From the Shareholders’ Spring to the Autumn of Activism

John Olson is a founding partner of Gibson, Dunn & Crutcher’s Washington, D.C. office and a visiting professor at the Georgetown Law Center. This post is based on a Gibson Dunn alert by Selina S. Sagayam; the full version, including footnotes, is available here.

This alert discusses some of the recent regulatory developments and debate in the UK and at EU level which may have an impact on institutional investors (asset managers and asset owners) and public companies and takes a look at some examples of investor activism in these jurisdictions.

I. Shareholder Spring — Recent Examples of Activism

The UK press has had a field day over the past 12 months with news of shareholder challenges or activism. In the run up to the AGM season in the spring, barely a day went by without report of shareholders flexing their muscles by taking on the boards of listed companies — the discussions and debates which typically had gone on behind closed boardroom doors had escaped into the public arena.

The issues that boards have been called up on have varied from corporate governance (with a particular focus on the highly emotive board remuneration issues), to influencing corporate events (acquisitions, disposals, takeovers) to more fundamental challenges on corporate and business strategy with a view to unlocking value for shareholders.

It was not just the banks which faced investor revolt over pay packages. An unprecedented number of major corporations, including insurer Aviva, car dealer Pendragon and resources group Cairn Energy, were left red-faced after their Remuneration Reports were voted down by shareholders. Many more companies were ‘fortunate’ to get the resolutions through but saw unprecedented numbers of shareholders voting against pay packages which led to a number of executive board resignations in some cases and waivers of bonuses as boards sought to appease disgruntled shareholders. While these votes are only advisory/ non-binding votes at the present time in the UK, the UK Government announced proposals in June which has paved the way for binding votes on pay. This would require binding annual votes on pay unless companies choose to leave their remuneration policy unchanged, in which case it will be compulsory to have a vote at least every three years. These proposals are expected to be incorporated into legislation and enacted by October 2013.

While the headline-grabbing fights on pay have attracted the interest of the general public, the focus of the business community and the sophisticated investor base has also been directed at other “big picture” issues facing companies. The past 12 months have seen major challenges by shareholders attempting to influence corporate events. Outspoken and noisy shareholders have created turmoil in a number of takeover situations which invariably have led to calls of changes at board level. Plus Markets search for a rescue bidder and proposed strategic moves into derivatives trading was disrupted by shareholder requisitioned meetings. The merger of Xstrata and Glencore has been challenged by its major shareholders including most recently, Knight Vinke. Europe has seen its fair share of activism with DuPont’s US$6billion takeover of Danisco being opposed by Elliott Associates and Dutch company, TNT Express being pressured by activist shareholders to consider sale options which culminated in the sweetened US$6.28billion bid by UPS Inc. National Express was forced into truce talks by Elliott Advisors who were pressing for a change of strategy. Notwithstanding their inability to secure changes to the board of Swiss biotech company Actelion, Elliott did manage to rumble the board into considering a strategic review and stir the markets. The disruption caused by such incidents of activism have led other companies, such as Alliance Trust, to consider radical changes to their shareholder voting system to fend off mounting pressure from short term activist investors.

In the private company arena, we have seen a different picture emerging. In particular, one of the more interesting (or in some quarter, alarming) developments in the UK has been the rise in shareholder disputes involving private companies. Such shareholder litigation has reportedly increased by 200% and these have largely manifested themselves in “unfair prejudice” claims under section 994 of the UK Companies Act 2006 and in post-deal disputes.

The financial crisis has certainly transformed shareholder behaviour — in the past, an investor may have had the luxury of voting ‘no’ with their feet and exiting their holding. However, market exit opportunities are limited as buoyant, stable stock markets have hardly been seen in recent times which have prompted institutional investors to move away from the passive (often deliberate policy driven) approach to one of dynamic and often heated engagement with boards. We expect to see much more “activist” behaviour in the months to come.

The rest of this briefing note considers certain forthcoming legal and regulatory developments which may impact the ability of shareholders to engage with boards.

