Chapter 14 - Shareholders' Rights & Engagement

Question 1

What is a member?

Answer 1

S.112 CA2006

• A subscriber to the Memorandum who is automatically entered on ROM on incorporation;
• Every other person who agrees to become a member / whose name is entered onto the ROM.

Question 2

What is a retail shareholder?

Answer 2

Individual investors who buy/sell securities for their personal account, not for another company or organisation
Will usually register shares in name of nominee belong to a stock-broking firm

Question 3

What is an institutional shareholder?

Answer 3

• One which trades securities in large quantities/monetary amounts on behalf of multiple beneficiaries.
• Assumed to be more knowledgeable and therefore better able to protect themselves.
• Have a role in economy to act as HIGHLY SPECIALISED INVESTORS on behalf of others
• Ex. pension funds

Question 4

What are the two most common company responses to short-termism and shareholder activism?

Answer 4

• Look for funding from private equity rather than listing
• Where listing - list in countries allowing dual share structure where listed shares are non-voting (founders retain more votes per share and so retain overall control)

Question 5

Whare some ways in which investor/shareholder priorities may differ?

Answer 5

• Strategic opportunities viewed differently.
• Different time horizons / investment objectives
• Risk attitudes differ
• The more powerful a shareholder, the more likely they are able to sway board/management
• Engagement leads to expectation of acceptance of ideas - if not the case this must be carefully managed

Question 6

What are the 7 sources of shareholder rights/powers?

Answer 6

• Legislation
• Regulations
• Corporate governance codes
• Resolutions passed at general meetings
• Case Law
• Articles of Association
• Shareholder agreements

Question 7

What are the 5 main types of shareholder?

Answer 7

• Member– person or entity entered into ROM of as holder of its shares. Normally have shareholder rights and powers;
• Beneficial shareholder – ultimately owns a share, but may not be member;
• Nominee/custodian – holds shares as a member on behalf of another (who may not be the ultimate owner of the share);
• Retail shareholder
• Institutional shareholder

Question 8

What are the 5 rights of shareholders?

Answer 8

• Information rights (receipt of information)
• Ownership & transfer
• Equal treatment (enfranchising)
• Share in profits (by way of distribution , dividend)
• Attend and request, meetings and to vote

Question 9

What are some ways in which CA2006 aims to enfranchise indirect shareholders?

Answer 9

CA 2006 aims to assist indirect investors become more involved in company’s affairs via:

• Exercise of rights (usually reserved for registered shareholders)
• PROXIES - enables registered shareholders to nominate another person to exercise / enjoy all / any of the rights, including voting, as long provided for by Articles (few have as such a largely immaterial provision);
• Give beneficial shareholders direct right to company information. Not automatic. Requires that the registered shareholder nominates the indirect investor. Company will usually alert indirect investor of right to be appointed as proxy for any meetings.

Question 10

What are the 4 most common abuses of shareholder rights?

Answer 10

• Tunnelling
• Dilution
• Market Abuse/Insider Dealing
• Related Party Transactions

Question 11

What are the 3 forms of market abuse?

Answer 11

• Engaging/attempting to engage in insider dealing (recommending/inducing another to);
• Unlawfully disclosing inside information;
  (Exceptions - disclosures to regulators or where requested/permitted by LRs)
• Engaging or attempting to engage in market manipulation.

Question 12

What are the 3 offences relating to insider information per CJA 1993 part V?

Answer 12

1. Dealing in securities on the basis of inside information
2. Encouraging another to engage in such dealing
3. Disclosing (otherwise than where during proper performance of employment, office or profession)

Question 13

What are the main defences re insider dealing?

Answer 13

• Dealing offence - would have dealt the same way if had not had the information
• Disclosing offence - did not expect them to deal / did not expect profit from it

Question 14

What should the contents of an insider list include?

Answer 14

• Identity of person having access;
• Reason for including that person in list;
• Date and time person obtained access to inside info;
• Date insider list was drawn up.

