Legal tools for Active or Activist Shareholders
Boards of quoted companies should prepare to face an increasing risk of campaigns from investors. These may come from activist shareholders, whose investment strategy includes proactively seeking catalysts for value creation often through structural change in the company, or from investors who aim to influence board strategy, either to drive value creation or for commercial, political, environmental, social or ethical reasons.
Investors are being encouraged to become engaged and active through recent changes in regulation, in England and at EU level, designed to encourage long term investors. Investors who may have traditionally taken a more passive approach are being empowered with additional tools enabling them to voice concerns and to influence and implement change. This article looks at some of the tools available to investors who may be considering actively engaging with a company and highlights issues which boards increasingly need to be prepared to face.
Listed companies (but not AIM companies) must prepare an annual report on remuneration setting out actual payments to directors and indicating how the company intends to implement its remuneration policy in the coming year. This report is submitted for approval by an ordinary resolution at the company's annual general meeting. The vote is advisory and does not bind the company with regard to the terms of remuneration offered to directors. However, details of how shareholders voted must be included in the next report, together with a summary of the reasons (if known) for any significant vote against and any action taken by the board in response.
Shareholders must also, at least every three years, approve the company's remuneration policy by ordinary resolution - a vote which is binding on the company. Any remuneration payments which are not aligned with the remuneration policy will have no legal effect. The UK Corporate Governance Code provides that the remuneration policy must be designed to promote the long term success of the company.
The EU has proposed EU wide similar "say on pay" provisions for shareholders as part of the proposed changes to the Shareholder Rights Directive.
Boards should be wary of signs of investor discontent where a remuneration report or policy may be voted down by shareholders. If this is the case, the board may need proactively to engage with investors to avoid escalation of shareholder action.
Re-election of directors
An active or engaged shareholder may seek to vote down the re-election of directors retiring by rotation at a company’s annual general meeting and may propose replacement appointments. The company's articles of association will determine the timing and number of directors that would be required to stand for re-election.
The UK Corporate Governance Code provides for annual re-election of directors of FTSE 350 companies, for directors of smaller quoted companies to continue to be re-elected at intervals of not more than every three years and for non-executive directors to be subject to annual re-election after nine years in office. Whilst the Code is directly applicable only to premium listed companies and is in any event a "comply or explain" regime, boards may now face more active engagement from investors who consider, for example, that appropriate standards of corporate governance are not being met or that board remuneration exceeds their expectations.
Requisitioning a general meeting and removal of directors
Activist or engaged investors holding 5% or more of a company's paid up voting shares can requisition a general meeting and propose resolutions to be considered at the meeting. Often, these will be resolutions to remove certain directors coupled with proposals to appoint alternative directors.
Investors may seek to remove certain directors as part of a strategy to implement change within the company or as part of a campaign to pressure the board for change. For example, a change in board structure (or pressure for such change) may result in the board approving a share buy back programme or an M&A transaction to secure value creation.
Investors holding at least 5% of the paid up voting shares (or at least 100 investors holding shares in the company on which there has been paid up an average amount of at least £100) may also require the company to circulate a statement to shareholders (not exceeding 1,000 words) relating to any matter proposed to be considered at a requisitioned meeting.
Investors holding 5% or more of the company's paid up voting shares (or at least 100 investors holding shares in the company on which there has been paid up an average amount of at least £100) have a similar right to call an annual general meeting.
An investor should ensure that, in accordance with the Disclosure and Transparency Rules (DTR 5), the company is notified within two trading days if the investor’s interests in the company’s shares or cash settled derivatives reach, exceed or fall below certain thresholds. The thresholds for a UK company are 3% and then every 1% change thereafter. The company must then disclose any notifications to the market. Acquisitions or disposals which result in a net short position in the shares of a company may also give rise to an obligation to disclose details of that position under the EU Short Selling Regulations. If a company goes into an offer period under the Takeover Code, investors are required to disclose their interests and dealings when their interest exceeds 1%.
