Italian Regulator Issues New Rules on Related-Party Transactions

On March 12, 2010, through Resolution No. 17221, Consob issued new rules governing related-party transactions entered into by listed issuers and other issuers with widely held shares. The new rules are applicable whether such transactions are entered into directly by such issuers or indirectly through subsidiaries (the “Regulation”). [1]

Main Innovations

The Regulation confers a pivotal role upon independent directors, organized in committees and possibly assisted by advisors, who shall be called upon to provide ex ante opinions on related-party transactions. Under the Regulation, independent directors will have to be involved in the negotiation and preparatory phases leading up to material related-party transactions.

In order not to render related-party transactions excessively burdensome, the Regulation provides a simplified regime for recently-listed issuers, small-sized issuers and widely held unlisted issuers, as well as exemptions for certain categories of transactions.

Continuing and periodic disclosure obligations are also provided. As to the former, a material related-party transaction shall trigger an obligation on the part of the issuer to publish an ad hoc disclosure document. As to periodic disclosure, on the other hand, each covered issuer’s annual management report and the interim management report shall contain specific information on related-party transactions.

In adopting the Regulation, Consob also amended Article 37 of the regulation adopted pursuant to Resolution No. 16191 of October 29, 2007, as amended (the “Markets Regulation”), introducing a specific and significant measure aimed at enhancing the protection of minority shareholders in issuers subject to “direction and coordination powers,” [2] with particular regard to the composition of the boards of directors and the internal control committees of such issuers.

The new rules on related-party transactions will come into force gradually, pursuant to a provisional regime. [3]

I. Scope of Application and Definitions of “Related Party” and “Related-Party Transaction”

The new rules introduced by the Regulation apply to all Italian issuers of shares listed on regulated markets (whether Italian or of other countries of the European Union) or with shares that are widely held. [4] As to the fundamental concepts of “related party” [5] and “related-party transaction”, [6] the Regulation – without making exclusive reference to international accounting standards [7] – introduces two specific concepts that essentially mirror the corresponding definitions under IAS 24 (with some adjustments necessary in order to account for the national legal system). The pursued goal was thus to make the “related party” concept consistent with international accounting standards, while preventing the scope of the Regulation from being automatically modified in connection with amendments to the IAS (which may be justified from an accounting viewpoint, but not necessarily in relation to rules on transparency and procedural fairness).

With regard to disclosure obligations (see infra § II) and substantive and procedural fairness (see infra § IV), the Regulation provides rules that are measured and differentiated in light of the relevance of the transaction at issue. To this end, the Regulation distinguishes:

• (i) related-party transactions in which at least one of the quantitative parameters identified by the Regulation – relating to, among other things, net assets, market capitalization, total assets and liabilities [8] – exceeds a 5% threshold [9] (“Material Transactions”); and
• (ii) related-party transactions in which none of such quantitative parameters exceeds the 5% threshold (“Non-Material Transactions”) and which are not transactions involving minimum amounts as may be identified by the Procedures (see infra § VII).

However, if a transaction may be qualified as a Material Transaction pursuant to the parameters provided by the Regulation and such a result seems to be manifestly unjustified in relation to the specific circumstances, Consob may indicate, upon the issuer’s request, [10] alternative methods of assessment.

II. Continuing and Periodic Disclosure Obligations

With reference to continuing disclosure obligations, the Regulation noticeably enhances current safeguards set forth, inter alia, in Article 71-bis of the Issuer Regulation. [11] Without prejudice to the disclosure obligations triggered in connection with price-sensitive transactions, when Material Transactions are entered into, issuers shall publish a disclosure document (the “Disclosure Document”) within seven days from approval of the transaction by the competent body [12] or from execution of the relevant agreement (including any preliminary agreement). The Disclosure Document shall describe, inter alia, the characteristics of the transaction, the economic rationale that led the issuer to enter into the transaction and the methods for determining the consideration in connection therewith.