II. Current Regulatory Reform Proposals & Debate

Financial Reporting Council (FRC): Revisions to the UK Stewardship Code — End of the Consultation Period

After only two years since it was first published, the FRC decided to undertake a review of its UK Stewardship Code — a set of “comply or explain” principles and guidance directed at institutional investors — the co “stewards” of publicly listed companies. On 13 July, the FRC closed consultation on its proposed changes to the Stewardship Code.

There are currently 184 asset managers and 53 asset owners who have publicly signed up to “comply or explain” with the Stewardship Code, who will be among the group of investors impacted by the proposed changes to the Code.

The Stewardship Code is founded on seven principles which will be left largely untouched under the proposed changes save for a few clarifications in terminology. The slightly revised seven principles state:

So as to protect and enhance the value to the ultimate beneficiary, institutional investors should:

(i) publicly disclose their policy on how they will discharge their stewardship responsibilities.

(ii) have an effective policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed.

(iii) monitor their investee companies.

(iv) establish clear guidelines on when and how they will escalate their stewardship activities.

(v) be willing to act collectively with other investors where appropriate.

(vi) have a clear policy on voting and disclosure of voting activity.

(vii) report periodically on their stewardship and voting activities.

The proposed changes to the Stewardship Code cover the following:

Definition & Delineation — clarifying the actual definition and aim of stewardship and identifying which principles/guidance applies to asset managers and which are directed at asset owners.

Disclosure — substantive changes on disclosure including disclosure to clients (on request) of assurance reports on their record of stewardship activities and public disclosure of: conflicts of interest policies; the use of proxy or other advisory services; the approach to stock lending and recalling lent stock; and enhanced disclosure on collective engagement.

Direction — additional helpful direction and guidance on matters such as how to monitor investee companies performance and keep abreast of developments relevant to investee companies, considering if and when to become an insider.

The FRC is expected to announce the result of its consultation and the final form of the revised Stewardship Code at the start of Q3, and the revised Stewardship Code would apply to reporting periods beginning on or after 1 October 2012.

The Kay Review of UK Equity Markets and Long-Term Decision Making — Final Report

Following a year-long study, leading economist Professor John Kay published, on 23 July 2012, the Final Report of his independent review of activity in the UK equity markets and its impact on the long-term performance and governance of UK quoted companies.

The Report has been welcomed by Vince Cable, the UK Secretary of State for Business, Innovation and Skills (the “Business Secretary”), who commissioned the review, and intends to respond in detail to the findings and recommendations of the Report later this year.

The response from industry however has been somewhat mixed the criticism ranging from the over-simplistic and hazy distinctions drawn between short and long term investment (investors) to the practical difficulty of carrying through a number of the recommendations put forward by John Kay.

Key Findings:

  • Short-termism: Myopic short-term behaviour is an acute problem for UK equity markets according to John Kay. The search for immediate monetary gratification at the expense of future returns has driven investors, pension funds, insurance company funds and mutual funds in their demands on UK companies for years, according to Kay. This myopic behaviour is supported by some startling data — in a worldwide analysis, UK companies ranked the highest in paying out shareholder dividends . . . short term gratification . . . and rock bottom in terms of investment such as R&D . . . long term gains.
  • Decline of the UK equity markets: New equity issuance has been negative over the last decade in the UK. John Kay notes that fund raising through placings, rights issues and IPOs have not been an important source of capital for new investment in British business. The larger companies have been self-financing and others companies have resorted to private equity and corporate debt to fund financing requirements. Acquisitions (particularly by non-UK bidders) have reduced the number of publicly traded companies. These factors inevitably mean a more concentrated, less liquid equity market with this backdrop, Kay believes that it is essential that asset manager investors start behaving like long-term stewards of public companies
  • Changing shareholder base and lengthening investment chain: As we have seen across many developed markets, the profile of share registers has changed considerably over the past 50 years. Individual shareholders used to account for nearly 55% of the beneficial owners in the early 60s this number had dropped to closer to 11.5% by 2010. The steady decline in small shareholders has been matched by an increase in institutional investors (asset owners, asset managers, SWFs). In parallel, we have seen an explosion in intermediation the investment chain has lengthened as the actual names on the register are dominated by registrars, nominees, custodians and the like. Kay also notes that the proportion of UK based beneficiaries has declined substantially over 40% of many UK publicly traded companies are foreign owned (the majority of which are believed to be US holders) resulting in a fragmented shareholder base which can make collective action or engagement with boards a real challenge. The new face of the investor base that UK traded companies confront will be critical in assessing the nature and form of regulation and legislation to repair the damage caused by the culture of short-termism identified by Kay.

