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Chapter Three - Improving information flows
3.1
This chapter examines the communication and information side of
shareholder engagement, while those issues related to shareholder
decision-making and accountability mechanisms are discussed later in Chapter Four.
In particular, this chapter examines issues relating to the communication
channels between companies and their shareholders, including the following:
- Facilitating communication and information flows between
companies and institutional investors, particularly in the context of complex
share ownership arrangements;
- Addressing the difficulties for retail investors in accessing
company information and communicating with company boards; and
- Potential improvements to disclosure on short selling and margin
lending activities.
Institutional investor issues
3.2
Institutional investors are generally large investment vehicles with the
ability to buy and sell securities in large quantities. In Australia, they are
typically superannuation funds and other managed funds investing on behalf of
their members. The committee was informed that while these entities increasingly
want to engage with companies, complex share ownership arrangements and
uncertainty over certain legal obligations was hindering communication between
companies and their institutional shareholders.
Willingness and capacity to engage
3.3
Institutional investors determine the extent of their engagement as
shareholders on the basis that its cost will be outweighed by the benefits that
accrue from engaging, namely improved investment returns.
3.4
Evidence to the committee suggested that the level of shareholder
engagement by institutional investors is increasing. For instance, Riskmetrics held
the view that institutional investors 'are increasingly involved in the
governance of the companies in which they invest'.[1]
This had been assisted by companies, in turn, becoming increasingly willing to
discuss with, and listen to, concerns and queries from shareholders on
corporate governance issues.[2]
3.5
They suggested that institutional investor participation may be
extrapolated, albeit imperfectly, from voting levels and the outcomes of votes
at company meetings:
Since 1999, when a study found only 35% of all available shares
were voted on director re-election resolutions at top 100 ASX-listed companies,
turnout on all resolutions at top 100 companies has increased to 58.2% of all
available shares in 2006. It is also worth noting that institutional
shareholders are also increasingly willing to vote against management – in 2006,
the average level of dissent by shareholders from the board recommendation on
controversial resolutions was 21.2% for top 200 companies, up from 8.2% in
2005. Equally importantly, however, the increased level of constructive
dialogue between company directors and managers, and shareowners, is evidenced
in the decline in the number of controversial resolutions put to shareholders,
from 20% of all resolutions put to top 200 company shareholders in 2004 to 8.9%
in 2006.[3]
3.6
The Business Council of Australia (BCA) indicated that institutional
investors preferred to influence corporate governance outcomes through
discussion with the board, rather than expressing their views by casting
negative proxy votes.[4]
The committee notes that this description of preference is probably accurate,
but is difficult to quantify.
3.7
Nowak and McCabe submitted that institutional investors are well placed
to engage with the companies in which they invest. They outlined the following
relevant factors:
- the availability of dedicated resources to monitor and analyse
individual company and industry performance;
- the services of corporate investor relations specialists; and
- access to company management through formal communications and
informal meetings.[5]
3.8
Despite their capacity to do so, Nowak and McCabe argued that
institutional investors would determine their level of engagement on the basis
of costs and benefits:
...the calculation for the institutional investor remains one of
balancing the information and transaction costs of active engagement against
the benefits of doing so. The benefits are more likely to outweigh the costs of
engagement where their holding of shares in a particular corporation is
significant in the context of their portfolio and/or overall market trading
volumes in that corporation. Nevertheless our research finding was that a
number of institutional investors adopted a policy of non-engagement and the
proponents of this approach argued that engagement would be a distraction from
their primary focus.[6]
3.9
The Association of Superannuation Funds of Australia Ltd (ASFA)
indicated that anecdotal evidence suggested 'growing engagement and more active
involvement of superannuation funds in voting'.[7]
However they commented that superannuation funds are limited in their capacity
to engage with the companies in which they invest:
...on some issues funds may seek to engage whereas at other
times their involvement may not be as active. Given that superannuation funds
in total have engagement with just about every company listed in Australia, it
is difficult for individual trustee boards to engage on every issue with every
fund. The trustees of each fund have responsibilities with regard to a number
of matters, and just one part of it is the engagement with companies and
participation in the voting processes.[8]
3.10
Australasian Investor Relations Association also held the view that
superannuation funds do not want to engage directly with companies:
Companies find it very difficult to actually engage directly
with their major beneficial shareholders in the case of superannuation funds.
To be fair, the reason given for why they do not want to engage directly with
companies is purely a resourcing issue. I think that is something that needs to
be borne in mind if you are going through a health check of shareholder
engagement and participation. There are many superannuation funds in this
country, but most are not terribly large, and even the largest industry
superannuation funds, for example, are not set up themselves to engage directly
with companies.[9]
3.11
The role of the intermediaries used to undertake this task is discussed in
the following section.
3.12
In the following chapter, the committee discusses the importance of
institutional shareholders engaging on corporate governance matters by
exercising an informed vote on important company resolutions.
The intervening role of custodians
3.13
Although institutional investors are increasingly involved with
governance issues, the capacity issues mentioned above usually makes their
engagement with companies indirect. In their submission to the inquiry, ASFA
indicated that it is reasonable for funds to delegate responsibility for
shareholder engagement to their fund managers, as long as this policy is
adequately disclosed.[10]
3.14
The ownership arrangements institutional investors enter into affect
their engagement with the companies they have an interest in. Superannuation
funds for example, which comprise the majority of institutional investors, often
delegate responsibility for managing their investment portfolio to an external
fund manager. The funds are the beneficial owners of the shares, but their
investments are often managed externally, particularly with smaller funds, and the
securities are invariably registered in the name of a custodian. Fund managers
are not necessarily the registered owners of the shares either, though; this
responsibility usually rests with entities that specialise in providing
custodian services, typically investment banks.
