Just as the new Presidential administration leads a charge to roll back corporate regulation, “the rest of the world seems to be headed in the opposite direction,” according to a recent post in the PubCo@Cooley blog. Last month, the European Parliament approved a new Shareholder Rights Directive that is intended to “sharpen big EU firms’ focus on their long-run performance, by fostering their shareholders’ commitment to it, according to the legislature’s press release announcing the Directive’s adoption. As the same time, a recent report from a U.K. Parliamentary Committee may signal further governance changes ahead in the U.K., as well. Both of these initiatives proceed from perceived governance shortcoming and concerns over disproportional corporate focus on short-term results.
The EU Shareholder Rights Directive
The Directive’s Purpose: According to a European Commission fact sheet, the aim of the new Shareholder Rights Directive is to “contribute to the long-term sustainability of EU companies, enhance the efficiency of the chain of intermediaries and to encourage long-term shareholder engagement.”
The legislative initiative came about because, according to the fact sheet, “the financial crisis had shown that many shortcomings in corporate governance contributed to the financial crisis.” These shortcomings included “deficiencies in engagement and control by shareholders” that “impede good decision-making by companies”; excessive directors’ pay not justified by performance, which has let to mistrust by shareholders and others; and complicated procedures for the exercise of shareholder rights.
In order to address these concerns, the new Directive introduces a number of measures.
Say-On-Pay: First, listed companies in the EU will be required to hold two say-on-pay votes: a prospective binding shareholder vote on director pay, and a retrospective advisory vote on the company’s compensation report (in other words, to approve pay plans in advance and to assess retrospectively how the plans worked out). These new votes are intended to “encourage more transparency and accountability about directors’ pay.” Shareholders will “have the right to know how much the company’s directors are paid and they will be able to influence this.”
Addressing Problems of Short-Termism: Second, in order to address concerns that companies are unduly focused on short-term strategies, the Directive focuses on the actions and motivations of the institutional investors that own the majority of shares in EU companies. The Directive requires institutional investors to disclose “how they will take the long term interests of their beneficiaries into account in their investment strategies and how they incentivize their asset managers to take these long-term interests into account.” The intent is that “through increase transparency requirements, the new rules will encourage these investors to adopt more long-term focus in their investment strategies and to consider social and environmental issues.
Related Party Transactions: Third, in order to address concerns regarding related party transactions, the new rules will “require companies to publicly disclose material related party transactions that are most likely to create risks for minority shareholders.” Companies will also have to submit these transactions for approval of the general meeting of shareholders or of the board.
Shareholder Identification: Fourth, in order to encourage shareholder engagement and to address concerns involved with the many layers between companies and their investors, the new rules will give companies the right to identify their shareholder, by obliging the chain of intermediaries to pass on relevant information and to facilitate exercise of shareholder rights including voting. In particular, the new rules will require intermediaries to transmit the voting information from the shareholder to the company.
Proxy Advisors: Fifth, on order to ensure high quality recommendations and to enhance trust, proxy advisory firms must disclose how the prepare policies and voting recommendations.
Companies Affected and Timing: The new Directive applies to the more than 8000 companies listed on the EU Regulated Markets. The Directive must still be formally approved by the EU Council of Ministers (which is anticipated shortly) and then Member states will have 24 months from the date of entry to bring the new rules into force.
Report of the UK Parliamentary Committee
As a result of two high-profile instances of perceived corporate governance shortcomings during 2016, the U.K Parliament’s Business, Energy and Industrial Strategy Committee undertook a broad review of corporate governance issues. The Committee’s April 4, 2017 report can be found here.
The Committee’s report follows on the Prime Minister’s November 2016 Corporate Governance Reform Green Paper, which focused on executive pay, private companies, and workers on boards. The Committee’s recent report also follows on its own March 2017 report (here) on industrial strategy, to which its corporate governance report is meant to be complementary. Among other things, the Green Paper proposed to make the shareholder’s say-on-pay vote binding.
The Committee noted that as a result of changes in the business environment, the rise of new business models and technological changes, as well as changing stakeholder expectations and changing ownership structure, companies are pressured to deliver short-term results rather than to invest for long-term benefit. There have also been, the Committee notes, high profile examples of “bad practice,” such as with respect to pay levels.