The obligation to prepare and publish a Disclosure Document shall also be triggered if, during the same fiscal year, the issuer enters into, with the same related party (or with parties related both to the latter and to the issuer), homogeneous transactions or transactions in execution of the same overall design, which, even though individually not considered Material Transactions, in the aggregate exceed the relevant thresholds. [13] In such case, the Disclosure Document shall be published within fifteen days from approval of the transaction or from execution of the agreement that causes the issuer to exceed the threshold.

With reference to periodic disclosure, the Regulation provides that the annual management report and the interim management report shall contain information: (i) on the single Material Transactions; (ii) on the other related-party transactions (thus including Non-Material Transactions) entered into in the relevant period and which have significantly affected the issuer’s assets or earnings; and (iii) on any change or development in the related-party transactions described in the previous annual financial report that have had a significant effect on the issuer’s assets or earnings.

III. Substantial and Procedural Fairness: the General Procedure for Non-Material Transactions

The Regulation confers a pivotal and, to a certain extent, new, role upon independent directors [14] in ensuring that related-party transactions are entered into in the interest of the issuer, transparently, and in accordance with principles of substantial and procedural fairness. Independent directors are granted such role both in connection with Non-Material Transactions (see this § III) and, to a greater extent, in connection with Material Transactions (see § IV below).

The Regulation requires the implementation of a general procedure for Non-Material Transactions (the “General Procedure”) which is overall less burdensome than the procedure for Material Transactions, and which, as set forth in the Procedures, must include at least the following elements:

• (i) Before the approval of Non-Material Transactions, a committee composed of non-executive and unrelated directors, the majority of which shall be independent, [15] shall express a reasoned (non-binding) opinion illustrating the issuer’s interest in entering into the transaction, as well as the convenience and substantial fairness of the relevant terms and conditions.
• (ii) The committee may rely on independent advisors of its choice, within the maximum budget (for each single transaction) eventually established by the Procedures.
• (iii) Adequate and exhaustive information on the transaction shall be provided, sufficiently in advance, to the committee expressing the opinion and the corporate body competent to decide on the transaction. [16]
• (iv) The minutes of the resolutions approving the transactions shall adequately explain the issuer’s interest in entering into the transaction, as well as the convenience and substantial fairness of the relevant terms and conditions.
• (v) Complete information on the transactions entered into shall be provided to the board of directors and the board of statutory auditors, at least every quarter.
• (vi) Without prejudice to provisions governing the disclosure of price sensitive information, the disclosure of Non-Material Transactions approved notwithstanding the negative opinion of the independent directors, at least on a quarterly basis, with the simultaneous publication of the negative opinion.

IV. The Special Procedure for Material Transactions

The Regulation sets forth a more rigorous course of action in connection with Material Transactions (the “Special Procedure”), delegating once again to the Procedures the specific determination of the relevant steps. In addition to the rules set forth for the General Procedure, the Special Procedure shall provide that:

• (i) In the event of a Material Transaction, the independent directors shall be involved in the negotiation and preparatory phases, by means of an exhaustive and timely information stream and the possibility of asking for clarifications as well as providing comments to the delegated entities and the persons leading the negotiations.
• (ii) The resolution which approves the transaction shall be taken by the administrative body in its entirety, with a reasoned favorable opinion [17] issued by a committee composed exclusively of unrelated independent directors [18] or, alternatively, other means of approval of the transaction shall be established which ensure a fundamental role for the majority of the unrelated independent directors.[19]
• (iii) The favorable opinion of the unrelated independent directors as well as any opinions of independent advisors [20] shall be disclosed within the same time period set forth for the publication of the Disclosure Document (i.e., within seven days from approval of the transaction, see § II above).

The Procedures may allow for the administrative body’s approval of Material Transactions notwithstanding the negative opinion of the unrelated independent directors, provided that such transactions are authorized by the general meeting of shareholders, which may only take their decision – pursuant to the majorities set forth under the law and the by-laws – with the favorable vote of a majority of the unrelated shareholders (the so-called “whitewash” mechanism). The possibility of engaging the general meeting of shareholders in the authorization of Material Transactions – at least in those transactions which involve a majority shareholder as a related party – entails, in practice, the granting of decision-making power to minority shareholders (which could largely act as a disincentive to the use of such instrument).