3.15
The interactions between funds, investment managers and custodians
varies, which is reflected in the myriad ways and extent to which beneficial
share owners either directly or indirectly engage with the companies in which
they invest, if at all. Funds' policies on corporate governance engagement outline
the fund managers' role in monitoring corporate governance and the
circumstances in which managers are required to exercise their own discretion
on voting, or consult with the fund on a voting position. IFSA told the
committee that it encourages fund managers to establish direct contact with
company boards and senior management.[11]
3.16
The role of intermediaries on voting, including advice from proxy
advisory services, is discussed in the following chapter.
3.17
The committee was advised that the main difficulty with these complex
arrangements is with companies struggling to identify, and thus engage with,
the beneficial owners of shares. According to Australasian Investor Relations
Association, listed companies are increasingly seeking to identify and
establish direct contact with beneficial share owners, usually fund managers,
so they can engage with their institutional shareholders.[12]
Despite sound intentions though, evidence suggested that the task of
identifying beneficial share owners behind custodial arrangements remained
problematic. ACSI told the committee that:
...the companies say to us that we are not really aware of which
superannuation funds own how much of what because you are all in there as
custodially owned. We are in favour of them having as much transparency as
possible without having to spend money to find out exactly who their
institutional shareholders are and who the ultimate beneficiaries are. [We are]
in favour of unpacking the institutional side.[13]
3.18
It added that companies having a clearer understanding of their
shareholder base would improve superannuation funds' capacity for engagement.[14]
3.19
Some organisations contended that the tracing provisions in section 672
of the Corporations Act, which enable companies to direct the registered owners
of shares to disclose information about those with relevant interests in the
shares, do not work as effectively as they could. AICD suggested that the
tracing provisions needed to be bolstered and recommended that section 672 of
the Corporations Act be amended to provide for the following:
- Imposing an administrative obligation on the registered holder of
shares or scheme interests to create, maintain and update a register of
relevant interests where that interest exceeds, say, 1% of all shareholdings in
the company.
- Requiring that a copy of that Register be provided on written
request to the company, scheme or ASIC.
- Should third parties desire to have access to such information
for bona fide reasons, they may make application via ASIC in the same manner
that they can now in the terms of S.672A(2) of the Corporations Act.[15]
3.20
They proposed that this would align the tracing provisions with the
substantial holding provisions in s671B of the Corporations Act.[16]
3.21
ASX Limited also highlighted the role of custodial ownership in
constraining 'genuine intentions on the part of [companies] to engage with
their investors'. They wrote:
A practical impediment to effective shareholder engagement is
the difficulty sometimes encountered by companies in seeking to identify their
shareholders. A lack of transparency as to ultimate shareholder identity may
result from the understandably widespread use by shareholders of custodians
through which to hold their investments. The use of trading techniques
involving equity derivatives and short selling may also make ultimate economic
ownership of securities difficult to establish.[17]
3.22
Australasian Investor Relations Association suggested that section 672
was deficient because it applies to ordinary shares only, without extending to interests
held via derivatives instruments such as equity swaps and contracts for
difference. Their submission provided the following example:
One of our members recently informed us that they became aware
that a foreign based hedge fund had acquired an economic interest in their
company to the value of AUD700 million via a contract for difference. This was
not able to be discovered through the operation of the beneficial ownership
tracing process as provided for in s.672.[18]
3.23
They recommended that section 672 of the Corporations Act be amended to
capture derivative instruments.[19]
Committee view
3.24
The committee recognises that institutional shareholders' inevitable use
of intermediaries is making it difficult for companies to know the identity of
beneficial share owners of companies. To alleviate this problem the committee
joins IFSA in urging institutional investors to make direct contact with
company boards to assist them in having this information. The committee,
however, does not support AICD's suggestion for custodial share owners to be
required to hold a register of interests, as it does not think the benefits
would justify the administrative burden created.
3.25
The use of derivative instruments presents a more significant problem, given
the evidence the committee received in regard to the application of the Corporations
Act tracing provisions. The committee recognises the complexity of these
arrangements and the practical difficulty of tailoring the legislative
framework to ensure companies can obtain accurate information regarding
ownership at any given time. However, the committee is of the view that the
government should at least investigate the implications of extending section 672
of the Corporations Act to include derivative instruments.
Recommendation 1
3.26
The government should examine the implications of amending the tracing
provisions in section 672 of the Corporations Act to include derivative
instruments.
The increasing significance of
responsible investment
3.27
Responsible investment for institutional investors refers to taking an
active approach to share ownership to engage with companies on environmental,
social and governance (ESG) issues. The basis for this investment approach is
the recognition of the importance of ESG issues to ensuring long term
sustainability and thus minimising long term investment risks.
