Corporate Law Update
- The High Court confirms that an investor can claim in relation to misleading information published by an issuer even if it holds shares indirectly through a chain of intermediaries
- The Financial Reporting Council has published a review of corporate governance and reporting during the 2018/2019 season
- The Investment Association has published its Principles of Remuneration for the 2020 season
- A few other items
The High Court has said that a person who holds publicly traded shares indirectly through a chain of intermediaries can bring a claim in relation to misleading statements by the issuer.
In SL Claimants v Tesco plc, numerous individual claimants brought a claim against a large listed company. They claimed to have suffered loss when relying on allegedly misleading information published by the company.
Under section 90A of the Financial Services and Markets Act 2000 (“FSMA”), if an issuer publishes a misleading statement and someone relies on that statement to acquire, continue to hold or dispose of “securities”, that person can recover from the issuer any loss they suffer. The purpose is to protect people who invest in the markets based on information in the public domain.
This remedy is available to anyone who deals in equity shares on a regulated market (such as the London Stock Exchange's Main Market) or a multilateral trading facility (such as AIM). It also extends to dealings in “interests in securities”, although FSMA does not spell out what amounts to an “interest”.
Importantly, in this case many of the claimants did not actually hold shares in the company. Rather, the shares were registered in the name of a nominee company, which held them on trust for a custodian. The custodian in turn held its interest in the shares on trust (a “sub-trust”) for the claimants.
This is a common structure for holding traded securities. Despite being complicated, it can make trading in securities cheaper and easier. However, a consequence of this structure is that, although the ultimate investor is economically exposed to the shares, they do not hold title to or ownership of them.
Rather, the legal title is held by the nominee and the “beneficial ownership” lies with the custodian (under the nominee trust). All the ultimate investor holds is an interest under the sub-trust. This is nothing more than an economic interest in the custodian’s own beneficial interest in the shares.
The company argued that, because of this structure, the claimants never acquired, held or disposed of securities in the company or an interest in those securities. All they could ever have done was acquire, hold or dispose of an interest in a sub-trust, and FSMA did not give them a right to recover in that case.
The company acknowledged that this created a gap in investor protection but said this was simply the result of poor legislative drafting.
What did the court say?
The court disagreed with the company.
The judge acknowledged that an investor under an intermediated structure described above has an interest in a sub-trust, rather than directly in the underlying securities. But he said there was “legally no doubt” that this was a proprietary interest in the securities with “the hallmarks of beneficial ownership”.
He concluded that the phrase “interest in securities” is wide enough to capture an investor who holds shares through a “waterfall or chain of equitable relationships” that allows the investor to enjoy the securities to the exclusion of others.
It is important to note that the court was not being asked to decide whether the information published by the company was in fact misleading, and indeed the judge gave no view on this. He was merely deciding whether the claimants were entitled to bring a claim if the information was misleading.
What does this mean for me?
Although the company advanced sophisticated arguments to the contrary, this does seem to be the right decision. The investor protection regime in section 90A of FSMA would be effectively neutered if investors holding through nominees and custodians could not claim against issuers.
Given that holding traded securities through intermediaries is the prevalent practice, it is perhaps surprising that this issue has not come before the courts until now. It also exposes some of the difficulties produced by “intermediated securities”. The Law Commission recently launched a request for views on how to improve this. (For more information, see our previous Corporate Law Update.)
For issuers, the possibly obvious point is to ensure that no information disclosed to the market is misleading or omits any material information, although this is no truer following the court’s decision than previously. Market participants, conversely, should not be put off considering claims against issuers merely because they have invested in securities through intermediaries.
The Financial Reporting Council (FRC) has published its annual review of corporate governance and reporting for the 2018/19 reporting year. The review covers both financial and narrative reporting.
The key points relating to corporate governance and narrative reporting are as follows:
- Climate reporting. Investors expect climate-related disclosures to cover a period consistent with the company’s longer-term investments and planning. This may mean that climate reporting extends to a longer period than the company’s viability statement.
- Non-financial reporting statement. The FRC found that, whilst many companies referred to environmental, social and governance (ESG) factors in their annual reports, disclosures were sometimes “generic”, did not identify the company’s policies and failed to consider the impact of the company’s business on the environment.
- Section 172 reporting. The review sets out items a company should include in its section 172(1) statement of how its directors have discharged their duty to promote the company’s success. These include (among other things) the factors and stakeholders the directors considered relevant when discharging their duty and the main methods they used to engage with stakeholders.
