Protecting Shareholders from Abusive Self-Dealing in Corporate Governance

1. 3rd Eurasian Corporate Governance Roundtable Shareholder Rights, Equitable Treatment and the Role of the State April 17-18, 2002 hosted by Securities and Stock Market State Commission of Ukraine State Property Fund of Ukraine PFTS with the support of The Government of Japan The Global Corporate Governance Forum

2. Eddy Wymeersch Professor at the University of Ghent-Belgium Chairman of the Banking and Finance Commission, Belgium Protecting Shareholders From Abusive Self Dealing

3. What is self dealing The basic agency relationship: accountability and fiduciary duties esp. duty of loyalty Types: • Directors entering into transactions with the company for their own interest • Directors dealing with third parties in which they have financial interests • Directors not supporting the interest of the shareholders • Corporate opportunities: diversion of opportunities

4. What is self dealing Types: • Directors acting in the interest of one shareholder, not of all, shareholders • What about the other conflicting interests: employees, creditors, suppliers • not involved in company structure • except: co-determination systems • creditors: in case of insolvency • Conflicts in state-owned firms • Conflicts with parent companies • Conflicts with the state as shareholder

5. Four main cases • The conflict between a director and his company • Conflicts between majority and minority shareholders • Conflicts in groups of companies • intragroup transactions, • corporate opportunities

6. Four main cases • Conflicts with the state as shareholder • multiple and conflicting interests • tax collector, • employment policy • monetary policy • other public interests

7. What is the problem with self dealing? • Perverts the fundamental scheme on which companies are based: Agents should act in the interest of the principal • Undermines investor confidence in the directors and the company • Leads investors to shun away from productive investment • Leads to overcostly control systems:audits, etc • Undermines the functioning of the public markets • Often: criminal behaviour, perverts honesty in the economy

8. Four Main Cases of Selfdealing • Case 1: The conflict between a director and his company • Case 2: The conflict between majority and minority shareholders • Case 3: The conflict inherent to groups of companies • Case 4: The conflict of interest in State owned firms

9. Case 1: The conflict between a director and his company This is the traditional hypothesis Solutions • outright prohibition: e.g. loans to bankers • may be detrimental: too rigid • mostly procedures: full disclosure and fairness • disclosure of the conflict • no voting - but what in SMEs? • decision reported to AGM: e.g. in France; no approval • auditor confirms the figures

10. Case 1: The conflict between a director and his company Solutions • structural measures: in two tier board structure, approval by supervisory board • general case law rule: fiduciary duty with heavy liability: US • vague, ex post • deterrent ex ante if sanction is sufficiently heavy • may result in formal procedures, with lawyers, experts, investment bankers

11. Four Main Cases of Selfdealing • Case 1: The conflict between a director and his company • Case 2: The conflict between majority and minority shareholders • Case 3: The conflict inherent to groups of companies • Case 4: The conflict of interest in State owned firms

12. Case 2: The conflict between majority and minority shareholders Frequently found: detrimental to the firm Remedies • Remedy 1 • In listed companies: exit through the market • In unlisted: fight ! • Winding up, dissolution: impracticable, costly, last remedy

13. Case 2: The conflict between majority and minority shareholders Remedies • Remedy 2 • Case law developments: abus de majorité • Comp. In Germany: Holzmüller • Is there also minority abusing their rights ??

14. Case 2: The conflict between majority and minority shareholders Remedies • Remedy 3: Mandatory take-over procedures in unlisted companies: Netherlands and Belgium rule • Plaintiff can demand other shareholders to take over his shares, • If serious reasons relating to defendant’s behaviour. • In fact “abus de majorité” remedy.

15. Case 2: The conflict between majority and minority shareholders Remedies • Remedy 4: Squeeze out: at the 90% or 95% threshold. • Leads to going private • Eliminates the conflict • Costly

16. Four Main Cases of Selfdealing • Case 1: The conflict between a director and his company • Case 2: The conflict between majority and minority shareholders • Case 3: The conflict inherent to groups of companies • Case 4: The conflict of interest in State owned firms

17. Case 3: The conflict inherent to groups of companies The central dilemma:conflict between the group interest and the subsidiary’s interest • Systems: German • European continental: Rosenblum case, Cassation France • Case law approach in the US

18. Case 3: The conflict inherent to groups of companies Philosophies • Group as an entity: rarely followed • Intragroup relations to set off: German Group law • Intragroup relations to be restrained within certain limits: French doctrine • No European generally accepted rules: • Except in consolidation of annual accounts • Except in accounting: related party transactions

19. Case 3: The conflict inherent to groups of companies Alternative solutions • Mandatory bids , squeeze-outs and similar • for listed companies mainly • Essential rule • 13th Directive • Corporate Governance techniques • independent directors • audit committees

20. Case 3: The conflict inherent to groups of companies Alternative solutions • Stock Exchange Regulations • No shareholder with more than 30% • If exceeds 30%: mandatory bid • Criminal law rules • Abus de biens sociaux: art 437 French Code • Frequent use even against top people

21. Four Main Cases of Selfdealing • Case 1: The conflict between a director and his company • Case 2: The conflict between majority and minority shareholders • Case 3: The conflict inherent to groups of companies • Case 4: The conflict of interest in State owned firms

22. Case 4: The conflict of interest in State owned firms What is the difference with a business shareholder? Complex system of divergent interests • composition of the board • decision making according to political criteria • whose interest are being served ? • board functioning • external control and auditing

23. Case 4: The conflict of interest in State owned firms Diverse other weaknesses • Financing • State aid • Procurement policy • Price setting • Financial rating

24. Case 4: The conflict of interest in State owned firms Diverse other weaknesses • Social relations • Foreign expansion • External controls • Sale of business • Industrial relations

25. How to solve the problem • privatisation: continuous problems e.g. Personnel ! • Autonomy in decision making • Better definition of the state’s interest – of the firm’s purpose • Indemnification cfr. German group law • reduction of state influence: in supervisory board yes; not in management

26. How to solve the problem • Professional management • Special rules for conflict of interest cases: conflicts committee • Accounting: greater transparency • Well defined state supervision

27. Conclusion Universal Topic Different solutions ONE AIM: GOOD GOVERNANCE is a safeguard for welfare