3.28
Responsible Investment Consulting told the committee that long term
issues are highly relevant to superannuation fund members who may be investing
over a 50 year period. Those companies that invest responsibly will be seen to
represent a lower risk, thus attracting 'a premium in terms of their
shareholder value'.[20]
3.29
Responsible Investment Consulting stated:
[Environmental, social and governance issues] tend to be
long-term issues that can have an impact on investment returns. One of the
problems therefore is that for disclosure obligations around materiality, it is
very difficult for an investor to be able to argue that it will influence the
share price on a day-to-day basis. Climate change for instance will have an impact;
we all know that. How a company responds to climate change will have an impact,
but will that impact happen in a day, a month, two months or two years? We are
arguing that we need a broader debate about disclosure.[21]
3.30
Regnan emphasised the importance of ESG issues to institutional
investors that spread their risk across the entire investment spectrum:
Because universal owners own cross-sections of the economy, they
inevitably find that some of their holdings are forced to bear the cost of
other sectors’ or firms’ externalities. This creates an incentive for
universal owners to minimize negative externalities and maximize positive ones
across portfolio holdings.[22]
3.31
Responsible Investment Consulting suggested that investors need to be more
demanding of companies for sustainability reporting, rather than having additional
reporting being mandated. It indicated that the greatest barrier to engagement
on ESG issues is cost:
Everyone is focused on their investment returns, and in a down
market that becomes more so. The problem is that, whilst we all know that
environmental and social issues are here to stay—in particular that climate
change is here to stay—the short-term temptation is to focus on our investment
returns today and not invest in the research, because the research may cost us
a few basis points.[23]
3.32
Interestingly, Regnan suggested that small companies have greater
exposure to ESG issues than large ones and were therefore not disadvantaged in
bearing the cost of engaging with shareholders about them. The reason, they
suggested, is that large companies are more diversified and better able to
absorb the consequences of an ESG risk coming to fruition:
Large companies are so large that they are exposed on a variety
of fronts—health and safety, natural environmental interface, social licence to
operate et cetera. In mining, for example, the consequences of a health and
safety breach are much more material for a small company than for a large
company. For a large company, they will be absorbed from a financial perspective.
If BHP Billiton have a breakdown in one part of their business, they are
unlikely to have a trading halt if production has dropped as a result of that
particular incident, because they are a diversified entity. Smaller businesses
are far more exposed to more narrow elements of ESG.
3.33
Both Responsible Investment Consulting and Regnan told the committee
that companies may be concerned about potential liability issues relating to
selective market disclosure. They requested that regulatory guidance be provided
to remove lingering concern about the potential liability that may accompany communicating
ESG information to shareholders.[24]
Regnan proposed an amendment to the Corporations Act giving 'safe harbour' to
companies undertaking this kind of engagement in good faith.[25]
3.34
Regnan also suggested that governments, when investing, do so 'within
the platform of the UNPRI'.[26]
3.35
The Australian Institute of Company Directors (AICD) suggested that,
given the evolving nature of sustainability reporting, it would be preferable
to allow practices to develop for another two years before contemplating
mandatory requirements or an 'if not, why not' regime.[27]
Committee view
3.36
The committee strongly supports and encourages companies adopting ESG
reporting on a voluntary basis. The committee recognises that ESG reporting is
in its early stages and companies should continue to be given the opportunity to
determine the best way to approach the task free of government regulations.
However, investors are increasingly pressing for ESG reporting and companies
should respond to this demand accordingly. If companies cannot, by the end of
the current decade, show that they have done this in a manner acceptable to
shareholders then it is the view of the committee that the government should consider
regulating in this area.
3.37
Companies should be encouraged to adopt ESG reporting and engage on ESG
issues without being concerned that it may contravene their continuous
disclosure obligations. Accordingly, the ASX should clarify the scope of
Listing Rule 3.1 as it applies to engagement on ESG matters.
Recommendation 2
3.38
The ASX should clarify the scope of continuous disclosure requirements
as they apply to engagement on ESG issues.
Legal uncertainty over engagement
3.39
The committee also received evidence outlining potential legislative
disincentives for institutional investors to engage with companies. In
particular there remains some doubt as to whether trustees may, in the course
of undertaking normal shareholder engagement practices, be contravening aspects
of the Corporations Act.
3.40
Regnan raised specific concerns relating to the responsibilities of
superannuation fund trustees under the sole purpose test contained in section
62 of the Superannuation Industry (Supervision) Act 1993. In general
terms, the provision stipulates that regulated superannuation funds must be
maintained for the purpose of providing retirement benefits to members.[28]
Regnan told the committee that the sole purpose test needed to be clarified to
ensure that trustees engaging on ESG issues, where relevant to financial
returns, fell within its scope.[29]
3.41
The committee discussed the sole purpose test in this context in its
2006 report on corporate responsibility. It did not accept a narrow
interpretation of the provision that would constrain trustees from researching
and considering environmental and social performance, but did recommend that the
Australian Prudential Regulation Authority (APRA) clarify the matter.[30]
At the time of writing, a government response to the committee's report had not
been provided.
3.42
The potential 'dampening effect on institutional investors acting
collectively' with the Corporations Act takeover provisions was also raised.
ACSI submitted that:
...there are certain sections of the Corporations Act (namely
section 606 and Part 6C.1) which when combined with the very broad definitions
of “relevant interest” and “associate” have a dampening effect on institutional
investors acting collectively. Institutional investors could unintentionally
breach these sections if they seek to act collectively, especially if they act
outside the context of an upcoming company meeting.
3.43
They warned that the Australian Securities and Investment Commission's
(ASIC) attempt to remove this potential impediment to engagement was too
narrow, as the relevant Class Order only applies to circumstances where
institutional investors enter into an agreement on matters relating to a
general meeting. ACSI contended that collective engagement often occurred
outside the context of company meetings, and recommended that ASIC revise its
guidance accordingly.[31]
Committee view
3.44
The committee is of the view that where institutional investors are
concerned that shareholder engagement may contravene their regulatory
obligations, ASIC should take the appropriate measures to clarify the scope of
the Corporations Act as it applies to collective actions under the takeover
provisions.
