Legal Tools for the Active or Activist Shareholders

Christine Phillips is partner at Fieldfisher LLP. This post is based on her Fieldfisher memorandum. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here), and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

Boards of listed companies face increasing risk of campaigns from investors. Activist shareholders seek value creation, passive and institutional investors are encouraged to become engaged and active through the discharge of stewardship responsibilities and ESG issues are becoming increasingly important for investors.

Remuneration

The draft UK regulations (Companies (Directors Remuneration Policy and Directors Remuneration Report) Regulations 2019 (the “2019 Regulations”)) have now been published to implement the provisions of the Second Shareholder Rights Directive (EU Directive 2017/828 (“SRDII”) with respect to remuneration. SRDII is required to be implemented in member states on 10 June 2019 and the 2019 Regulations will come into force on this date. Most of the requirements on directors’ remuneration contained in SRDII were already provided for in the UK, including the requirement to produce a remuneration report and remuneration policy which are each subject to a shareholder vote (advisory in the case of the remuneration report and binding for the policy). The Companies Act 2006 requires a remuneration policy to be approved at least every 3 years or at the next AGM or general meeting if the remuneration report was not approved at the last AGM. The 2019 Regulations will require a new remuneration policy to be brought to a vote at the next general meeting or AGM if the company loses a vote on its remuneration policy.

The 2019 Regulations require the remuneration policy to explain the decision making process for its determination, review and implementation and to explain any changes compared to the previous policy. The result of the shareholder vote must be put on the company’s website as soon as reasonably practicable and remain there for the life of the policy.

Where 20 per cent or more of votes are cast against a board recommended resolution, the 2018 UK Corporate Governance Code provides that a listed company should explain when announcing the result how it will consult with its shareholders to understand the reasons and the company should publish an update on the views from shareholders and actions taken no later than 6 months after the shareholder meeting. In addition to the information published by the company, the Investment Association public register tracks details of significant votes against a proposed resolution and the related company updates. Listed companies will need to consider investor engagement on remuneration prior to any vote on the remuneration policy.

The 2019 Regulations also amend the Companies Act 2006 requirements with respect to the annual remuneration report which is now to be made available free of charge on the company’s website for 10 years, to show the split of fixed and variable remuneration awarded to each director each year, to specify any changes to the exercise price and date for the exercise of shares or share options by directors and to compare the annual change in directors’ remuneration to the annual change in pay of the company’s employees and the company’s performance over a 5 year rolling period. The 2019 Regulations also align the Companies Act 2006 with the SRDII requirement that all payments to directors must be made in accordance with the approved remuneration policy. Shareholder approval will, therefore, be required to authorise any inconsistent payment by way of an amendment to the approved remuneration policy

Changes in ESG reporting

The Companies (Miscellaneous Reporting) Regulations introduces additional ESG annual reporting obligations. For financial years starting on or after 1 January 2019 listed companies are required to report in the annual strategic report on the engagement with employees where they have more than 250 employees. Where the company has also either a turnover of more than £36 million or a balance sheet total of more than £18 million, the company must also report on how it has engaged with suppliers and customers and on how it has complied with its duty to promote the success of the company for the benefit of members as a whole having regard to the long term, employees, suppliers, customers, the environment and high standards of business conduct. For companies which are listed on the Main Market of LSE the ratio of the CEO’s remuneration to the median, 25th and 7th quartile pay remuneration for UK employees must also be published.

Re-election of directors

The 2018 UK Corporate Governance Code provides for the annual re-election of all directors which previously only applied to FTSE 350 companies. This is a “comply or explain” regime which applies to premium listed companies but one that smaller listed companies are encouraged to follow. The annual re- election of all directors replaces the procedure for retirement by rotation provided in the Articles of Association of smaller listed companies. Details are to be provided in the AGM notice of the contribution made by each director seeking re-election and the importance of such contribution to the company’s long term sustainable success. The 2018 UK Corporate Governance Code also provides that a listed company should have a director appointed from the workforce, or a formal workforce advisory panel or a designated workforce non executive director.

