Stilpon Nestor

explain material events and transactions that have taken place during the relevant period and their impact on the financial position of the issuer’s group;

generally describe the financial position and performance of the issuer and its group during the relevant period.

As regards control transactions, shareholders should inform issuers within four days at the latest of the acquisition or disposal of voting control above certain thresholds starting at 5 per cent of relevant voting rights. The Directive requires an issuer to disclose publicly the information contained in the notification given by the shareholder, no later than three days after receiving the notification.

Hedge fund and stock lending

As noted above, hedge funds play an increasing role in corporate control challenges. Some companies have voiced fears that these ‘short-termist speculators’ might hijack corporate strategy and control and that they might be prepared to sacrifice long-term shareholder value for short-term gains by, for example, forcing the company to distribute its cash reserves, or incur excessive leverage, or sell important assets.

The claim that hedge funds are becoming the scourge of issuers is somewhat overstated. A 2007 study by the OECD concluded that activist hedge funds and private equity firms could help strengthen corporate governance practices by increasing the number of investors that have the incentive to make active and informed use of their shareholder rights.18 Despite the publicity around activist hedge funds, they remain a small part of the capital market: there are only some 120 funds (managing around US$ 50 billion (excluding leverage)) that pursue investment strategies explicitly aimed at influencing publicly held company behaviour and organisation.19

Activist hedge funds seek to influence corporate behaviour without acquiring control. They often focus on the company’s operational strategies and its use of capital. Their targets are mostly companies that lack a credible long-term strategy or maintain large cash reserves without being able to communicate a credible investment strategy. Hedge funds seem to have a 60–75 per cent success rate in preventing mergers or in supporting takeovers, in changing Chief Executives and board composition, and in altering the capital structure of a company through share buybacks.

Notwithstanding their overall beneficial role, there are two concerns with hedge funds that seem to be justified: the first one regards accountability. Companies need to know who are their important shareholders, and whether they are there for the long term or just a few weeks. Companies should be given the

18See OECD, The Role of Private Pools of Capital in Corporate Governance: Summary and Main Findings about the Role of Private Equity and ‘Activist’ Hedge Funds, May 2007, p. 2.

19By way of comparison, the global mutual funds industry alone has US$ 18 trillion under management. See OECD, p. 2.

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Regulatory trends and corporate governance

possibility to engage with them. In this respect, the regulatory framework might not be capturing the vesting of significant control rights (de facto or de jure) to stock borrowers in some stock-lending situations. Stock-lending transactions are typically structured in two ways: either as outright sales of stock with a put option on the seller; or as contracts for difference (CFDs), which do not require any transfer but stipulate a certain payment to the borrower. At first glance, the former method would result in the full vesting of control rights to the borrower, who would then presumably be liable to report the crossing of any important regulatory control threshold as set in company law or securities regulation. In the case of CFDs, no transfer of control would normally occur. However, explicit or implicit side arrangements as regards control rights (from an outright proxy to an informal agreement as to how the shares should be voted by the lender) can be made. Any such arrangement that crosses relevant thresholds should, in principle, be captured by disclosure regulation and treated no differently from any other type of change in control. The broad language of the Transparency Directive on this point seems to cover these instances which should thus be subject to timely notification. However, the transposition of these provisions by EU Member States has not yet been tested in the courts. As regards the US,20 the regulatory framework might be too fragmented to produce comprehensive, timely disclosure of hedge fund positions.

The second concern arises on the investor side, when institutions (usually their back offices) or, even worse, custodians without their client’s express authorisation, lend shares with their votes attached to third parties during general meeting periods. A recently issued ICGN code of stock-lending best practice establishes three fundamental principles: transparency of stock-lending practices, especially towards the beneficiaries of the institution’s investments; consistency, meaning that ‘a clear set of policies which indicates with as little ambiguity as possible when shares shall be lent and when they shall be withheld from lending or recalled is necessary in order to ensure that similar situations are handled in the same way’; and responsibility, meaning that ‘responsible shareholders have a duty to see that the votes associated with their shareholdings are not cast in a manner contrary to their stated policies and economic interests’.21 Many institutions will be looking at the tension between the back office’s legitimate objective to earn some extra cash from their stock inventory, and the overall objective to create long-term value and respond to stewardship imperatives. If institutions do not manage to address these issues effectively, it is likely that regulators will take up the baton and impose solutions that limit contractual freedom to a greater extent than the market would like to see.

20As per Hu and Black, see above note 5.

21The International Corporate Governance Network is an investor organisation, grouping some of the world’s largest institutional investors, whose members manage collectively more than US$ 10 trillion worth of assets globally. The code can be found at www.icgn.org.

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