Principles for Reform:

The report sets out ten principles upon which the foundation of “honest stewards” should be built [See Appendix 1]. Although lofty in some parts and self-evident in others, some of the principles espoused serve as useful reminders of the duties and obligations of market participants and seek to set the parameters for future regulation. In particular, the reminder to directors of companies of their role as stewards of the assets and operations of their business and their duties to the company (not its share price), are welcome. Kay (in line with the recommendations of the FRC in their review of the Stewardship Code see above), also notes the need for all participants in the investment chain to observe fiduciary standards in their relationships with their clients and customers.

Key Recommendations:

The report sets out 17 recommendations [See Appendix 2], the most significant of which are discussed below:

  • UK Stewardship Code to cover strategic issues also Kay recommends that the guidance for investors should not only provide direction on matters relating to corporate governance but also should go into issues of strategic importance to companies.
  • Establishment of an investors forum to facilitate collective engagement by investors in UK companies Kay’s proposal to address the fragmented shareholder base issue has not met with much enthusiasm by both UK and non-UK asset managers. There is some doubt as to whether membership of such a body would suit many asset managers or owners whether for concerns around confidentiality, “labelling” or other substantive legal issues which will need to be addressed in promulgating legislation in this area (including the rules on insider dealing and concert party rules). Others have concerns that such a forum would be yet another mouthpiece with no impact in practice.
  • Full disclosure of all asset manager costs (including transaction costs and performance fees) and income earned from stock lending The push for greater transparency in these areas is already being considered at the European level and is generally welcomed. The more controversial element is the proposal that the income earned from stock lending be rebated to investors.
  • Review of the legal concept of fiduciary duty as applied to investment (investors) to address the misunderstanding on the part of trustees This recommendation has met with general support and is an issue that others, such as the FRC, have identified but have hitherto been unable to provide any clarification upon. Kay is keen for the laws to clarify that fiduciary duties apply to all investment and/or advisory parties in the investment chain and that these duties should not be capable of being contractually overridden.

It is too early to tell how significant the Kay Review will turn out to be. The optimistic consider that it may be as significant as the 1992 Cadbury Report which changed the face of corporate governance regulation in the UK. Others are more sceptical Kay will be able to set the foundations to change the culture of myopia deeply embedded within the industry. The first test of whether any of the recommendations will become enshrined in legislation will be the response from the Business Secretary expected later this year.

European Securities and Markets Authority (ESMA): Discussion Paper: An Overview of the Proxy Advisory Industry. Considerations on Possible Policy Options (“Discussion Paper”) — End of the Comment Period

Of further interest to shareholders and traded companies alike is the current review being undertaken by ESMA into the proxy advisory industry. The review has taken on much of the colour of the further advanced EU review of credit rating agencies (commenced in the wake of the financial crisis), in the possible approaches to legislation mapped out in the Discussion Paper noted above. This includes consideration of registration of proxy advisers and the development and full disclosure of conflicts of interest policies discussed further below.

On 25 June 2012, ESMA closed the first round of comment solicitation on its Discussion Paper on rules and regulations to govern the proxy advisory industry. The debate around regulation of the proxy advisory industry is still in the early stage in Europe ESMA is using the Discussion Paper as an opportunity to gather more evidence upon which to formulate European policy in this area as currently there are no pan-European rules which cover proxy firms directly.

ESMA is considering four policy options: (i) do nothing (at an EU level); (ii) encourage European member states and/or industry to develop standards; (iii) introduce quasi-binding EU regulations such as “comply or explain” standards or EU guidelines/recommendations; or (iv) introduce binding EU rules. The Discussion Paper considers the pros and cons of the four different approaches and notes that if evidence procured through this process indicates that the role played by proxy advisors is significant and there are market failures, this may point away from the “do nothing” approach towards the introduction of effective standards, rules or legislation.