Recommendation 3
3.45
ASIC should clarify the position of institutional investors engaging
collectively with companies outside company meetings in terms of the
Corporations Act.
Retail investor issues
3.46
Retail investors are essentially those shareholders who are not
institutions. As a category, they range from a person holding a handful of
shares in a single company to private investors with substantial, diverse
shareholdings.
Willingness and capacity to engage
3.47
Retail shareholders are faced with essentially the same question as
institutional investors on the question of whether to actively engage with the
companies in which they invest: is engagement worth it and do I have the ability
to do it?
3.48
AICD told the committee that many shareholders have no interest in
engaging with the companies they invest in.[32]
Professor Margaret Nowak and Dr Margaret McCabe from the Curtin University of
Technology suggested that the costs of engagement to small retail investors are
often not worth the benefits:
Cost (especially in time) relative to the benefits from
accessing and analysing comparative industry and market information to make
judgments on relative firm performance, is a major factor. ASX research shows
that direct investors spread their portfolio across industry sectors and that
40% have a spread across three or more sectors. This compounds the cost of
acquiring and analysing the information to facilitate active engagement.[33]
3.49
They added that the powerlessness felt by individual investors over
company decision-making and board composition compounded the disincentive to
engage.[34]
3.50
Nowak and McCabe questioned the reasonableness of any expectation for
retail shareholders to be engaged with companies, proposing instead that
'rational apathy ... is often optimal'. When dissatisfied with company
performance or direction, retail investors selling their shareholding remains
the most effective option.[35]
3.51
Treasury framed the issue of retail investor apathy as a 'free rider'
problem:
The free rider problem ... encourages shareholders to refrain from
undertaking acts of management oversight because it is in their interest for
someone else to undertake these acts (allowing them to reap the benefits
without bearing the costs).[36]
3.52
Dr Shann Turnbull of the International Institute for Self-governance proposed
that companies need to better harness the efforts of shareholders who are willing
to engage to overcome the free rider problem. He suggested that company
constitutions allocate governance powers to a 'shareholder watchdog committee'
to facilitate a self-regulatory approach from companies. This would in turn enable
government to reduce its own regulatory burden on companies. [37]
Simplifying company information for
retail investors
3.53
The relationship between the information available to shareholders about
companies and their ability to engage and make informed assessments on the
basis of that knowledge was briefly outlined in Chapter Two. The most important
primary source of this information is contained in the annual reports companies
provide investors in accordance with their obligations under section 314 of the
Corporations Act. However a common complaint amongst contributors to the
inquiry was that the overwhelming and inaccessible nature of corporate
reporting information has become a major hindrance to shareholders' capacity or
willingness to engage with companies.
3.54
The CLERP 9 reforms helped to alleviate the problem, for both
shareholders and companies, of the requirement to send shareholders hard copies
of mandated company reports. These reforms to the Corporations Act have allowed
shareholders to choose whether they are sent the inevitably bulky company
annual report or be left with the option of accessing it via the internet.[38]
Unfortunately, this measure has not necessarily addressed the reason why
shareholders do not, or cannot, read annual reports.
3.55
Contributors to the inquiry maintained the view that mandated company
information remains inaccessible to ordinary retail investors.[39]
For instance, the Australian Shareholders' Association said that:
The difficulty with giving shareholders too much information is
that they will not read any of it. This is what frequently seems to happen with
documents that are sent to shareholders to communicate with them: they are too
voluminous, the language is legalistic. Shareholders look at them but give up
before reading them.[40]
3.56
Chartered Secretaries Australia (CSA) stated that company reports have
become inaccessible as a consequence of mandated disclosure 'bolt-ons' in the
Corporations Act.[41]
While supporting the continued availability of mandated information to those
wishing to access it, CSA suggested that companies should have greater
discretion when determining the most appropriate way to communicate with their
shareholders.[42]
They also encouraged companies to utilise interactive technology to make the
online annual report more relevant.[43]
3.57
CSA recommended removing the Corporations Act requirement for companies
to provide a 'concise report' to shareholders, due to its conciseness having
been eroded by additional regulation:
As more and more companies become more sophisticated in
portraying the information electronically, the easier it will be for
shareholders to access it. The concise report has had its day, and any further
tampering with it would be a waste of time.[44]
3.58
AICD indicated that it would prefer to see a principles-based, rather
than 'black-letter', approach to company reporting.[45]
Their submission advocated greater emphasis on providing meaningful information
by focussing on 'performance rather than conformance', encouraging companies to
provide voluntary company reviews in a comprehensible form.[46]
According to AICD, voluntary 'shareholder-friendly' reporting should be
characterised by the following:
- a balanced view of company performance written in plain English; and
- clear explanations of the relevant financial results.[47]
3.59
The Institute of Chartered Accountants stated that 'reporting and
communications are the mechanism through which a company drives effective
engagement and participation'. They criticised the 'tool-kit' approach to
reporting for not containing the sort of information that investors desire:
In their current form, these reports do not address the
company’s strategy, its success or failure in implementing it, or insights into
what future performance might look like if the strategy is well executed.
...
