Related Party Transactions under Stock Exchange Rules
The UK Listing Rules for Premium Listed companies are well known for containing some strong corporate governance rules, as well as information disclosure rules for the benefit of investors (whether shareholders or not). Thus, the requirement for shareholder approval of ‘significant transactions’ (LR 10) are credited with saving Barclays from the mistake of acquiring Lehman Brothers during the frantic negotiations over the weekend before Lehman Brothers collapsed (there was not enough time to organise a shareholder meeting), though it did not prevent the ill-fated acquisition a little earlier of ABN-AMRO by a consortium of banks led by the Royal Bank of Scotland (the shareholders endorsed the acquisition).
LR 11 requires shareholder approval of related party transactions (RPT), where these exceed 5% on the class tests. Below that, but at the 0.25% level or above, disclosure to the market is required at the time the transaction is entered into (but not shareholder approval), and the London Stock Exchange’s rules for Alternative Investment Market (AIM) companies never go beyond disclosure (and are triggered at the 5% level). LR 11 is sometimes presented, especially outside the UK, as typically requiring shareholder approval for RPT. Recent research, however, based on an analysis of all market announcements made from mid-2019 to mid-2020, casts doubt on this view. (See Paul Davies, ‘Related Party Transactions on the London Stock Exchange: What Works and What Does Not’ (2022) 43 Business Law Review 2; ECGI Law Working Paper 624/2022.) During this period there were 90 announcements of RPT by premium-listed companies, of which only 16 (18%) involved shareholder approval. Moreover, the announcements were heavily skewed, both in terms of market capitalisation. None of the announcements was by a FTSE 100 company and only 1 by a FTSE 350 constituent. Thus, the approval requirements fell almost exclusively on the Small Cap and Fledgling constituents of the Premium Segment, which, however, represent only 3% by value of the overall market. Further, half the shareholder approvals related to revised arrangements with the managers of closed-end funds, a matter of irrelevance to commercial companies. There is clearly an argument for revising the 5% threshold downwards, perhaps to the 2% level originally proposed by the Exchange when the modern rules were adopted in the early 1990s. (Before that the approval rules seem to have been even more demanding.)
LR 11 operates predominantly as a disclosure mechanism, as, of course, do the AIM Rules. Even though set at a higher level, during the investigation period the AIM rules generated many more market announcements than LR 11 (400 as against 97), even though the number of issuers subject to the two sets of rules was roughly equal. This startling discrepancy is probably due to the incentives, first, for institutions and wealthy individual investors to take reasonably large stakes in AIM companies (if they invest at all) in order to protect their positions, AIM companies not being subject to the UK Corporate Governance Code (CGC). Second, such investors are willing to fund AIM issuers only on a stage-by-stage basis, so that AIM companies engage in frequent small fund-raisings, usually via placings, which in turn cement the position of the larger shareholders. Consequently, together with founders, there emerges a larger proportion of shareholders controlling 10% or more of the voting rights in the company—the threshold for being regarded as a related-party shareholder—in AIM than in Premium Segment companies. Once in existence, large shareholder are often willing to invest in the company in ways other than equity investments, for example, through debt, thus generating further RPT.
As disclosure mechanisms, however, both LR 11 and the AIM rules are subject to deficiencies. Both sets of rules go a long way towards disclosure of the terms of the transaction. But the disclosures do not give the market what it then crucially needs, ie criteria for assessing whether the terms are fair to the non-controlling shareholders and the company. In the absence of an external criterion for making this assessment, which in complex cases is unlikely to exist, there is no guarantee that the information disclosed will provide a basis for coming to a view on this matter. Sensitive to this point, the framers of both sets of rules require fairness certification to be provided by the company’s sponsor or nominated adviser (as the case may be). However, the utility of the certification is reduced by the fact that only the existence of the certificate has to be disclosed and not the reasoning upon which it is based. What the market is told about the certificate is pure boilerplate. The value of the disclosures would be enhanced significantly by requiring disclosure of least the basis of the fairness conclusions by both the sponsor/nomad and the board making the announcement. However, if this reform were put in place, the board could be permitted not to make use of a sponsor/nomad certification where it felt it could convincingly convey to the market its own view that the transaction was fair. Finally, it would enhance the value of the directors’ statements if they had to be provided, not just by the non-involved directors (as a present) but by those directors who were independent in the CGC sense of the term. This would be an easy reform to introduce for Premium Listed companies and probably also for the largest 50 or 100 AIM companies.
Paul Davies is a Senior Research Fellow at Harris Manchester College, University of Oxford.
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