Question 15

What is included in ‘ICSA GUIDANCE NOTE ‘MARKET ABUSE REGULATIONS (MAR) DEALING CODE & POLICY DOC’ 2016 regarding share dealing policies?

Answer 15

• ‘specimen’ group-wide dealing policy for issue to employees as an intro to concept of market abuse
• ‘specimen’ dealing code - co’s to issue to PDMRs/others they wish to be covered
• ‘specimen’ dealing process manual- use by CoSec/ whoever responsible for clearance of dealing

Question 16

Why might there be more successful prosecutions for insider dealing under MAR than under then CJA 1993?

Answer 16

Under MAR insider dealing is a civil offence, burden of proof is that is on ‘balance of probabilities’ instead of ‘beyond reasonable doubt’ as applied to criminal prosecutions (CJA insider dealing offence is a criminal offence)

Question 17

What are the 3 ways in which ‘dilution’ can occur?

Answer 17

• Ownership percentage voting control reduced;
• Per-share earnings cut when disbursed among a greater number of shareholders;
• Share value fall depending on proceeds recieved from selling more shares to investors.

Question 18

What 3 protections has CA2006 put in place against the dilution of shares?

Answer 18

• Directors must be authorised to allot shares in the company by shareholders (s.250)
• Pre-emption rights on issue of new shares (can be waived @ GM / some listed companies waive to certain level @ AGM each year)
• Shareholder right to approve LTIPS (CoSec often involved in preparing plan rules / resolutions placed for AGM regarding these)

Question 19

What is the Company Secretary’s role in protecting shareholder rights/preparation of share issues/allotments?

Answer 19

• Ensure resolutions re allotment of shares/waivers etc. included in AGM agenda
• Ensure waivers / authorities are in line with shareholders’ expectations

Question 20

What is tunneling?

Answer 20

Illegal business practice where majority shareholders direct company assets/future business to themselves for personal gain

Question 21

What are some examples of tunneling?

Answer 21

• Assets sold/transferred at non market prices to 3rd parties
• Value-destroying acquisitions or investments are made to help related companies
• Off-balance sheet loan guarantees made
• Corporate opportunities are exploited by related companies - rather than by the company itself
• Articles / capital structure amended to give priority to one set of shareholders over another
• Changes (inc merg/ac/disp) made affecting fundamental legal/de facto bases of company

Question 22

What is a related party transaction?

Answer 22

IAS 24 Related Party Disclosures = ‘ transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is paid’.

Question 23

What should a company disclose in respect of RPTs?

Answer 23

If company had any RPTs in the period covered by the financial statements, it must disclose:-

• Nature of related party
• Name of related party
• Date/value of transaction or arrangement
• Any other info re - fair/reasonable for the company and uninterested/unrelated shareholders

Rules / definitions are set out in LRs and DTR 7.3

Question 24

Under CA2006 what transactions require shareholder approval prior to being entered into?

Answer 24

Company may not transfer to director/director to company-

• Non cash >10% net assets and >£5,000
• > £100,000

CoSec will aid if shareholder approval required- coordinating GM & dealing with applicable documentation.

Question 25

What does the identity of shareholders being known enable the shareholder(s) to do?

Answer 25

• Assert their rights;
• Communicate with companies;
• Monitor CG best practice and hold management accountable;
• Join with fellow shareholders to overcome legal hurdles leading up to GMs;
• React with management in a timely manner to hostile takeovers.

Question 26

In what ways does a (listed) company know who its interested shareholders are?

Answer 26

• Shareholders who have a substantial holding in a company are required to inform the company.
• Disclosure makes it clear to potential investors who owns the company or who aspires to secure control of the company.
• It also warns the company and allows them, together with shareholders, to prepare for an impending takeover.
• UK - initial disclosure is triggered at 3% of total voting rights and further disclosures for each full percentage point over 3%.
• Exemption for market makers, if under 10% and not exerting significant influence/control. After 10%, must disclose.
• Under s.793 of CA2006, public companies can give notice to individual/entity it believes to have interest in shares (or at any time in 3 years before the date of the notice being issued)
• They should disclose whether or not they have an interest, and if so the nature of the interest
• If an individual does not comply - company can get a court order placing certain restrictions on the shares
• It is a criminal offence not to comply with such a court order.