... there is little meaningful information available about how the
objectives of the company are set, how risk is monitored and assessed, how
performance is optimised and whether a company has the ability to create value
through entrepreneurialism, innovation, development and exploration, providing
accountability commensurate with the risks involved.[48]
3.60
The Institute of Chartered Accountants suggested a more 'holistic'
approach to corporate performance reporting and recommended that the committee
conduct a separate, detailed inquiry into the issue.[49]
Australasian Investor Relations Association emphasised that investors
increasingly preferred to access company information via electronic media and suggested
that the opt-in for hard copies of the annual report should be extended to
other forms of statutory communication, such as the notice of meeting.[50]
ASA, however, opposed this proposal on the basis that shareholders may
mistakenly opt out of notification of a meeting they have an interest in
attending.[51]
Committee comment
3.61
The committee acknowledges that while the CLERP 9 reforms on the
electronic provision of annual reports may have saved a considerable amount of
paper, the information that companies must legally provide shareholders is so
dense as to be incomprehensible to most people. Evidence to the committee
suggests that the concise report, which was intended to overcome some of these
problems, has failed to serve its purpose. The absence of a report from
companies outlining their performance and objectives in plain English represents
a major barrier to retail investors engaging with companies.
3.62
The committee is of the view that the ability of shareholders to access
company reports on the internet has made the concise report much less relevant
than it once was. The electronic provision of company reports now allows
shareholders to access specific aspects of company reports that are of interest
to them, making the necessity to provide a concise report increasingly obsolete.
Therefore, companies' obligation to provide it under section 314(2) of the
Corporations Act should be removed. This would hopefully encourage companies to
produce a plain, comprehensible statement of company performance and direction
that is better suited to the requirements of shareholders.
Recommendation 4
3.63
The government should amend section 314 of the Corporations Act to
remove the requirement to produce a concise financial year company report.
The usefulness or otherwise of AGMs
3.64
The requirement for publicly listed companies to hold an annual general
meeting (AGM) is included at section 250N of the Corporations Act. These
meetings provide an important opportunity for retail shareholders to engage
directly with company boards and executive management. However, the committee
heard a number of claims that the relevance of the forum is diminishing, an
argument supported by falling AGM attendances. There was, however, support for
reviving the AGM and the committee received a number of suggestions on how it
might be made more relevant.
3.65
The voting process as it relates to AGM attendees is discussed in the
following chapter; the focus of the following discussion is the AGM's
deliberative function.
3.66
CSA suggested that the original purpose of the AGM had been overtaken by
technological advances, making it less relevant to shareholders:
...the AGM was created in an era of horse and coach; pen and ink;
limited printing and a fledgling postal service, all of which dictated that
members would physically meet with directors annually. It is now an era of
advanced technology: mobile telephones; cameras and text messaging; the
internet; webcasting; powerful portable computers and geographically dispersed
shareholders.
...
...the information that is dealt with at an AGM is available many
months before the AGM is held and that this affects attendance.[52]
3.67
They informed the committee that AGM attendances for the top 200
ASX-listed companies were falling steadily, continuing a long term trend. The
results of their biannual survey of governance practices reported:
- the proportion of top 200 company AGMs attracting more than 300
shareholders falling from 35.7 per cent in 2001 to 11.1 per cent in 2007; and
- the proportion of top 200 company AGMs attracting fewer than 100
shareholders increasing from 23.2 per cent in 2001 to 41.3 per cent in 2007.[53]
3.68
CSA suggested that recent strong company results may partly explain falling
attendances.[54]
However, they also expressed the view that AGMs no longer appeal to
shareholders due to the absence of a deliberative purpose, with votes
determined by proxy before the start of the meeting. Further, continuous
disclosure has removed the informative role AGMs once served.[55]
AICD also emphasised the diminishing importance of physical meetings in a
technologically advanced society, highlighting the constant information available
to investors in the financial media.[56]
3.69
AICD further claimed that shareholder activism had 'diverted attention
away from the traditional agenda of the annual meeting'.[57]
This view was supported by the Business Council of Australia, who expressed the
view that special interest groups were dominating company meetings.[58]
3.70
Despite falling attendances, both AICD and CSA maintained that retail
shareholders still relied on company meetings as a forum for engagement.[59]
AICD stated that:
Despite its limitations many still believe that the annual
general meeting provides an invaluable opportunity for shareholders –
particularly retail shareholders – to raise issues, question the board and
management and personally express their views on company performance.
The meeting provides a forum for personal appraisal of new
candidates for election to the board and the way in which the meeting is
conducted conveys to shareholders something of the culture of the board and the
chairman’s character.[60]
3.71
CSA proposed improving the relevance of the information gleaned at the AGM
by separating its formal voting and informal information/dialogue functions.[61]
This would be achieved by keeping voting open beyond the close of the meeting
to enable shareholders to exercise their vote having had the benefit of
discussion and questioning during the AGM.[62]
This proposal is discussed further in the following chapter from paragraph 4.43.
3.72
CSA also questioned the requirement for small companies - those outside
the ASX top 300 - to hold an AGM every year when direct voting can be used
instead.[63]
ASA disagreed that small companies should be exempted:
The AGM is the only forum for shareholders to directly question
the board with regard to the management of the company. It is the one
opportunity for directors to hear directly the views of shareholders and is an
important part of shareholder participation and engagement. In the experience
of the ASA, companies within the ASX 200 are generally better at communicating
with shareholders. It is those companies the CSA seek to exclude where
shareholders most need this forum.[64]
3.73
In its discussion paper, 'Rethinking the AGM', CSA also posed other
potential changes:
- mandating a minimum time for discussion and questions at AGMs;
- extend the statutory timeframe for holding AGMs by a month to
ameliorate the crowded AGM season; and
- encourage chairs of board committees to answer shareholders'
questions at the AGM.[65]
3.74
A potential option for improving the relevance and accessibility of AGMs
is to utilise technology to enable participation from remote venues. Boardroomradio,
for example, strongly advocated the benefits of companies having the option to
host 'virtual' AGMs over the internet.[66]
However CSA told the committee that a major concern with this idea was the
reliability of current technology to transmit meetings in real time; querying whether
such meetings would be deemed to be invalid if a technological failure
restricted participation. They also raised the logistical issues that eventuate
when trying to equitably manage a meeting with questioners in multiple
locations.[67]
3.75
Mr Stephen Mayne also made a number of suggestions to improve AGMs.