The Discussion Paper is a good read for anyone interested in the use and practices of the proxy advisory firms in Europe. The paper looks at the types of firm who dominate the European market; their size; nature of operations and internal organisation; fee structures; and conflicts policies in place (if any). Interesting comparisons are drawn out between the experience in the US of users of proxy advisory firms and those in Europe in particular the Paper notes that in the US (where there is a significantly longer history and greater use of proxy firms), proxy advisors tend to rely more on their own voting policies, whereas European firms generally tend not to develop their own guidelines but follow clients’ policies. However, when it comes to the correlation between proxy advisor recommendations and actual investor voting, there is a high correlation between the two which suggests a more of a box-ticking exercise by many investors without independent verification of the recommendations of firms.

The Discussion Paper paves the way for the contentious debates which are yet to face the European proxy advisory industry including the issue of (i) publication of voting policies and guidelines by proxy advisory firms (ii) publication of voting recommendations; (iii) the dialogue between proxy advisory firms and issuers. The Paper notes the diametrically opposed views on this. For example, in France, the AMF recommends that proxy firms should engage in dialogue with issuers. This is to be contrasted with the position in the UK where engagement with issuers is not mandated nor even encouraged but left to investors (and the firms they engage) recognising that many investors and firms do not want to run the risk of becoming insiders. Whilst investors may want to avoid the risk of becoming insiders, ESMA raises the possible risk this may give rise to — inaccuracy in the information which formulates a proxy advisory firm’s recommendation. The theory being that direct engagement with issuers can facilitate access to accurate and more up to date information about an issuer and therefore improve the information base and quality of the recommendations of proxy advisers. These issues and the challenge of the different corporate governance standards in European members states (both in terms of the level of advancement of such standards and the underlying approach taken on corporate governance issues) will be some of the challenges that European regulators will face in their attempt to devise a set of proxy advisory firm rules to span across the “Federal States of Europe”.

ESMA has stated that it expects to publish a feedback statement in Q4 of 2012.

III. Entering into the Autumn of Activism — Some Food for Thought

As these and other reforms which impact and/or empower shareholders are considered by legislative and industry bodies in the UK and Europe, a number of key policy and legal philosophical questions inevitably surface for consideration. Before we pose these questions, it is worth reminding ourselves of the backdrop within which these discussions and deliberations are happening

New activists — As noted earlier, shareholder registers have seen a significant transformation to greater institutional holdings. Company boards will need to adjust their behaviour and the nature in which they engage with the new breed of investors. One of the more recent and surprising entrants on the “activist” scene have been investors from the Middle East including certain sovereign wealth funds (typically passive and low-key investors). Examples include the public engagement of the Qatar Investment Authority in the Xstrata/Glencore merger. This was happening at the same time as Amar Dhari Investments (a Kuwaiti investment syndicate) partnered up with another shareholder in PLUS Markets to push for board changes.

High Stakes — Company boards also should be aware of the level to which the activist investor can go, once it decides to engage. For example, we have seen activist investors suing regulators over decisions in respect of companies they have invested in.

How much counts? — With increasingly fragmented individual holdings in publicly traded companies, the perceived stewardship failure can be blamed on the dislocation between the theory of share ownership and its economic impact in the commercial world. Some say that ownership rights are most effective where exercised by a majority of the equity owners or at least a significant minority. Hence, in major listed companies with thousands of shareholders with only a fraction of ownership rights (where even the largest shareholders have a single digit percentage holding) and collective engagement is practically impossible and legally difficult, how are shareholders to effectively engage with boards? Others are not convinced of this line of argument and say it does not matter how much of a holding an investor has and smaller holdings do not preclude the ability to facilitate positive change in a company. In support of this latter view, just under a month ago, one hedge fund manager stated at a CNBC conference that he believed he could influence a large publicly held company even with a stake that was relatively small (equating to roughly one per cent of its outstanding shares).