V. Related-Party Transactions to be Approved by the Shareholders

With regard to transactions that must be resolved upon at a general meeting of shareholders – without prejudice to the application of the procedures illustrated above in connection with the proposals to be submitted by the administrative body in advance of the meeting – the resolutions concerning Material Transactions for which the independent directors have issued a negative opinion shall be adopted with the whitewash mechanism, in order to prevent the final vote from being determined by shareholders that are related parties in the transaction. However, the Procedures may provide that the transaction may be blocked only if the unrelated shareholders attending the meeting represent at least a certain percentage of the issuer’s share capital, not, in any case, to exceed 10%.

VI. Framework Resolutions and Simplified Regime for Specific Categories of Issuers

In order to avoid the repeated application of costly and burdensome procedures in connection with similar and reoccurring transactions, the Regulation envisages that the Procedures may allow, for specific categories of transactions, the adoption of “framework resolutions” in relation to a series of homogeneous transactions with specific categories of related parties. In such case, the application of the General Procedure or of the Special Procedure (as well as the publication of the Disclosure Document) will depend on the foreseeable maximum aggregate amount of the relevant transactions. Framework resolutions may not in any case be effective for more than one year and must relate to sufficiently determined transactions (specifying the foreseeable maximum amount of the transactions to be entered into in the relevant period and the reasons for the terms and conditions in connection thereto).

The Regulation also envisages a simplified regime for recently listed issuers (in the first two years since the start of trading), for small-sized issuers (revenues and net assets not exceeding Euro 500 million) and for widely held issuers. Without prejudice to the application of the disclosure obligations illustrated above under § II, such issuers may apply the General Procedure also to Material Transactions. However, such simplified regime is not available for listed issuers subject to the direct or indirect control of issuers of shares traded on a regulated market.

VII. Cases and Possibilities of Exemption

The provisions of the Regulation do not apply to resolutions adopted at a general meeting of shareholders concerning director compensation or to resolutions on the compensation of directors entrusted with specific powers (e.g., the chief executive officer), if the shareholders, acting at the general meeting, have set forth an aggregate maximum compensation in accordance with the by-laws.

Only the disclosure rules illustrated above under § II shall apply to transactions entered into in compliance with instructions issued by Regulatory Authorities in pursuance of stability objectives.

Other transactions may be exempted (completely or in part) from the application of the rules set forth by the Regulation depending on a specific choice made when adopting the Procedures. These include: (i) transactions involving small amounts; (ii) transactions with and among subsidiaries and affiliates; [21] (iii) ordinary transactions entered into on terms equivalent to market or standard terms; (iv) urgent transactions (i.e., those that cannot be postponed or that are linked to a financial crisis of the issuer); [22] (v) the awarding of compensation (including compensation based on financial instruments) to directors and other managers on the basis of well-established remuneration policies already approved by shareholders [23] and by a committee composed exclusively of non-executive directors, the majority of which are independent. [24]

VIII. Issuers Subject to “Direction and Coordination” Powers
When adopting the Regulation, Consob significantly amended Article 37 of the Markets Regulation, providing a specific and significant provision aimed at enhancing minority shareholders’ rights in issuers subject to direction and coordination powers. It is indeed provided that (i) issuers subject to control and coordination powers must have an internal control committee composed exclusively of independent directors and (ii) if the entity exercising direction and coordination powers is a listed issuer, the board of directors of the issuer subject to such direction and coordination powers shall be composed in its majority by independent directors. [25]

IX. Entry into Force of the Regulation

In order to allow issuers to comply with the new rules, the Regulation sets forth a differentiated provisional regime:

• the disclosure regime described under § II will enter into force on October 1, 2010;
• the Procedures shall be adopted (as indicated under § X below) before October 1, 2010; and
• the substantial and procedural fairness regime outlined under § III, IV and V will enter into force on January 1, 2011.

