The Decoupling of Voting and Economic Ownership (IVOR nr. 88) 2012/1.5:1.5 Policy Implications

The Decoupling of Voting and Economic Ownership (IVOR nr. 88) 2012/1.5

1.5 Policy Implications

Documentgegevens:

mr. M.C. Schouten, datum 01-06-2012

Datum: 01-06-2012
Auteur: mr. M.C. Schouten
JCDI: JCDI:ADS593603:1
Vakgebied(en): Ondernemingsrecht / Rechtspersonenrecht

From the preceding analysis it becomes clear that, as a general matter, policymakers contemplating how to respond to bidden ownership and empty voting should not focus only on the most obvious problems caused by these phenomena, such as malfunctioning of the market for corporate control. Instead, they should take into account the whole range of adverse effects on market efficiency and corporate governance, as described in this Chapter.

This observation should be particularly relevant to the European Commission, which is currently evaluating the European ownership disclosure regime, embodied in the Transparency Directive. The European Securities Markets Expert Group has suggested that informing market participants of significant changes in the voting structure is the Directive's "exclusive"purpose.1 But this Chapter has shown that ownership disclosure can improve market efficiency and corporate governance through various mechanisms. This means that the Commission should assess the extent to which each of these mechanisms are functioning adequately, taking into account their relative significance and interaction.2

Moreover, the analysis suggests that the Transparency Directive in its present form does not effectively prevent hidden ownership, and that hidden ownership severely undermines the mechanisme through which ownership disclosure improves market efficiency and corporate governance. This strongly suggests that the Commission should consider expanding the scope of the disclosure rules.3 Yet, while most of this Chapter has been devoted to discussing the benefits of disclosure, policymakers should duly take into account the potential costs of increased disclosure — beyond incremental compliance costs.4 By increasing market impact cost, for example, disclosure could reduce hedge funds' incentives to incur the costs of searching for fundamental information and of engaging in activism.5 Given that preliminary findings suggest hedge fund activism benefits existing shareholders,6 regulators should caution not to unduly limit hedge funds' ability to engage in activism.7 Fear that disclosure will prompt replication of trading strategies may also adversely affect liquidity. AIMA, which represents the hedge fund industry, has explicitly voiced this concern.8

Still another cost could result from management of listed companies responding to information on stakebuilding through equity derivatives in a way that serves its own interest rather than the interest of the company and its shareholders. In the U.S., some issuers have changed their shareholder rights plans to explicitly include derivatives when calculating the level of beneficial ownership that triggers the poison pi11.9 Skeptics of the pill may be concerned about the adverse affects this strategy could have on the market for corporate contro1.10 Issuers could also respond by filing lawsuits alleging inaccurate disclosures, the accuracy of which becomes increasingly contestable as disclosure obligations become more complex. Such litigation risk could not only deter potential bidders, but also chill shareholder activism.11 Indeed, the fact that issuers are among the loudest proponents of increased transparency should caution policymakers to carefully examine their motivations.12 This is of particular concern given that the current financial crisis may have affected the political economy so as to make policymakers even more responsive to issuers' concerns over hedge fund activity.13 A case in point is the restriction of short selling, the efficacy of which remains controversia1.14

Similarly, the analysis has shown that the Transparency Directive sheds virtually no light on empty voting, and that empty voting severely undermines the mechanisme through which ownership disclosure improves market efficiency and corporate governance. Again, this strongly suggests the European Commission should consider expanding the scope of the disclosure mies, while being mindful of the potential costs and unintended consequences. One such unintended consequence could be an overflow of information. With respect to securities lending, the European Securities Markets Expert Group has expreseed concern that too much disclosure could be misleading by making material information less easy to identify.15 Moreover, if and to the extent empty voting enhances efficiency, as some research suggests, disclosure could improve efficiency but also reduce efficiency, depending on the circumstances.16 This reminds us that any measure designed to address empty voting requires a thorough understanding of this phenomenon. Ironically, transparency may be exactly what we need to obtain such understanding.17

