms should not overshadow the many points of agreement. Company law What amendments to the Second Company Law Directive on public limited liability companies are planned for the short term? The Second Company Law Directive (77/91/EEC) was adopted by the Council on 13 December 1976 and refers to the formation of public limited liability companies and the maintenance and alteration of their capital. The Directive introduces a minimum legal capital requirement, and contains a number of detailed provisions aiming at protecting creditors and shareholders, applicable inter alia to distributions to shareholders and acquisitions of own shares by the company, as well as to increases and reductions in capital. Some of the features of the current legal capital regime organised by the Second Directive are perceived as too inflexible and costly. In order to improve the current regime and to promote business efficiency and competitiveness, without reducing the protection offered to shareholders and creditors, the Commission is considering proposing amendments in the short term. These may include - the introduction of "real" no par value shares (i.e. shares without any reference to either nominal or fractional value in relation to the company's capital); - the limitation of the need for an expert valuation of contributions in kind; - the partial relaxation of the prohibition of financial assistance by the company for acquisition of its shares by third parties; - the introduction of squeeze-out and sell-out rights (i.e. the right of the majority shareholder, under certain conditions, to buy out minority shareholders and the complementary right of those minority shareholders to compel the majority shareholder to buy their shares); 7

8 - the introduction of the right for the company to acquire its own shares up to the limits of distributable reserves; - a relaxation of the current rules applicable to the limitation or withdrawal of preemption rights, in order to make the procedure of issuing new shares less burdensome while at the same time maintaining the protection for existing shareholders from dilution of their shareholdings. Why is an alternative approach to the legal capital regime envisaged? How would it be introduced? Some argue that the traditional legal capital regime does not fully achieve its objectives (protection of shareholders and creditors). In particular, some consider that better information could be provided on the adequacy of a company's assets for its entrepreneurial activity and on the company's ability to pay its debts. In addition to the modernisation of the current legal capital regime as explained in the previous question, the introduction of an alternative regime for creditor and shareholder protection is therefore envisaged as an option for Member States. Such a regime would require that any dividend payment or distribution to shareholders is based on a solvency test and on a solvency certificate signed by the directors. This would be a substantial change from the current legal capital regime. How it would work in practice and the potential impact on other issues (e.g. share issue price, contributions in kind, pre-emption rights) would therefore need to be studied carefully. Why do we need a Directive on cross-border mergers? European firms are calling for the speedy adoption of a legal instrument capable of meeting their needs for co-operation and mergers between companies from different Member States. Until such mergers are more practicable, the EU economy will continue to be handicapped in efficiently allocating resources compared to its major competitors. There are at present insurmountable legal obstacles to cross-border mergers in the EU. Some Member States national laws allow companies established there to absorb a company from another Member State or to form a new company by merger with a company registered in another Member State. However, such an operation may be carried out only with companies from those other Member States where it is likewise not prohibited by law. In the absence of legislation governing cross-border mergers, any such operation currently requires complicated legal arrangements. On 23 July 1990, the Council adopted Directive 90/434/EEC on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States. But this instrument cannot be applied to cross-border merger operations without harmonisation of the corresponding company law legislation. 8

9 How would a new proposal for a Directive on cross-border mergers be different from previous failed attempts? A first proposal for a Tenth Company Law Directive on cross-border mergers was transmitted by the Commission to the Council on 14 January It was never discussed in the Council for want of a European Parliament opinion, never adopted because of difficulties over the issue of employee participation. This proposal for a Tenth Company Law Directive was withdrawn in 2001, when the Commission decided to withdraw several proposals for Directives regarded as obsolete. On 8 October 2001, the Council adopted Regulation (EC) N 2157/2001 on the European Company Statute and Directive 2001/86/EC supplementing that Statute with regard to the involvement of employees (see IP//01/1376). A European Company may be created inter alia by merger of two or more public limited liability companies from different Member States. 9

10 A new proposal for a Tenth Company Law Directive is nevertheless desirable, since companies may wish to enter into a cross-border merger without creating a European Company. Furthermore, the new proposal would apply, like the 1990 mergers taxation Directive, to all limited liability companies. The previous proposal covered only public companies. Why do we need a Directive on the cross-border transfer of corporate headquarters ("seat")? Industry has repeatedly, most recently in the consultation organised by the High Level Group of Company Law Experts, called for companies to be able to transfer their "seat" (their centre of activities and/or their registered office) within the EU. There are for now insurmountable legal obstacles to such cross-border transfers. This is because Member States laws either do not provide the necessary means or conflict with each other as to the practicalities of the transfer. The Court of Justice concluded in its Daily Mail judgment (Case 81/87) that, making companies equivalent to natural persons for the purposes of freedom of establishment thus allowing easier transfers of seat - cannot be achieved simply by applying Treaty provisions, precisely because of the differences which exist between Member States laws. As the Court concluded, a new law is needed in this field in order to implement freedom of establishment in the manner intended by the Treaty. What is the aim of creating a "European Private Company" Statute? To help small and medium-sized enterprises (SMEs) who are active in more than one Member State. The main potential advantages are that it could: - facilitate the establishment by SMEs of subsidiaries in other Member States; - simplify cross-border mergers for SMEs; - contain simpler requirements for company registration than with other European legal forms such as the European Economic Interest Grouping ("EEIG") or the European Company Statute; - have a minimum capital requirement more convenient for SMEs than that of the European Company; - reduce extensive advice, consultancy and information costs incurred by SMEs active in more than one Member State because of legal differences between Member States. If there are so many advantages, why is a study necessary before any proposal on this point? The introduction of a European Private Company Statute would require solving a number of issues, on for example taxation and workers' rights. It may not be the only way to facilitate cross-border business for SMEs in the EU, given the current and possible future European legal forms already available to business in general, and given the proposal envisaged for a Tenth Company Law Directive on cross-border mergers. The Commission therefore proposes a detailed study to get the broadest possible overview of the practical benefits of and problems related to the introduction of an EPC Statute. 10