Based on these concerns, the Committee proposes a series of reforms “designed to require directors to take more seriously their duties to comply with the law and [the U.K. Governance Code].” The report’s authors take pains to emphasize that the corporate governance reforms they propose are” not intended to create onerous new requirements, but to establish arrangements to ensure that the better enforcement of the Companies Act 2006, to improve the voice of other stakeholders, including employees, and to require companies to engage in a more open and transparent manner with the public.” Among other things, the Committee proposes:
(1) to require directors “to report in an accessible, narrative and bespoke form on how they have complied with their duties under section 172” of the Companies Act 2006 (Duty to Promote the Success of the Company);
(2) to develop legislation to strengthen the Financial Reporting Council enforcement authority, in order to hold directors to account with respect to the full range of directors’ and to empower the FRC to initiate legal action for breach of Section 172 duties;
(3) to recommend to the FRC that it develop a system for the annual rating of corporate governance practices, with companies obliged to publish the rating results in their annual reports;
(4) that the FRC consult with stakeholders with an eye toward amending the U.K. Governance Code, among other things to establish deferred stock as the preferred practice, in preference to long term incentive compensation, as the best way to incentivize long-term decision making, and in order to simplify the structure of executive pay;
(5) to set a target that from May 2020 that women are placed in at least half of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies, with companies required to explain in their annual reports their failure to meet this target and remedial steps being taken.
The Committee’s complete list of recommendations can be found here.
Conflict Minerals Disclosure
In a separate but topically related development, in March 2017, the European Parliament adopted measures imposing due diligence and reporting requirements with respect to conflicts minerals. The EU rules must still be adopted by the EU Council of Ministers. If adopted, the rules would go into effect on January 1, 2021. European Commission’s March 16, 2017 press release regarding this action can be found here.
This development in the EU stands in interest contrast with the developments on the conflict minerals disclosure requirements in the U.S. Just this past Friday, April 7, 2016, the SEC announced that as a result the entry of judgment in the judicial proceedings that had been launched to challenge the conflicts minerals rules, that it would no longer enforce the conflict minerals disclosure requirements, at least for now. Acting SEC Chair Michael Piwowar is quoted as saying In light of the judicial developments and regulatory uncertainties, “until these issues are resolved, it is difficult to conceive of a circumstance that would counsel in favor of enforcing” the rule.
It is interesting to consider, as this blog post does, developments relating to the E.U. and to the U.K. but that do not involve Brexit. I will say, as a long-time observer of corporate governance trends, that there is a definite pendulum effect in force when it comes to standards of corporate governance regulation and enforcement. In the U.S., with the new Presidential administration, the pendulum is swinging away from tighter regulation and enforcement, while in the E.U. and the U.K., where the memories of the global financial crisis appear to be longer-lasting, the pendulum is swung toward greater regulation and enforcement.
Although the current state of affairs in the U.S. with respect to conflicts minerals disclosure is reflects judicial developments, there is no doubt that as a result of political events momentum had swung against the conflicts minerals rules; the respective state of affairs in the E.U. and in the U.S. concerning the conflicts minerals rules is both one example of and is somewhat emblematic of the differences between the two jurisdictions in the corporate governance pendulum swing.
Even though the current environment in the U.S. is against tighter corporate governance requirements, there are elements of the U.K and E.U. initiatives that might well catch the attention of reformers and activists in the U.S. For example, the E.U. Directive’s proposals with respect to proxy advisory firms and the identification of shareholders are similar to proposals that activists in the U.S. have previously circulated. The U.K. initiative on board gender diversity also likely will attract the attention of certain corporate governance in the U.S. Even if these consideration of these kinds of proposals do not lead to immediate action in the U.S., the proposals nevertheless enrich the dialogue and will be part of the environment when, as inevitably will happen, the corporate governance pendulum swings back again in the U.S.
Grace Notes: Saturday evening, my wife and I were fortunate enough to be able to join the sold-out crowd at Severance Hall, Cleveland’s amazing concert hall, for a truly memorable musical performance. The famed pianist Mitsuko Uchida was the soloist, playing Mozart’s Piano Concertos No. 12 and 20. We have seen Ms. Uchida perform with the Cleveland Symphony before; she was the artist-in-residence with the Cleveland Symphony from 2002 to 2007, and during that period she played and recorded the full cycle of Mozart piano concertos with the orchestra. Her performance on Saturday night was dazzling, a demonstration of stunning power and virtuosity. I haven’t the words to describe her performance; instead, I have included below a video of Ms. Uchida playing Mozart’s Piano Concerto No. 20. Do yourself a favor and take a few minutes to watch this recording of Ms. Uchida playing the No.20 piano concerto with the Camerata Salzburg in Nov. 2012. Even if you don’t have time to watch the whole thing, at least watch through the first cadenza.