In assessing the costs and benefits of increased disclosure, policymakers should also be mindful of the limitations of the law. Even if disclosure mies are updated, acquirers, with the help of financial and legal advisers, can be expected to devise new and sophisticated ways to circumvent those mies. Indeed, the chief lobbyist of the German hedge fund industry was recently quoted as saying that he saw no need for a regulatory clampdown of equity derivatives in response to cases like Schaeffler because "[n]ew types of derivatives or trading techniques would emerge that were not subject to this regulation."18 This observation fits within a broader theory that law is inherently incomplete due to the fact that lawmakers are unable to foresee all future contingencies.19 The originators of this theory highlight the role for regulators as proactive law enforcers with an ability to adapt mies flexibly over time, an issue that will be revisited below. The inherent incompleteness of law also calls for a principle-based approach rather than a legalistic approach. With this in mind, the FSA has extended the scope of its new disclosure mies to any financial instruments that have "a similar economie effect" as financial instruments that would trigger disclosure.20

Finally, policymakers should assess whether existing mies are adequately enforced. As with any ad hoc disclosure obligation, because recipients do not expect particular disclosures in advance, vigorous enforcement is key to ensure compliance.21 Focus on enforcement by the European Commission is especially warranted in view of the recent accession of a host of Eastern European countries to the European Union. Although most of these countries had adopted a 5% disclosure threshold by 2002, an empirical study found that in most of these countries the identity of the ultimate owner was still undisclosed due in part to the laxity in enforcement.22 A related study found substantial variations across Eastern European countries in what companies disclose regarding their corporate governance arrangements, and concluded that while accession to the European Union has been successful in transforming the laws on the books, implementation at firm level is still lagging.23

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ESME, supra note 3, at 2. According to the ESME, the Directive has other 'acceptable' effects, but these effects are considered secondary and 'must not condition the shape and scope of the disclosure requirements under the [Directive].'

This is not to suggest that ensuring transparency of the voting structure is not the primary objective of the disclosure regime. It is. In 1997, the ECGN concluded that the level of transparency was not enough to guarantee that those who had ultimate control could be properly identified; Becht, supra note 8, at 90. In 2002, the High Level Group of Company Law Experts emphasized the need for more transparency of the governance structures of groups of companies, in particular the ownership structure of pyramids. High Level Group, supra note 91, at 96, 98. The evaluation should therefore first and foremost be concemed with determining whether the Directive has sufficiently improved this situation.

For detailed proposals on how to expand the UK disclosure mies, see FSA, supra note 177. With respect to the U.S. disclosure mies, see Hu & Black, supra note 2, at 864; Wachten, Lipton, Rosen & Katz, Beneficial Ownership of Equity Derivatives and Short Positions — A Modest Proposal to Bring the 13D Reporting System into the 21ST Century (Client Memorandum dated March 3, 2008, on file with author).

The cost-benefit analysis conducted by the FSA prior to the expansion of the scope of the UK ownership disclosure regime focuses heavily on incremental compliance costs (including upfront costs and ongoing costs), which is understandable given that these costs can at least to some extent be quantified. Yet the FSA also observes that '[o]ne of the difficulties of producing a robust [cost-benefit analysis] in this area is the possible variations of the indirect costs. These costs, which can manifest themselves in a large variety of ways, are often difficult to predict and can be impossible to quantify [nevertheless, these costs can be more significant than the direct costs].' The FSA identifies the following potential indirect costs, some of which are discusses in more detail below: (i) negative impacts on the activity of hedge funds and other investors who seek to profit from undertaking research and exploiting arbitrage opportunities; (ii) negative impacts on the CfD volumes written by banks; (iii) reduced demand for the underlying shares, to the detriment of issuers; (iv) increased cost for market participants due to monitoring a higher number of disclosures for meaningful information, and risk of reduced liquidity due to excessive information. FSA, supra note 65, annex 1 at 6-10. See also Isaac Alfon & Peter Andrews, Cost-Benefit Analysis in Financial Regulation: How To Do It and How It Adds Value, FSA Occasional Paper Series nr. 3, at 10, 11 (noting that '[t]he main conceptual problem is that satisfactory [cost-benefit analysis] is difficult to achieve within any given sector, given that optimum conditions do not obtain in the rest of the economy. Under these `second best' conditions, it is not certain that an improvement in one sector would make the country as a whole better off, for example because market valuations of resources may be unreliable,' and also noting that the main practical problem is lack of data, partly as a result of the difficulties that arise in the identification of compliance costs); Christian Leuz & Peter D. Wysocki, Economic Consequences of Financial Reporting and Disclosure Regulation: A Review and Suggestions for Future Research (2008) (reviewing the theoretical and empirical literature on the economic consequences of financial reporting and disclosure regulation), available at http://ssrn.com/abstract=1105398.

