In a recent paper,
Know Your Shareholders: The Use of Cash-Settled Equity Derivatives to Hide
Corporate Ownership Interests, The Conference Board offers
guidance for directors of public companies to address or prevent
situations where shareholders accumulate undisclosed equity stakes by
means of cash-settled derivatives.
Derivatives are an important
class of financial instruments that has taken center stage in today’s
capital markets. The reason for their increasing popularity is that they
offer risk protection while also allowing innovative investment
strategies. In particular, in a regulatory environment where disclosure
requirements are triggered by voting rights rather than economic interest,
derivatives can be used to conceal equity ownership of a public company—a
practice generally known as “hidden ownership.”
The new report by The
Conference Board cites anecdotal evidence—including the most notable
recent cases regarding Continental, Fiat, and Volkswagen-Porsche—that
cash-settled derivatives are increasingly being used by investors and
strategic bidders to discretely expand their ownership positions in
business corporations listed on European stock exchanges.
The major recommendations
included in the report are:
Directors should ensure that
the company relies on a sound process to monitor securities holdings,
including derivative instruments, where the company’s securities are the
underlying instrument. At a minimum, the company should regularly review
public filings by investors and available shareholder lists. However, the
thoroughness of the monitoring process should be elevated based on market
indicators of abnormal shareholder activity that may signal situations of
Obtain insights from
Through investor dialogue,
the company can 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.
Cultivating proactive relations with the investment community can prove
helpful with larger institutions such as pension funds and mutual funds.
Regular outreach to investors
can help management recognize a perceived valuation gap between the stock
price and the company’s intrinsic value, which is often the impetus for
the recourse to hidden-ownership accumulation strategies. If such a
valuation gap exists, the board may consider commissioning a perception
study to gain better insight into the issues causing the discrepancy.
reporting from management
The board should be provided
with regular reports on important shareholder intelligence, such as
abnormal shareholder activity or a change in company ownership. Directors
should meet with executives to discuss the implications and recognize
possible hidden ownership.
Compile profiles of
investors and prospective strategic bidders
The board should expect
management to maintain profiles of any private pool of capital with
investments in the company’s securities, as well as any prospective
strategic acquirer in the marketplace.
Directors must ensure that
any material information on shareholdings is promptly communicated to the
market and regulators in accordance with applicable laws. Enforcement
agencies should be notified in situations where there is evidence that a
shareholder or a group of shareholders are operating under an undisclosed
understanding with investors or other market participants or dealers and,
most important, in any case where there appears to be a violation of
applicable securities regulation.
intentions of hidden owners
A company should not assume
that investors resorting to hidden ownership schemes always pursue a
hostile intent or a merely speculative agenda. Instead, directors should
remain open-minded and review significant requests made by such
shareholders in light of the company’s current strategy, industry
benchmarks, analyst reports, and the investor profile and track record.
The full paper is available
© 2010 The
President and Fellows of Harvard College