These included:
- maximising attendance by holding meetings at more convenient
times for those with work responsibilities;
- allowing the press to ask questions at the meeting; and
-
limiting the time available to individual shareholders speaking
at AGMs to prevent them being hijacked.[68]
3.76
The Business Council of Australia noted that some companies found it
useful to invite shareholders to submit questions prior to the AGM, though the
limited resources of small companies may not permit this.[69]
Committee view
3.77
The committee is of the view that although technology has replaced the
informative purpose company AGMs once served, they are still a useful engagement
forum for retail investors. These are shareholders who are not generally
invited to the private briefings accorded to institutional investors, and the
AGM is their only chance for a face-to-face meeting with the company board. Companies
should therefore endeavour to hold AGMs at convenient times and allow
reasonable time for questions and discussion with shareholders. They should
also broaden participation by allowing investors to submit questions to the
board and by transmitting the meeting online. The committee agrees with CSA,
though, that online participation is potentially unwieldy and unfair to those
attending the meeting in person.
3.78
The committee does not support exempting small companies from holding
AGMs.
3.79
The relevance of AGMs to modern shareholder requirements clearly needs
to be addressed. The current legislative framework does not prevent the AGM
from facilitating shareholder engagement, but the attitude and culture of some
company boards has meant that AGMs do not always represent a forum that best
serves that purpose. The committee is therefore of the view that ASIC should
carefully examine this area in preparation for establishing a comprehensive set
of guidelines or principles for companies holding an AGM. These should include
ways to improve the participatory aspect of meetings through discussion and
questions, including questions on notice to the board, as well as maximising
shareholder attendance. The guidelines should also outline best practice for
managing conflicts of interest at company meetings, particularly with respect
to the Chair maintaining control over procedural matters where a conflict
exists, and the handling of discretion over voting undirected proxies.
3.80
Best practice guidelines have worked well to improve corporate governance
generally and the committee is of the view that guidelines on AGMs would
encourage companies to adopt a better approach to this important forum for
shareholder engagement.
Recommendation 5
3.81
ASIC should establish best practice guidelines for company annual
general meetings.
3.82
The committee is also of the view that companies should be encouraged to
simplify their reporting to shareholders in this way.
Recommendation 6
3.83
ASIC should establish best practice guidelines for clear and concise
company reporting.
The 100 member rule
3.84
Section 249D(1) of the Corporations Act stipulates that:
- The
directors of a company must call and arrange to hold a general meeting on the
request of:
- members with at least 5% of the votes that may be cast at the general
meeting; or
- at least 100 members who are entitled to vote at the general meeting.
This is usually referred to as the '100 member rule'.
3.85
A significant history of opposition to the 100 member rule was
reinforced during the inquiry, with the general tone of complaint continuing to
be that the rule is open to abuse. For instance, Treasury stated that ability
of relatively small groups of shareholders to impose the cost of an extraordinary
general meeting (EGM) on companies gave them 'significant and undue leverage
when negotiating with large companies'.[70]
3.86
The ACTU disagreed, suggesting that the 100 member threshold was large
enough to prevent meetings being called 'on a vexatious basis'.[71]
3.87
The Exposure Draft of the Corporations Amendment (No. 2) Bill 2006
proposed to abolish the 100 member rule and leave the five percent requirement,
which would have brought Australia's law into line with comparable jurisdictions.[72]
The committee also notes its previous recommendation in support of abolishing
the rule.[73]
However, Treasury indicated that attempts to modify the rule had failed to
garner the support of state attorneys-general. It told the committee that the
new government was attempting to have the matter reconsidered:
Recently, the minister, Senator Sherry, indicated at the last
meeting of MINCO that he would like this issue reconsidered. He has asked
Commonwealth officials, in consultation with our state counterparts, to put
together a discussion paper that identifies all the options and the pros and
cons of those options and that will, hopefully, move the debate forward.[74]
3.88
CSA gave their support for a five per cent threshold of voting
entitlements, while retaining a 100 member rule for proposing resolutions at
AGMs. They told the committee that the purpose for calling a special meeting
should have substantial enough support to justify the expense borne by the
company:
...if you are asking a company to convene a special meeting and go
through the expense, there should at least be some likelihood of that
resolution passing, so we turn to the five per cent of shareholders as being
the trigger. Then at least there are enough people so that it has a likelihood
of succeeding.[75]
3.89
AICD offered conditional support for this proposal:
...it [would have] to be a resolution that is in accordance with
the business of the meeting. We would be concerned if there were a multitude of
frivolous resolutions, which would serve to disrupt the conduct of the business
of the meeting.[76]
Committee view
3.90
Although no significant abuse of the 100 member rule has occurred, the
committee is again of the opinion that it has the potential to be abused and
should be replaced. The government should continue to negotiate with state attorneys-general
to achieve this outcome.
Recommendation 7
3.91
The government should continue to negotiate with the states to have the
100 member rule abolished.
Disclosing material information
equitably
3.92
The committee heard mixed reports about the equitable distribution of
company information to different classes of shareholders. In particular,
concerns were raised that the practice of companies offering private briefings
to institutional shareholders disadvantaged retail investors and may breach their
continuous disclosure requirements.