- Business reviews. The FRC frequently identified instances of companies failing to explain significant balances or transactions in their strategic report. The review cites examples of matters the FRC would have expected to see covered, including the progress of transformation programmes, significant impairment charges and bad debts, significant concentrations of credit risk, and the performance of businesses acquired during the year.
- Alternative performance measures. The quality of Alternative performance measures (APMs) improved during 2018/19. However, the FRC will continue to identify shortcomings. It notes that the most common area of challenge relates to measures that are not clearly defined or reconciled to line items in the accounts.
- Boilerplate. The FRC is discouraging “boilerplate reporting” on topical issues such as climate change, cyber risk and Brexit. Any disclosures should address specific areas of risk.
- Dividends. The FRC found multiple instances of companies that paid interim dividends in excess of the distributable profits shown in their most recent annual accounts. It challenged those instances and reminded companies that, to pay a dividend in these circumstances, the company must draw up interim accounts showing sufficient profits and file them at Companies House.
The Principles (which are updated annually) contain best practice guidelines and highlight investor expectations that publicly traded companies invariably follow to ensure shareholder support for their executive remuneration arrangements.
This year’s changes are relatively minor and mainly seek to clarify certain aspects of the IA’s existing guidance. The key changes are as follows:
- Alternative remuneration structures. Although the Principles still encourage “simple and understandable” remuneration structures, the IA will now consider alternative structures “if aligned to company strategy”. This statement further opens the door for companies to consider alternatives to the traditional LTIPs (such as restricted share award plans). The Principles contain detailed provisions on the IA’s expectations in respect of the structure of these plans.
- Malus and clawback. The Principles continue to encourage remuneration committees to spell out the circumstances in which performance-related remuneration can be withheld, reduced or recovered. However, they now directly reference the circumstances set out in the FRC’s Board Effectiveness Guidance (including misstating accounts, serious reputational damage and corporate failure).
- Caps on vesting outcomes. The IA now recommends that remuneration committees introduce discretion into incentive schemes to limit vesting outcomes where a specific monetary value is exceeded (i.e. a cap on payments). Committees should decide what level is appropriate and how to implement it. This goes beyond the new provisions in the UK Corporate Governance Code that allow remuneration committees to override formulaic performance outcomes.
- Performance criteria. The Principles now state that companies should (rather than “may”) consider including strategic and non-financial criteria in performance measures, particularly environmental, social and governance (ESG) objectives. Conversely, the IA’s previous guidance on “operational measurements” for performance criteria has been removed.
- Pension contributions. From 2020, if directors’ pension contributions are above those of the majority of the workforce, the remuneration committee should produce a “credible plan” to bring them in line by the end of 2022. Companies should disclose the majority workforce pension contribution rate in their remuneration report and explain how it has been calculated.
- Outgoing directors. Payments to in lieu of notice should comprise only contractual entitlements and be limited to salary, pensions and benefits. In addition, companies should disclose whether an outgoing director is a “good” or “bad” leaver and pay annual bonuses only to good leavers.
- Shareholder consultation. IA members will support companies involving the IA’s Institutional Voting Information Service (IVIS) in their consultation process. Following its consultation, a company should send its shareholders a “wrapping-up letter” explaining the final approach it has decided to take.
Separately, the House of Commons Business, Energy and Industrial Strategy Committee has published recommendations to the Government following its review of the collapse of Thomas Cook. The recommendations focus primarily on executive pension contributions and bonuses, as well as late payments to suppliers, the current statutory insolvency process and ethnicity pay gap reporting. The recommendations are, however, unlikely to progress in the short term, given that Parliament has now been dissolved for the forthcoming General Election on 12 December 2019.
- Capital markets. The European Securities and Markets Authority (ESMA) has published its annual report on prospectus activity in 2018. The report shows that prospectus approvals across the European Economic Area (EEA) decreased by almost 5% compared with 2017. Almost 74% of prospectuses in 2018 related to non-equity securities.
- Audit. The FRC has published its report on developments in audit for 2019. Among other things, the report notes that auditors may be continuing to struggle to challenge management effectively. It also notes that too many auditors did not properly identify relevant controls in areas of significant risk or adapt their audit approaches sufficiently in response to deficient controls.
- Corporate reporting. The FRC has published its year-end letter to audit committee chairs and finance directors setting out the FRC’s key areas of focus for the 2019/20 reporting season. Those areas include the non-financial information statement, a company’s section 172(1) statement, environmental disclosures, critical judgements and estimates, and APMs.