Question 27

What are the benefits of good governance for any type of investor?

Answer 27

Shareholders delegate management of the company and the board/mgmt should be accountable to the shareholders for how it uses the company’s resources, good corp gov:
* Provides ‘checks and balances’ on the board
* Helps boards monitor management of the company.

Institutional shareholders should take an interest in good governance as:
* Investors expect a return on their investment.
* Evidence suggests well-governed companies deliver reasonable returns over the long term
* Arguably, shareholders in well-governed companies are less exposed to downside risk
* Institutional investors have legal responsibility (fiduciary duties) to the individuals on whose behalf they invest.
(ex. pension funds - such individuals are the beneficiaries of the funds)

Question 28

What are some ways in which institutional shareholders can call the board to account?

Answer 28

• Voicing concerns directly;
• Escalate – can escalate to a wider pool of shareholders;
• Vote – withhold vote / vote against a particular resolution or re-election of directors;
• Exit – shareholder can sell their shares.

Question 29

What were the key findings of ICSA’s “Shareholder Engagement: The State of Play” 2018?

Answer 29

• Evidence of increase since 2013 (60%) including quality of the engagement (70%)
• Issues similar , but increased focus on ESG and technology
• Equally initiated by companies and investors
• Still predominantly event-driven but some evidence of it being on an ongoing basis

Question 30

What actions might institutional shareholders take re shareholder activism?

Answer 30

• Use of voting rights as shareholders
• Engaging in active dialogue with the board to influence decisions.

In most cases activism is constructive - conducted via dialogue & discussion

Where board fails to respond acceptably/appropriately - more aggressive act may be considered for example
* Withholding vote at AGM or
* Voting against resolution in GM but this can be difficult to organise a voting majority of dissident shareholders

Sometimes votes will be guided institutional investor organisations / voting advisory firms

Question 31

What are wolf packs?

Answer 31

Where hedge funds join with other activists to push through agendas in companies for short-term gain- these actions will not usually be in the company’s best interests in the long-run.

Question 32

What is a ‘red-top’ notice?

Answer 32

A ‘red top’ warning is a notice sent out by institutional investor organisations to its members, advising the members who are shareholders to vote against a particular resolution at an approaching AGM of a company.

Question 33

What are the main features of the UK Stewardship Code?

Answer 33

1 - Definition of Stewardship

2 - Consistent with holistic definition of stewardship, applies more broadly

3- Signatories expected to take ESG, including climate change, into account and ensure their investment decisions aligned with needs of their clients.

4- Signatories expected to explain how have exercised stewardship with a requirement to report annually on stewardship activities & outcomes

5- (As with some parts of 2018 UKCGC) - explain organisation’s purpose, investment beliefs, strategy and culture and how these enable them to practice stewardship.

6- Follows an ‘apply and explain’ model : must implement all and explain how they have done so.

7- All principles are supported by reporting expectations.

Question 34

What are the Code’s requirements for the production of a Stewardship Report?

Answer 34

• Succinct, engaging, plain English
• Single document, structure providing a clear picture how applied code (indexing to more complex parts if required)
• Fair, balanced, understandable
• Info given should clearly indicate how stewardship differs across funds/classes/geographies proportionate to operations - despite not needing to disclose on a fund by fund basis
• Should be reviewed/approved by applicant governing body - signed by chair, CEO or CIO
• When accepted as signatory/report approved by FRC - must be publicly available document - publish document on website or elsewhere if they do not have a one

Question 35

What should the statement published by signatories of the Stewardship Code on their websites state?

Answer 35

• How the principles have been applied;
• Specific information required
• Explanation of any non-compliance.

Question 36

What can the Company Secretary do re the stewardship of their company’s institutional investors?