X. Adoption of the Procedures and Other Changes

From a practical standpoint, by October 1, 2010, the boards of directors of issuers shall have to adopt the Procedures in compliance with the principles indicated in the Regulation [26] and promptly disclose them on their websites. [27] A resolution adopting the Procedures (as well as any future amendment) shall obtain the prior favorable opinion of a committee composed exclusively of independent directors. [28]

As regards their content, the Procedures shall,

inter alia

:
• identify Material Transactions, including at least those exceeding the quantitative thresholds mentioned under § I.(i);
• identify directors’ independence requirements, relevant for the purposes of the Regulation (which may be more rigorous than those set forth under the TUF, corporate governance codes and any other applicable provisions);
• establish the means pursuant to which related-party transactions are prepared and approved and indicate the rules governing the cases in which the issuer examines or approves subsidiaries’ transactions;
• establish the means and timing for providing information on related-party transactions to independent directors; and
• ensure alignment between the Procedures and the administrative and accounting procedures set forth by the executive responsible for the preparation of financial statements.

Moreover, on a voluntary basis, the Procedures may, among other things:

• allow the approval of Material Transactions notwithstanding the negative opinion of the independent directors, provided that such transactions are authorized at the general meeting of shareholders through the whitewash mechanism;
• condition the application of the whitewash mechanism upon attendance at the general meeting of a minimum number of unrelated shareholders (not exceeding 10%);
• establish, where expressly allowed under the by-laws, that urgent transactions may be carried out without applying the General Procedure and the Special Procedure (without prejudice to the application of the disclosure regime illustrated under § II) provided that, inter alia, such transactions are subsequently subject to a non-binding resolution of the first possible ordinary general meeting;
• allow framework resolutions concerning specific homogenous categories of transactions (see above, § VI);
• define the maximum budget allowed for services provided by independent advisors, with reference to each transaction;
• opt for a simplified regime for small-sized issuers, recently-listed issuers or widely held issuers, by applying the General Procedure also to Material Transactions (without prejudice to the application of the disclosure regime illustrated under § II);
• exclude from the scope of the Regulation transactions involving small amounts (which could allow, by establishing appropriate criteria, the role of independent directors to be balanced);
• exclude from the scope of the Regulation transactions with and among subsidiaries and with affiliated issuers (without prejudice to the application of the periodic disclosure regime illustrated under § II);
• exclude from the scope of the Regulation ordinary transactions [29] entered into on terms equivalent to market or standard terms [30] (without prejudice to the application of the periodic disclosure regime illustrated under § II);
• exclude from the scope of the Regulation the awarding of compensation (including compensation based on financial instruments) to directors and other managers, based on well-established remuneration policies already approved by, among others, the shareholders (without prejudice to the application of the periodic disclosure regime illustrated under § II); or
• extend the scope of the Regulation to include transactions entered into among unrelated parties, in light, inter alia, of specific ownership structures or contractual obligations.

When adopting the Procedures, boards of directors shall also identify the possible amendments to the by-laws and the relevant proposals to be made at the relevant general meetings of shareholders. In particular, it should be noted that:

• should the issuer intend to carry out Material Transactions notwithstanding the negative opinion of the independent directors, the authorization of the shareholders shall require the insertion in the issuer’s by-laws of an authorization to carry out acts of the board of directors (Article 2364 paragraph 1, number 5, of the Italian Civil Code);
• the adoption of a whitewash mechanism shall require specific provisions in the by-laws aimed at preventing the adoption of a resolution if the majority of unrelated voting shareholders votes against the transaction; and
• the possibility to carry out urgent transactions without applying the General Procedure and the Special Procedure is subject to the insertion of an express provision in the by-laws.