3.93
Chapter 6CA of the Corporations Act outlines companies' obligations to
disclose in accordance with the ASX Listing Rules. ASX's principles on which
the Listing Rules are based include the following:
Timely disclosure must be made of information which may affect
security values or influence investment decisions, and information in which
security holders, investors and ASX have a legitimate interest.[77]
3.94
ASX Listing Rule 3.1 states:
Once an entity is or becomes aware of any information concerning
it that a reasonable person would expect would have a material effect on the price
or value of the entity’s securities, the entity must immediately tell ASX that
information.[78]
3.95
ASA told the committee that a disincentive for retail investors to
engage is a perception of an uneven playing field with respect to disclosure.[79]
Boardroomradio argued that there is a divergence of information available to
different classes of investors. For instance, market information disclosed to
professional investors in selective briefings may not be appropriately
reflected in the company's disclosure to the market at large in accordance with
the ASX Listing Rules. They claimed that retail investors are at a disadvantage
by not having timely access to market information of a material nature.[80]
Boardroomradio proposed that companies should be required to maintain
up-to-date shareholder email lists to allow instant dissemination of important
company information.[81]
3.96
Boardroomradio also suggested that audio transmissions of such briefings
should be provided to all investors, via the internet, and should fall within
the terms of the ASX's continuous disclosure requirements.[82]
AICD also recommended that the information provided in these briefings should also
be posted on company websites.[83]
3.97
Responsible Investment Consulting complained that the present ad hoc
approach to companies' engagement with shareholders was inefficient for
companies and inequitable for shareholders:
From a company perspective the demand for engagement, whether it
be to supply additional information, or to communicate views places pressure on
a company’s resources.
Where a company does respond to an engagement request there is
no mechanism for the response to be distributed to other market participants
beyond making an announcement to the market. This is a highly inefficient
practice and can result in a company entering multiple dialogues on similar
issues, wasting valuable company resources. It is also counter to the principle
that market participants should have equal and timely access to material
information.[84]
3.98
They proposed a system of 'questions on notice' to companies, whereby
both questions and responses would be available to registered market
participants.[85]
3.99
Treasury told the committee that any company that selectively disclosed
price sensitive information would be in breach of the listing rules and the
Corporations Act.[86]
3.100
AICD defended the practice of offering private briefings:
These briefings give institutional investors opportunities to
question the board and management on more detailed matters, often financial,
than might be raised at annual general meetings. Such briefings are not a means
for giving some shareholders inside information and anything significant should
be reported immediately to all investors. The company may not divulge any
exclusive information or anything that is price sensitive.[87]
3.101
They rejected assertions that such briefings contravened ASX Listing Rule
3.1 and indicated that prudent retail investors would check the ASX website for
new information releases.[88]
Australasian Investor Relations Association also rejected claims that selective
disclosure was occurring during private briefings to certain investors.[89]
Committee view
3.102
The committee supports companies holding private briefings with
institutional investors conducted within the parameters established by ASX
Listing Rule 3.1. ASIC should carefully monitor the effect of these briefings
on share prices to ensure companies are not selectively disclosing material
company information.
3.103
The committee also considers that companies should post the information
contained in private briefings on their websites. If possible, this information
should be available at the same time as the briefing itself and shareholders
should be forewarned of its pending availability to provide the most equitable
access.
Recommendation 8
3.104
ASIC should selectively or periodically monitor and enforce company
information disclosure in private briefings to institutional shareholders to
ensure compliance with their continuous disclosure obligations.
The public share register: concerns
about privacy and predatory offers
3.105
Presently, section 173 of the Corporations Act allows anyone to inspect
a register of shareholders kept pursuant to section 168 of the Act. The
unrestricted nature of this provision and the associated lack of privacy it
affords shareholders was the subject of strong criticism to the committee.
3.106
In their evidence to the inquiry, CSA strongly advocated legislative
changes to protect the privacy of retail shareholders. They described the
current legislative arrangements as an 'anachronism', mostly utilised nowadays
for the nefarious purpose of making under-priced offers in an attempt to
exploit uninformed shareholders. In their submission CSA wrote:
Modern technology makes the disclosure of shareholders’
particulars vulnerable to predatory behaviour, in a way that is not possible
with other forms of wealth holdings such as bank accounts and superannuation.
CSA notes that Australians understand their right to privacy, as
embodied in legislation, and increasingly query why they have no right to
privacy as investors. With the growth of the numbers of shareholders in Australia,
the question of providing privacy and protection to them has become more
urgent.[90]
3.107
They suggested that companies releasing their share register details to
predatory parties served to further disengage shareholders, some of whom assume
the offers are supported by the company.[91]
3.108
Both ACSI and CSA recommended that a 'proper purpose' test be applied,
enabling companies to test the bona fides of those seeking access to the
personal details of their shareholders.[92]
ACSI recommended that a proper purpose could include:
- shareholders wishing to contact other shareholders about issues
relating to a general meeting resolution;
- shareholders checking their details have been correctly recorded;
- a request from an executor; and
- a request from a regulatory agency.[93]
3.109
In response to a question on notice from the committee, CSA offered its
support for a proposal to amend the Corporations Act to allow companies to keep
two separate registers. One would contain all shareholders, whose details would
only be disclosed to other shareholders and those making offers as part of a
takeover bid in accordance with Chapter 6 of the Corporations Act. The other
register, available publicly, would only include the details of those with a
substantial shareholding – over five per cent. This would align the public
register with the substantial shareholding provisions in section 671B of the
Corporations Act.[94]
3.110
ASA disagreed that access to share registers should be restricted:
Whilst the ASA is mindful of the fact that shareholder registers
can be misused, it would not support moves to restrict this information. On
balance the importance of the legitimate reasons to access to register outweigh
the privacy arguments. Shareholders are aware that they are investing in a
public company. That the registers are open to abuse by predatory share offers
is clear, but the solution to this problem should not be found in restricting
the legitimate rights of shareholders to identify and contact each other.[95]
3.111
ASA and ASX Limited both stressed that improving financial literacy is
the most effective way to protect unsophisticated investors.[96]
3.112
The committee notes the work of the Financial Literacy Foundation in
developing a number of programs aimed at improving Australians' financial
knowledge.[97]
Committee view
3.113
The committee agrees that universal access to shareholder registers is
inconsistent with the privacy of personal information generally. Further, the
details of those who invest in funds that manage shares on their behalf are not
accessible as the details of those who invest directly. The financially
illiterate have been exposed to predatory share purchase offers, while shareholders
who mistakenly believe the company is complicit in making the offer may avoid
engagement with the company as a consequence. The committee supports proposals
to amend the Corporations Act to limit access to the personal details of
shareholders, in line with acceptable privacy standards.