Requisitioning a general meeting and removal of directors

Investors holding 5% or more of the company’s paid up voting shares can requisition a general meeting and propose resolutions to be considered at the meeting, often the removal of certain directors and the proposed appointment of new directors. Investors holding at least 5% of the paid up voting shares (or at least 100 investors holding shares with an average paid up amount of at least £100) may also require the Company to circulate a statement to shareholders (not exceeding 1,000 words) relating to any matter proposed to be considered at a requisitioned meeting.

Investors holding 5% or more of the company’s paid up voting shares (or at least 100 investors holding shares with an average paid up amount of at least £100) have a similar right to call an AGM.

Disclosure

In accordance with the Disclosure and Transparency Rules (DTR 5), an investor must notify a listed company within two trading days if the investor’s interests in the company’s shares (including also cash settled derivatives) reach, exceed or fall below certain thresholds. The thresholds for a UK issuer are 3% and then every 1% change thereafter. The company must disclose any notifications from investors to the market. Acquisitions or disposals which result in a net short position in the shares of a company may also give rise to an obligation to disclose details of that position under the EU Short Selling Regulations. If the company goes into an offer period under the Takeover Code investors are required to disclose their interests and dealings when their interest exceeds 1%.

Boards are increasingly aware that the company’s share register should be monitored as this will provide early signals that active engagement may commence. Under section 793 of the Companies Act 2006 a company can require disclosure from any party it believes has or had an interest in its shares at any time during the previous three years. A Board may use this process to ascertain details of beneficial interests in the shares. A company’s articles may also provide for disenfranchisement of an investor’s shares for non compliance with a section 793 request.

Litigation, derivative claims and unfair prejudice

As part of its negotiations with a Board an investor may consider the possibility of action, for example, for breach of directors’ duties. Investors or the Board may require legal advice on the grounds for such a claim and how best to progress a potential action or how best to protect the Board.

Collective action and regulatory issues

Section 116 of the Companies Act 2006 enables an investor to inspect or request a copy of the share register of the Company in order to identify other shareholders. A company is also required to keep a register of any interests disclosed under section 793 requests and an investor can inspect or request a copy of this register. An investor should consider the risks involved in contacting other shareholders.

The formation of a concert party would be presumed where an investor has a “board control seeking proposal”. If a concert party is formed it will be necessary to consider the shareholdings of those in concert to ensure that a rule 9 mandatory offer has not been triggered. In any event it will be important to control stake building and standstill arrangements may be required to prevent a rule 9 mandatory offer being subsequently triggered.

Compliance with insider dealing and market abuse regulation should also be monitored. Whilst ESMA have published a White List of certain activities which shareholders may engage in which in themselves would not lead to shareholders acting in concert, it will remain important to liaise with the Panel Executive with respect to the Panel’s practice statement 26 relating to shareholder activism.

UK Stewardship Code

The UK Stewardship Code introduced good practice for institutional investors on a “comply or explain” basis. Institutional investors are required to have and to disclose their policy on the discharge of their stewardship responsibilities, the manner in which voting rights are exercised and to disclose voting activity. The draft 2019 UK Stewardship Code seeks to improve stewardship requirements and goes beyond provisions in SRDII. The draft 2019 UK Stewardship Code defines stewardship as the “responsible allocation and management of capital across the institutional investment community to create sustainable value for beneficiaries, the economy and society”. The draft 2019 Stewardship Code includes the principle of constructive engagement, the requirement for an engagement policy to be established as well as reporting on how the engagement policy has been integrated into the investment strategy (including methods of engagement and escalation) and disclosure on how ownership rights have been exercised. Asset owners and managers will, therefore, have increased reporting requirements which in turn are likely to result in increased engagement with the companies in which they have invested.

Investor Forum

As recommended by the Kay review, the investor forum was launched on 1 July 2014 to facilitate collective engagement by investors with the objective of creating value through long term investment.

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