Boards should, in addition to implementing effective investor communications, also consider the systems they have in place to monitor the company’s share register to be aware of changes which may indicate that active investor engagement may commence. Under section 793 of the Companies Act 2006, a board can require disclosure from any party it believes has or had an interest in the company's shares at any time during the previous three years. A board may use this process to ascertain details of beneficial interests in its shares. A company’s articles may also provide for disenfranchisement of an investor’s shares for non-compliance with a section 793 request. However, in the light of certain case law, a board should take care if considering this as a course of action and take legal advice beforehand.
Litigation, derivative claims and unfair prejudice
As part of its negotiations with a board, an investor may consider the possibility of action against the company or individual directors, for example, for breach of directors’ duties. Investors or the board may require strategic legal advice on the existence of grounds for such a claim and how best to progress a potential action or how best to protect the board from such a claim.
Collective action and regulatory issues
An investor may need to gather support from other shareholders as part of its engagement strategy, in order to accumulate sufficient votes to pass a proposed resolution or to evidence sufficient shareholder support for the purposes of negotiations with the board.
Under section 116 of the Companies Act 2006, an investor can inspect or request a copy of the share register of the company in order to identify other shareholders whom the investor may wish to approach. A company is required to keep a register of any interests disclosed under section 793 requests and an investor is also able to inspect or request a copy of this register.
An investor would need to think carefully about how it approaches other shareholders to canvass opinion and support. Legal advice should be obtained, particularly where an open approach to shareholders is contemplated or where shareholders are likely to resist an approach where there is a perceived risk that inside information is to be shared with them thereby restricting dealing in the company’s securities.
An investor should also seek legal advice to avoid the formation of a concert party which can be presumed where an investor has a "board control seeking proposal". It would not generally be considered to be control seeking for an investor to seek to appoint non-executive directors where the appointment is being sought to improve standards of corporate governance. Legal advice should be sought in relation to the wording of any proposed resolutions to this effect as well as the structure of such a proposal more generally.
If a concert party has been formed, it will be necessary to consider the shareholdings of those in concert to ensure that a Rule 9 mandatory offer has not been triggered under the Takeover Code. If not, it will remain important to ensure that further stake building is controlled and standstill arrangements may be required to prevent a Rule 9 mandatory offer being subsequently triggered, as well as monitoring compliance with the restrictions on insider dealing and market abuse.
Whilst ESMA have published a White List of certain activities in which shareholders may engage, which in themselves would not lead to the conclusion that such shareholders are acting in concert, it will remain important to liaise with the Takeover Panel Executive on a case by case basis particularly in light of the Panel’s Practice Statement 26 relating to shareholder activism.
Investors may wish to seek support from other shareholders for their proposals by engaging with the press, for example, where it is necessary to achieve support to pass any proposed resolutions. Equally a board may wish to engage more with investors via the press to seek support and protect their position.
Both investors and boards who engage with the press should take legal advice on any press statements to avoid creating grounds for an action in defamation and to ensure compliance with other regulatory requirements, such as the market abuse regime or requirements relating to price sensitive information.
UK Stewardship Code
The UK Stewardship Code introduced standards of good practice for investors on a "comply or explain" basis which seek to encourage dialogue between investors and the board of a listed company. This may provide a tool to more passive investors to become more engaged and active in managing their investments in listed companies. The UK Stewardship Code requires investors to monitor their investee companies, to have in place clear guidelines on when and how they will escalate stewardship activities and to publicly disclose their policy on how they will discharge stewardship responsibilities. It also requires investors to be willing to act collectively with other investors where appropriate.
The Investor Forum
One of the recommendations of the Kay review of UK equity markets and long-term decision making was the establishment of an investors' forum to facilitate collective engagement by investors. The Investor Forum was formally launched on 1 July 2014 with the objective of creating value by way of long term investment and may offer some investors an alternative route to discuss and take action collectively.