Endnotes

[1] The Regulation implements Article 2391-bis of the Italian Civil Code which requires that issuers adopt rules aimed at ensuring the transparency and substantial and procedural fairness of related-party transactions (the “Procedures”), delegating to Consob the definition of general principles pursuant to which the Procedures shall be adopted. The Regulation also brings together, in a single document, provisions concerning continuing and periodic disclosure obligations, which implement Articles 114 and 154-ter of Legislative Decree No. 58 of 24 February 1998 (the “Italian Financial Act”, or “TUF”) and thus replace certain provisions set forth in the regulation adopted pursuant to Resolution No. 11971 of May 14, 1999, as amended (the “Issuer Regulation”). The approval of the Regulation came after a long and complex public consultation, which began with the publication of a first consultation document on April 9, 2008 (the “First Consultation Document”) and continued with the publication of a second consultation document on August 3, 2009 (the “Second Consultation Document”). The Regulation and the documents related to the consultation, including comments provided by our firm in response to the First Consultation Document and the Second Consultation Document, are available on Consob’s website.
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[2] Under Article 2497 et seq. of the Italian Civil Code, special rules apply to legal entities that exercise “direction and coordination” powers over an Italian company. Although the law does not set forth specific criteria for determining when an entity exercises “direction and coordination” powers over a given company, a court may generally find that an entity has “direction and coordination” powers with respect to a given company where, inter alia, a significant part of the management decisions at the company, although formally implemented by the directed company’s managers, is substantively taken by management at another entity.
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[3] See § IX and footnote No. 23 below.
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[4] “Widely held issuers” relevant for the purposes of the Regulation are unlisted issuers of shares with more than 200 shareholders (not counting controlling entities) owning in aggregate more than 5% of the share capital and which exceed certain quantitative thresholds, as defined under Article 2-bis of the Issuer Regulation.
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[5] A “related party” is an entity which:

• (a) either directly or indirectly, including through subsidiaries, trustees or third parties: (i) controls the issuer, is controlled by it, or is under common control; (ii) holds an interest in the issuer that gives it significant influence; or (iii) has joint control over the issuer.
• (b) is an affiliate of the issuer;
• (c) is a joint-venture in which the issuer participates;
• (d) is a member of the key management personnel (including executive or non-executive directors) of the issuer or its parent;
• (e) is a close family member of any individual referred to in (a) or (d);
• (f) is an entity in which one of the persons under letter (d) or (e) exercises control, joint control or a significant influence or holds, directly or indirectly, a significant percentage, not less than 20%, of the voting rights; or
• (g) is a complementary pension plan, collective or individual, Italian or foreign, established in favor of the issuer’s employees or of any entity that is a related party of the issuer.

