1.3.2.2 Adverse Effects on Corporate Governance

Hidden ownership also undermines the mechanisme through which ownership disclosure improves corporate governance. Transparency of economic interests facilitates enforcement of the prohibition of trading on non-public information, or, more generally, the prohibition of market abuse. Regulators worldwide have applied this line of reasoning recently when they mandated disclosure of short positions.1 Interestingly, the International Organization of Securities Commissions (IOSCO) has acknowledged that "the reporting of short positions might not provide a full picture if the data excludes derivatives."2 The primary concern in the area of enforcement, however, is that the undisclosed use of equity derivatives can affect the market for corporate control by putting the acquirer at an advantage over other players in the game. As we have seen, if the objective is to facilitate the market for corporate control, setting the trigger for disclosure at the appropriate level is key. On the one hand, a bidder's ability to use equity derivatives to acquire a toehold can facilitate takeover bids.3 But if the target company's ability to bargain for a higher offer price is limited, or if potential interlopers are discouraged from launching a competing offer, the market for corporate control may be adversely affected overall.

The market for corporate control does not operate solely through public offers. Control can also shift through contested director elections, as in CSX. A shift in control can even be initiated by a minority shareholder who puts a controversial item on the agenda. This is exemplified by the case of Dutch bank ABN AMRO. Early 2007, TCI (indeed, the same hedge fund as in CSX) initiated a shareholder vote on the break-up of the company. The resolution was partially adopted and, while it was not legally binding on the board, it would set in motion a string of events eventually leading to the break-up of ABN AMRO as a result of a public offer by a consortium of three European banks. By using equity derivatives, shareholders who merely hold sufficient shares to put an item on the agenda of the shareholders' meeting may in fact hold a much larger economic interest. They may also hold a smaller economic interest, which implies a risk of empty voting, discussed in the following section. In each case, it is impossible to determine the relevant shareholder 's true interest and hence its incentives and potential influence. This raises real concerns for issuers, as evidenced by the fact that by late 2008, no less than 369 U.S. issuers had amended their bylaws to require full disclosure of derivative positions by shareholders submitting a proposal or nominating directors for election at shareholder meetings.4

A related concern is that equity derivatives make it more difficult for issuers to know who has a stake in them. Recall that this issue was on the Commission's mind when it extended the scope of the disclosure obligation to derivatives granting the right of access to voting rights. Can the same argument be invoked to mandate disclosure of equity derivatives that may offer informal access to voting rights, such as Cfd? Issuers certainly seem to believe so.5 The FSA has dismissed this concern on the ground that it sees no evidence of a market failure here.6 But with barriers to cross-border investment fading away and issuers seeing their shareholder base becoming increasingly widespread, the importance of managing investor relations is only growing. Against this background, there may well be reason for concern.

Finally, while this section has focused on how hidden ownership affects the efficiency of ownership disclosure mies, it should be emphasized that hidden ownership can also affect the efficiency of other mies, such as the mandatory bid rule. Pursuant to the Takeover Directive, the mandatory bid obligation is triggered upon acquisition of control of the issuer, as proxied by a percentage of voting rights (e.g., 30%) specified by the Member State. Thus, the same potential problem crises: if the scope of the Member State's relevant provision does not include cash settled equity derivatives, acquirers may be able to circumvent the mandatory bid rule by building their stake in part through such derivatives. Accordingly, in the UK, not only shares and physically settled equity derivatives count toward the mandatory bid trigger, but so do cash settled equity derivatives.7 This is not the case in every Member State, however. In Italy, for example, the use of cash settled equity derivatives apparently enabled the Agnelli family to retain control of carmaker FIAT while avoiding a mandatory bid obligation.8 This reinforces the need for a systematic analysis of the impact of equity derivatives on mies pursuant to which the holding of a certain amount of shares triggers certain obligations.