Pan-European/pan-global rules an impossibility? The view of many practitioners is that a set of pan-European rules on the regulation of proxy advisers or legislation on stewardship is ambitious in the absence of a common approach to share ownership and shareholder rights. We saw earlier how different EU member states approach the issue of investors becoming insiders when engaging with boards. The very status itself of the activist shareholder varies across different nations globally — in many countries across the globe, the stewardship concept has historically been a hard sell as shareholders have been marginalised in corporate governance. In parallel with this view, the concept of pre-emptive rights (deeply embedded in UK public companies) are regarded by many non-UK investors as a handicap and indeed the root of underperformance of UK listed companies. In countries like Japan, the political and business elite regard shareholders as a troublesome irrelevance. In the UK, the dialogue between shareholders and investee companies is better and has tended to avoid the “locust” like labels which have attached to investors in many European member state companies who have dared to voice their views in public. With these divergent views on issues as fundamental as the nature of the “property rights” that shareholders are entitled to, the challenge facing regulators as they seek to transform the stewardship landscape is not insignificant.

IV. Recent Regulatory Changes and Forthcoming Regulatory Developments

Binding Say on Pay

On 20 June 2012, the Business Secretary announced a set of comprehensive reforms on directors’ remuneration giving shareholders a greater say on pay. Following lobbying from industry, the Government backed down from the earlier ‘threat’ to increase the majority required to pass resolutions on pay to a threshold above that required to pass an ordinary resolution (50%), to a higher level. The UK Government does, however, intend to continue to trail blaze in the area of pay by introducing binding votes on pay.

The binding vote on remuneration policy will be held annually unless companies choose to leave their remuneration policy unchanged in which case it will be compulsory to have a vote at least every three years. Once a policy is approved, companies will not be able to make payments outside its scope without re-approval.

In addition to the binding vote on pay policy, companies will continue to have an annual advisory (i.e., non-binding) vote (passed by ordinary resolution) on how pay policy was implemented in the previous year, including actual sums paid to directors. If a company’s advisory vote does not pass, the company will be required to hold a binding shareholder vote on its overall pay policy the following year.

On 28 June 2012, the Government published a consultation on regulations setting out how UK incorporated quoted companies must report on directors remuneration under the new framework. The proposed regulations were set out in new clauses of the Enterprise and Regulatory Reform Bill 2012-13 (which includes a proposed amendment to the Companies Act 2006 which is the primary legislative source covering remuneration votes). The Bill, having had a second reading in the House of Commons is currently being scrutinised by the Parliamentary Bill Committee. The intention is for legislation to be enacted by October 2013.

Institute of Chartered Secretaries and Administrators (ICSA): New Guidance for Shareholder Engagement

ICSA, the international qualifying and membership body for the chartered secretary profession and recognised authority on corporate governance and compliance, has also been looking to steer debate and best practice on investor stewardship.

Last year, ICSA produced the Guidance on Board Effectiveness for the FRC (which is appended to the FRC’s Corporate Governance Code).

In discussions held earlier in the year by the 2020 Stewardship Working Party, company chairmen described the deficiencies they had encountered in investor engagement. This led to the first recommendation in their March report, 2020 Stewardship – Improving the Quality of Investor Stewardship, that a good practice guide be developed by all relevant parties. ICSA has agreed to be part of this process.

Last month, ICSA announced that it will commence a consultation exercise in September in order to produce the first draft good practice guide which it hopes will “transform” the relationship and engagement between company boards and their investor owners. The anticipated publication date of the good practice guide is March 2013. This non-binding guide or statement of best practice is not intended to replace or circumvent the Stewardship Code (see above) and is expected to receive support (falling short of formal endorsement) from the FRC.

Changes to the UK Code on Corporate Governance and Guidance on Audit Committees

At the same time as it initiated consultation on changes to the Stewardship Code, the FRC commenced a consultation exercise on changes to the UK Corporate Governance Code.

The proposed changes to the UK Corporate Governance Code include:

  • Requesting FTSE 350 companies to put the external audit contract out to tender at least every ten years;
  • Asking boards to explain why they believe their annual reports are fair and balanced;
  • Encouraging more meaningful reporting by audit committees;
  • Providing more guidance on explanations that should be provided to shareholders when a company chooses not to follow the Code; and
  • Provisions requiring boards to report on their gender diversity policies.

The results of this review will be published alongside the final changes to the Stewardship Code.


We will continue to monitor these developments and keep you updated as draft proposals and legislation unfolds.