Answer 36

CoSec should monitor websites of asset owners and managers (including their service advisers) who have or manage investments in the company to:

• See if anything in content of their Stewardship Reports can assist the company’s dialogue with them
• Can do the same with any disclosures req by Conduct of Business Rules if not signatories of Code
• Outcome of this assessment should be shared with the board
• Many asset managers will also publish voting policies in addition to S-Ship Report (detail factors taken into account when deciding how to vote on resolutions)

Question 37

What is a derivative claim? Who is able to bring it and when

Answer 37

Introduced by CA2006.

• Claim that can be brought by shareholders on grounds that the company itself has a cause of action against the directors of the company.
• Cause of action must involve some negligence, default or breach of duty on the part of the director and may be brought against the director involved in the breach.

Minority shareholders are therefore able to bring such actions against directors who have acted in a way that is preferential to a majority shareholder and have breached their duty to promote the interests of company as a whole.

Question 38

What is the purpose of a shareholder representative body?

Answer 38

To provide guidance for their members on corporate governance issues of listed companies.

Question 39

What are the two main shareholder represenative bodies in the UK?

Answer 39

• PLSA - examples of good stewardship practices & recommendations for voting at an investee AGM. Guide aloso includes recommendations for reporting of corporate culture with an emphasis on importance of boardroom diversity - Gender and Ethnic targets as identified in Davies and Parker reports.
• Investment Association - guidelines for members in issues such as CG, share capital management, other issues relating to capital markets.

Question 40

What are international shareholder advisory bodies and why should UK companies be aware of/monitor them?

Answer 40

• Organisations such as Glass Lewis & Institutional Shareholder Services (ISS) exist due to global nature of shareholdings to express views on UK companies
• CoSecs/Gov Professionals should be aware views of these companies as far as they affect their organisation.
• When board discuss issues these bodies have an opinion on, this fact should be brought to the board’s attention, if they are unaware.

Question 41

What is the difference between responsible investment and socially responsible investment?

Answer 41

• Responsible or ethical investing - refusing to invest in ‘unethical’ companies and ‘sin stocks’, that is, companies that produce or sell addictive substances (like alcohol, gambling and tobacco) because the activities of the company are inconsistent with the investor’s ethical, moral or religious beliefs.
• Socially responsible investment (SRI) - goes further. It includes refusing to invest in ‘unethical’ companies, but SRI investors also encourage companies to develop CSR policies and objectives, in addition to pursuing financial objectives. SRI investors will seek out companies engaged in social justice, environmental sustainability and alternative energy/clean technology efforts. SRI investors may also be involved in shareholder activism when companies have social or environmental policies with which they disagree.

Question 42

What is ESG?

Answer 42

Describes a group of risks that are explicitly acknowledged/integrated into investment research and decision-making processes.

Question 43

What are the ways in which an investor can pursue an SRI strategy?

Answer 43

• Engagement : acquire shares where wants (financial reasons) & engages to try and persude them to adopt policies that are socially responsible or make improvements to CSR policies.
  May involve investor telling what CSR policies should be & persauding it to change is policies in some areas (via reg meetings with directors) if company indicates willing - investor may then help form new policies.
• Investment Preference: only invest where meet guidelines (some soc/envi/ethic in nature)- not entirely based on CSR considerations. Investor can consider the expected financial returns and the selected investment portfolio can be a suitable balance of investments which are ethically sound and those that are not so ethical (or ‘riskier’ re social, environ terms) but should provide better financial return.
• Screening - investments are restricted to companies that pass a ‘screen test’ for ethical behaviour - can be positive or negative. Positive = companies must meet certain criteria for ethical/socially responsible behaviour - or investor will not buy shares. Negative = investor will** identify companies that fail to meet** certain min. criteria for socially responsible behavior and refuse to buy shares in those companies. Could make use of a CSR index such as Down Jones Sust Index / FTSE4Good Indices.

Question 44

What is an institutional shareholder?

Answer 44

• One which trades securities in large quantities/monetary amounts on behalf of multiple beneficiaries.
• Assumed to be more knowledgeable and therefore better able to protect themselves.
• Have a role in economy to act as HIGHLY SPECIALISED INVESTORS on behalf of others
  Ex. pension funds