Board’s report cites anecdotal evidence
– including cases involving Continental, Fiat, and
Volkswagen-Porsche – that cash-settled derivatives are
increasingly being used by investors and strategic bidders to
discreetly expand ownership positions in European listed
When used for this purpose, cash-settled derivatives can
disrupt a company’s internal governance and voting
process and the efficient operations of markets, argued the
report’s co-author, Eugenio De Nardis, a corporate
lawyer at Cleary Gottlieb.
"Directors of European corporations should be aware of the
risks and possible distortions caused by the undisclosed use of
cash-settled derivatives," added Matteo Tonello, director of
corporate governance research at the Board and the other author
of the study.
"The danger is in having investors’ public
filings that only tell half the story about who actually owns
the company. Also, when the transactions or stakes are
eventually disclosed, markets might be unable to react
promptly, giving rise to speculation and volatility."
Chief among the Board’s recommendations for
corporate managers is closer monitoring of trading activities.
It suggests directors maintain sound procedures in monitoring
all securities holdings, including derivative instruments where
the company’s securities are the underlying
instrument. At a minimum, it suggests companies should
regularly review public filings by investors and available
Talk to investors
Investor dialogue with major shareholders should be improved
as well, the report argued. The Board says this will allow a
firm to learn early on about potential shareholder concerns and
critical changes in its ownership base, such as information on
group voting arrangements and other understandings among
shareholders. It also suggests regular outreach to investors
can help management recognise perceived valuation gaps between
a company’s stock price and its intrinsic
Board members should then be provided with regular reports
on this intelligence, the report suggests, including updates on
abnormal shareholder activity or changes in company ownership,
profiles of any private pool of capital with investments in the
company’s securities and information on any
prospective strategic acquirer in the marketplace.
Finally, the body suggests companies should seek to
understand the intentions of investors resorting to hidden
ownership schemes, and remain open-minded when reviewing
significant requests around corporate strategy, industry
benchmarks, analyst reports, and investor profiles.
The report concludes that directors must take it upon
themselves to notify the market and regulators of situations
where there is evidence of shareholders operating under an
undisclosed understanding with investors or other market
participants or dealers, and in any case where there appears to
be a violation of applicable securities regulation.
Continental, the German tyre and car parts maker, was bought
in July 2008 by family-owned manufacturer Schaeffler Group,
along with a consortium of five banks. Schaeffler managed to
build up a 36% stake without any regulatory disclosure.
Of this, 28% of the capital was held through cash-settled
derivatives, the Conference Board found, which did not trigger
any disclosure obligations under German law.
Another 2.97% of Continental’s capital was held
in shares, when the threshold triggering disclosure was 3%.
Similarly, 4.95% was held in physically settled derivatives,
for which the threshold was 5%.
Back in 2005, Fiat’s holding company maintained
control of the firm without triggering disclosure by amending a
cash-settled derivative with underlying Fiat shares to require
physical settlement concurrently with the expiration of a
convertible loan. Consob, the Italian regulator, has already
sanctioned the parties involved for providing misleading
information to the market.
In the still more complex Porsche-Volkswagen case, the
luxury carmaker announced in October 2008 that it had built up
a 72% stake in VW, almost half of it undisclosed. Porsche held
about 30% of VW’s share capital through
cash-settled derivatives. Some of the parties involved are,
however, under investigation in connection with violations of
market abuse rules, the study notes.
To date, such moves are still allowed under German law. In
May, the Bundestag began debating a bill – the "Act on
strengthening investor protection and improving the
functionality of capital markets" – which will, among
other considerations, attempt to establish concrete disclosure
requirements for long equity holdings.
According to the report, the draft bill would set a 5%
holding benchmark – including cash-settled futures
– for triggering disclosure requirements. The
Conference Board report suggests it is unlikely any new
legislation will come into effect before 2011.
On a pan-European level, the EC’s most recent
Transparency Directive on disclosure requirements was adopted
in December 2004. The Committee of European Securities
Regulators recently recommended that the
directive’s scope be extended to include the
disclosure of derivatives positions, regardless of whether the
relevant instruments are settled physically or in cash.
Tom Osborn +44 207 779 8361 firstname.lastname@example.org