See Hu & Black, supra note 2, at 841.

Brav et al., supra note 41; Klein & Zur, supra note 41.

This does not only have implications for determining the optimal scope of the disclosure rules but also, for example, for determining the optimal period of time allowed between crossing the reporting threshold and filing the notification form.

Letter from the Altemative Investment Management Association (AIMA) to the FSA (Feb. 12, 2008) (on file with author) (noting that disclosure would leave trading strategies 'open to replication by those who have not expended the resources to conduct their own diligent research and investment analysis').

Mara Lemos-Stein, Poison Pills Target Derivatives, Wall St. J., June 18, 2008; Charles M. Nathan, Second Generation Advance Notice Bylaws and Poison Pills (2009), available at http://blogs.law.harvard.edu/corpgov/2009/04/22/second-generation-advance-notice-bylaws-and-poison-pills/.

10.

See also Hu & Black, supra note 2, at 841 (noting that reducing bidder resistance could enhance the market for corporate control); supra notes 132-134 and accompanying text.

11.

See supra note 135 and accompanying text.

12.

See supra note 132 and accompanying text. For an early explanation of mandatory disclosure rules from a public choice theory perspective, see Macey & Netter, supra note 39, at 157, 158 (arguing that narrow interest-group concerns (in particular those of incumbent management) motivated the legislative process that produced the US ownership disclosure rules).

13.

CE McCahery & Vermeulen, supra note 135, at 541, 555 (identifying protection of incumbent management as one objective of ownership disclosure rules, and noting that the credit squeeze has slowed down hedge fund activity and resulted in intense scrutiny from regulators, policymakers and the judiciary).

14.

For a survey of the literature on this point, see FSA, supra note 79, Annex I.

15.

ESME, supra note 3, at 7. Notice that the risk of overflow appears to be smaller if the targeted audience consists primarily of financial professionals, who can be expected to identify material information more easily.

16.

Brav & Mathews, supra note 219, at 29.

17.

See Hu & Black, supra note 2, at 886.

18.

Christiaan Hetzner, VFV Shares Halve As Porsche Eases Short Squeeze, Int'l Herald Tribune, Oct. 29, 2008.

19.

Katharina Pistor & Chenggang Xu, Incomplete Law, 35 N.Y.U. J. Int'lL. & Pol. 931 (2002-03).

20.

FSA (2009), supra note 177, at 6, 7 and DTR 5.3.1 R 1 (b) (ii) (in force as of June 1, 2009).

21.

John Armour, Henry Hansmann & Reinier Kraakman, Agency Problems and Legal Strategies, in The Anatomy of Corporate Law: A Comparative and Functional Approach 50 (Oxford University Press 2009); see also Siems, supra note 141, at 142 (noting that the enforceability of ownership disclosure provisions is endangered by the fact that the shareholders' register does not identify holders of bearer shares or fiduciary holdings).

22.

E. Berglbf & A. Pajuste, Emerging Owners, Eclipsing Markets? Corporate Governance in Central and Eastern Europe, in Corporate Governance and Capital Flows in a Global Economy 267, 286, 291 (P.K. Cornelius & B. Kogut eds., 2003); see also John C. Coffee, Law and the Market: The Impact of Enforcement, 156 U. Pa. L. Rev. 229 (2007) (finding a disparity in enforcement intensity between common law and civil law countries).

23.

Erik Berglbf & Anete Pajuste, What Do Firms Disclose and Why? Enforcing Corporate Governance and Transparency in Central and Eastern Europe, 21 Oxford Rev. Econ. Pol. 178, 180 (2005); see also Yuan Ding et aL, Firm-Level Transparency in the Former East Bloc: Empirical Evidence from the Baltic Region, manuscript at 15, available at http://ssm.com/abstract=1098193 (finding that in 2004, Baltic firms disclosed significantly less ownership information than Nordic firms)