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[6] A “related-party transaction” is any transfer of resources, services or obligations between related parties, with or without consideration. The Regulation contains the same clarification contained in the accounting principle, pursuant to which the following transactions are automatically included: (i) mergers, demergers by incorporation or non-proportional demergers, when entered into with related parties, and (ii) any decision related to awards of compensation and economic benefits to members of management and controlling bodies and to executives with strategic responsibilities.
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[7] The choice to define these concepts by making exclusive reference to the IAS 24 principle characterized both the First Consultation Document and the Second Consultation Document.
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[8] The quantitative parameters set forth by the Regulation include (i) the ratio between the transaction consideration and net assets or, if greater, the market capitalization of the issuer (for banks, the relevant parameter is the ratio between the transaction consideration and the bank’s regulatory capital), (ii) the ratio between the assets of the entity involved in the transaction and the issuer’s assets, and (iii) the ratio between the acquired entity’s total liabilities and the issuer’s total assets.
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[9] For transactions between the issuer and its listed parent (or affiliates of the latter, which, in turn, are also affiliates of the former) the threshold is reduced to 2.5%. In adopting the Procedures, issuers may establish lower thresholds for all transactions, or lower thresholds for transactions that may influence the issuer’s administrative autonomy (e.g., transfer of intangible assets such as trademarks or patents).
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[10] The issuer shall inform Consob of the relevant characteristics of the transaction and the specific circumstances on which the request is based, before the negotiation phase ends.
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[11] Under the previous regime, disclosure obligations were triggered only by related-party transactions that could have affected the issuer’s assets, or the completeness and correctness of information (including accounting information) regarding the issuer, in light of the subject matter, consideration, terms, or timing of the transaction.
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[12] If the shareholders, acting at a general meeting, constitute the competent body to approve the transaction or its approval is needed, the Disclosure Document shall be made available within seven days from the approval of the proposal submitted to the shareholders.
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[13] In such case, the Disclosure Document contains information (including on an aggregate basis) concerning all transactions considered.
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[14] To identify the relevant concept of independence, the Regulation refers to the requirements set forth under Article 148, paragraph 3, of the TUF and, for issuers complying with the Corporate Governance Code, to the more rigorous independence requirements set forth therein.
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[15] Accordingly, it should be possible for numerous issuers to use the internal committees already existent if composed exclusively of non-executive directors, the majority of which are independent. If unrelated independent directors are not at least two in number, the Procedures shall have to set forth specific means to ensure the substantial fairness of the transaction.
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[16] If the terms of the transaction are recognized as being equivalent to market or standard terms, the information shall refer to the objective elements supporting such determination.
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[17] If the issuer is subject to direction and coordination powers, such opinion (as with the analogous non-binding opinion provided by the committee in the General Procedure) must specifically indicate the reasons and convenience for the transaction, including in light of the overall outcome of the direction and coordination activity or of transactions aimed at eliminating damages caused by the single related-party transaction.
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[18] If the unrelated independent directors are fewer than three in number, the Procedures shall set forth specific equivalent means to ensure the substantial fairness of the transaction.
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[19] Similar rules to those described herein and in § III and IV are provided for issuers adopting the two-tier board model, where the opinion may be issued by a committee of independent members of the supervisory board or, should the issuer so choose and if in existence, independent members of the management board.
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[20] In relation to the independent advisors’ opinions, the issuers may, giving reasons for such choice, decide to publish only the most relevant elements (e.g., specific limits encountered while performing the services, assumptions or conditions to which the opinion is subject, evidence of any critical issue, indication of evaluation methods adopted to assess the adequacy of the consideration).
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[21] This exemption shall only be possible if there are no significant interests of other parties related to the issuer but not party to the transaction (interlocking directorates, for example, are not considered significant).
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[22] Whenever the transaction need not be approved nor authorized at the general meeting of shareholders, the procedures may provide that, if expressly established in the by-laws, in case of urgency, related-party transactions may be carried out without following the General Procedure or the Special Procedure provided that, among other things:

• if a managing director or the executive committee are competent to carry out the transaction, the president of the board of directors or of the management board shall be informed of the reasons for the urgency, before the transaction is carried out;
• such transactions, without prejudice to their effectiveness, shall be acknowledged by a non-binding resolution in the first possible general meeting of shareholders; and
• the body convening the shareholders’ meeting shall prepare a report adequately explaining the reasons for such urgency and the monitoring body shall prepare a report for the general meeting on the existence of such reasons.

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[23] Specific exemptions are also provided for transactions that are governed by Legislative Decree No. 385/1993 applicable to banks.
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[24] The compensation committee provided by the Corporate Governance Code meets the requirements set forth by the Regulation.
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[25] Listed issuers subject to direction and coordination powers on the date of entry into force of the resolution (i.e., 15 days after the publication on the Official Gazette) or before October 1, 2010, shall comply with Article 37 of the Markets Regulation within 30 days from the first general meeting called after October 1, 2010 for the renewal of the board of directors or of the supervisory board.
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[26] The monitoring body shall supervise the consistency of the Procedures with the principles set forth in the Regulation, as well as compliance therewith (reporting on such matters in its report delivered at the general meeting of shareholders).
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[27] The Procedures must also be disclosed in the annual management report (including by reference to the issuer’s website).
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[28] If unrelated independent directors are fewer than three, the Procedures shall be adopted with the prior favorable opinion of all independent directors that may be present or, should they be absent, with the prior non-binding opinion of an independent advisor. For issuers adopting the two-tier board model, the committee may be composed both of independent members of the management board and of the supervisory board.
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[29] Ordinary transactions are those transactions that fall within the ordinary transaction activity and related financial activity.
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[30] Conditions similar to those usually applied to unrelated parties in transactions having the same nature, extension and risk, or based on regulatory rates or on imposed prices or those applied to entities with which the issuer is bound by law to negotiate a certain price.
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