Appendix 1

Kay Review Principles

1. All participants in the equity investment chain should act according to the principles of stewardship, based on respect for those whose funds are invested or managed, and trust in those by whom the funds are invested or managed.

2. Relationships based on trust and respect are everywhere more effective than trading transactions between anonymous agents in promoting high performance of companies and securing good returns to savers taken as a whole.

3. Asset managers can contribute more to the performance of British business (and in consequence to overall returns to their savers) through greater involvement with the companies in which they invest.

4. Directors are stewards of the assets and operations of their business. The duties of company directors are to the company, not its share price, and companies should aim to develop relationships with investors, rather than with ‘the market’.

5. All participants in the equity investment chain should observe fiduciary standards in their relationships with their clients and customers. Fiduciary standards require that the client’s interests are put first, that conflict of interest should be avoided, and that the direct and indirect costs of services provided should be reasonable and disclosed. These standards should not require, nor even permit, the agent to depart from generally prevailing standards of decent behaviour. Contractual terms should not claim to override these standards.

6. At each stage of the equity investment chain, reporting of performance should be clear, relevant, timely, related closely to the needs of users and directed to the creation of long-term value in the companies in which savers’ funds are invested.

7. Metrics and models used in the equity investment chain should give information directly relevant to the creation of long-term value in companies and good risk adjusted long-term returns to savers.

8. Risk in the equity investment chain is the failure of companies to meet the reasonable expectations of their stakeholders or the failure of investments to meet the reasonable expectations of savers. Risk is not short-term volatility of return, or tracking error relative to an index benchmark, and the use of measures and models which rely on such metrics should be discouraged.

9. Market incentives should enable and encourage companies, savers and intermediaries to adopt investment approaches which achieve long-term returns by supporting and challenging corporate decisions in pursuit of long-term value.

10. The regulatory framework should enable and encourage companies, savers and intermediaries to adopt such investment approaches.
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Appendix 2

Kay Review Recommendations

1. The Stewardship Code should be developed to incorporate a more expansive form of stewardship, focussing on strategic issues as well as questions of corporate governance.

2. Company directors, asset managers and asset holders should adopt Good Practice Statements that promote stewardship and long-term decision making. Regulators and industry groups should takes steps to align existing standards, guidance and codes of practice with the Review’s Good Practice Statements.

3. An investors’ forum should be established to facilitate collective engagement by investors in UK companies.

4. The scale and effectiveness of merger activity of and by UK companies should be kept under careful review by BIS and by companies themselves.

5. Companies should consult their major long-term investors over major board appointments.

6. Companies should seek to disengage from the process of managing short term earnings expectations and announcements.

7. Regulatory authorities at EU and domestic level should apply fiduciary standards to all relationships in the investment chain which involve discretion over the investments of others, or advice on investment decisions. These obligations should be independent of the classification of the client, and should not be capable of being contractually overridden.

8. Asset managers should make full disclosure of all costs, including actual or estimated transaction costs, and performance fees charged to the fund.

9. The Law Commission should be asked to review the legal concept of fiduciary duty as applied to investment to address uncertainties and misunderstandings on the part of trustees and their advisers.

10. All income from stock lending should be disclosed and rebated to investors.

11. Mandatory IMS (quarterly reporting) obligations should be removed.

12. High quality, succinct narrative reporting should be strongly encouraged.

13. The Government and relevant regulators should commission an independent review of metrics and models employed in the investment chain to highlight their uses and limitations.

14. Regulators should avoid the implicit or explicit prescription of a specific model in valuation or risk assessment and instead encourage the exercise of informed judgment.

15. Companies should structure directors’ remuneration to relate incentives to sustainable long-term business performance. Long-term performance incentives should be provided only in the form of company shares to be held at least until after the executive has retired from the business.

16. Asset management firms should similarly structure managers’ remuneration so as to align the interests of asset managers with the interests and timescales of their clients. Pay should therefore not be related to short-term performance of the investment fund or asset management firm. Rather a long-term performance incentive should be provided in the form of an interest in the fund (either directly or via the firm) to be held at least until the manager is no longer responsible for that fund.

17. The Government should explore the most cost effective means for individual investors to hold shares directly on an electronic register.
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