11 Why do we need a European Co-operative Statute (ECS)? Cross-border co-operation between co-operatives, which are a form of enterprise generally recognised in all Member States, is hampered in the EU by legal and administrative difficulties. The objective of the proposed Statute (which would be optional and would not replace national laws governing co-operatives) is to provide a legal instrument to help co-operatives to undertake cross-border activities more easily. This would ensure competition on equal terms between co-operatives and companies established under the European Company Statute, which is a capitalbased undertaking and is therefore not suited to the specific features of cooperatives. The European Co-operative Statute would be useful for existing co-operatives with activities in more than one Member State. It would also allow two or more companies of any type, in more than one Member State, to create a "Societas Cooperativa Europaea" from scratch with 30,000 capital. That would be an appropriate legal vehicle, with limited liability, for cross-border groupings of small enterprises for common activities such as research, product development, marketing and distribution, tendering or offering joint services. Why do we need a European Association (EA)? According to one recent statistical study, associations account for 10.3% of nonagricultural employment in Western Europe 1. Their level of economic activity is therefore significant. 73% of these associations are active in the education, health and social welfare sectors, often providing services (schools, hospitals, etc) in competition with other forms of enterprise. Associations that undertake economic activities (i.e. produce goods or provide services) are understood to be companies or firms under the definition provided in Article 48 2 of the Treaty of Rome, even if they are commonly considered to be non-profit making. As a form of company, associations should fully benefit from the freedoms of the Internal Market. A relatively large proportion of associations have cross-border activities and they should not suffer from obstacles to these activities. The original calls for a European Statute for associations came from the European Parliament 2. Why do we need a European Mutual Society (EMS)? Large mutuals in various Member States are increasingly trying to work more closely across Europe. The Statute for a European Mutual Society should provide them with an adequate legal instrument which takes into account their specific characteristics, permitting them to develop their cross-border activities. These activities are currently inhibited by the diversity of laws to which they are subject at national level. This statute should also provide a means for the grouping of mutual organisations which is often absent at national level. 1 2 John Hopkins University Comparative Non-Profit Sector Project: Resolution of Louis Eyraud, November 1984, on "the mission, administration and regulation of associations in the European Communities" ; Resolution of Nicole Fontaine March 1987, on "Non-profit associations in the European Communities OJ C99 of 13/4/1987, p

12 What is the background and current state of play for each of these proposed European forms (ECS, EA, and EMS)? In 1992 the Commission presented three proposals for Regulations for the creation of a European Co-operative, European Mutual Society and European Association respectively. These texts, whilst taking into account the specific features of cooperative, mutual and associative enterprises, closely paralleled that of the European Company. All substantial rules concerning the structure, powers and obligations of their organs are similar to those of the European Company. Now that the European Company Statute has been adopted, negotiations on the other three proposals have restarted. It is expected that the Statute for a European Co-operative Society will be adopted by the Council of Ministers shortly. From then, Member States will have 3 years to implement the related Directive concerning the involvement of employees in an ECS in their national law. Therefore, the Statute should be available for use from June The Statute for a European Association is currently being discussed by Member States in the company law working group of the Council of Ministers. Its future progress will depend upon the willingness of future EU Presidencies to move forward rapidly on this work and the ability of all Member States to reach agreement on a final text. The Statute for a European Mutual Society will be discussed again as soon as agreement has been reached on the Statute for a European Association. Possible difficulties linked to differences concerning the definition and understanding of a mutual in Member States may need to be solved before it can be adopted. The Action Plan proposes to improve the transparency of legal entities. Why? What exactly does the Commission intend to do? The First Company Law Directive applies only to limited liability companies, and not to a series of alternative forms of enterprise. Increased disclosure requirements for all legal entities are needed to preserve fair competition. and to prevent company law from being abused for fraud, terrorism or other criminal activity. Pursuant to the conclusions of the Tampere Special Council of October 1999 and the joint ECOFIN/JAI Council of October 2000, the Commission launched a study into the transparency of legal entities notably for the purpose of identifying the beneficial owners more easily - and into obstacles to international co-operation to combat money laundering The study was undertaken by Professor Savona from the Transcrime Institute (University of Trento, Italy). His report was submitted to the Commission in October It presents a number of recommendations to increase the transparency of limited liability companies (both at the formation stage and thereafter) as well as of other vehicles (e.g. trusts). The Savona Report covers a complicated and sensitive issue, and the appropriate regulatory response needs to be carefully examined. In view of the numerous other priorities set in the Action Plan and because the Commission is concerned in particular to be associated with - and take into consideration - the important work being carried out in other international fora (e.g. the OECD), the necessary action will be proposed in the medium term. 12