Recommendation 9
3.114
The government should amend section 173 of the Corporations Act to limit
access to the details of shareholders with non-substantial holdings, subject to
a proper purpose test to allow access on certain conditions.
Obligations on small companies
3.115
Finally, the committee recognises concerns that the substantial corporate
governance requirements imposed by the Corporations Act may impede small,
closely held, entities from incorporating. The thrust of this disquiet is that
the one-size-fits-all approach best suited to regulating large financial
entities is not necessarily suitable for small businesses without a diverse
group of equity investors to protect.
3.116
Family Business Australia called for an amendment to the 50 shareholder
rule in section 113 of the Corporations Act, which provides that companies with
more than this number of shareholders are required to become unlisted public
companies. It claimed that family companies with successive generations of
shareholders could exceed 50 shareholders; unfairly forcing them to relinquish
family control as well as triggering reporting obligations unsuited to
family-run companies. It instead suggested a threshold of 300 shareholders.[98]
3.117
Treasury informed the committee that companies with more than 50
shareholders had a sufficiently diverse ownership base to justify greater
governance requirements. They also noted that proprietary companies classified
as 'large' due to their economic significance still face similar reporting
obligations to unlisted public companies. Treasury did not accept that there is
a 'compelling rationale' for amending the restriction.[99]
Committee view
3.118
A slight increase in the 50 shareholder limit for proprietary companies would
address the difficulty some family businesses face when new generations acquire
an interest in the company. The committee does not believe increasing the limit
to 100 would have any deleterious regulatory consequences and suggests that
this change be implemented.
Recommendation 10
3.119
The government should amend section 113 of the Corporations Act to raise
the limit for shareholders in a proprietary company to 100.
3.120
The committee is also of the view that the broader issue of the
framework for regulating small, closely held companies needs to be reviewed.
The one-size-fits-all approach of the Corporations Act may be appropriate for
large publicly listed companies with a diverse shareholder base with a
considerable equity investment, but it places a significant regulatory burden
on small companies and not-for-profit organisations for which the protection
offered to investors by the Corporations Act is not as appropriate.[100]
The government should therefore begin to investigate an alternative regulatory
framework for small incorporated companies and not-for-profit organisations.
Recommendation 11
3.121
The government should investigate an alternative regulatory framework
for small incorporated companies and not-for-profit organisations.
Potential disclosure improvements
3.122
During the committee's inquiry the Australian equities market was
undergoing a period of volatility and the practices of short selling and margin
lending attracted considerable public attention. There was a widespread view
that these activities are not subject to sufficiently rigorous disclosure
requirements to ensure shareholders remain adequately informed.
Short selling
3.123
Short selling describes the technique of obtaining profit from the falling
value of a stock by selling it at current market price with the intention of
re-purchasing it at a lower price and retaining the difference. This allows
investors to profit by trading shares they consider to be overvalued. 'Covered'
short selling describes the practice where the shares being traded are
borrowed, usually from fund managers or custodial owners holding shares on
behalf of institutions. The shares are lent subject to a contractual agreement
that they will be returned at an agreed time, for a premium. Typical stock
borrowing agreements formally involve the borrower actually purchasing the
securities from the lender and contracting to re-sell at an agreed time or on
demand.[101]
If within that time the short seller can re-purchase the shares at a lower
price, then a profit is made. If they are re-purchased at a higher price then a
loss is incurred.
3.124
'Naked' short selling differs in that it involves agreeing to sell a
stock that is not held - neither owned nor borrowed - and subsequently buying
it at a lower price, within the brief window of time that enables settlement
obligations to be met. In other words, the later share purchase at a lower
price needs to be completed soon enough to enable the seller to meet the
original undertaking to sell the stocks that were not held at the time the
agreement was made.
3.125
Lending stock for the purposes of short selling potentially enables fund
managers and trustees to maximise shareholder returns; they can benefit not
only when the value of their shares is increasing, but also when they are in
decline. However, the practice has also been associated with nefarious
activities such as insider trading and spreading mischievous market rumours.[102]
For example, company insiders may offload stock prior to the announcement of a
profit forecast downgrade and re-purchase soon after the price has fallen; or
short sellers may seek to drive a share price down by spreading false rumours
about a company's financial position. The judiciousness of lending a stock to
somebody seeking deterioration in its value can also be questioned.
3.126
While the committee notes that the ASX benefits from increased trading
volumes generated by the practice, ASX has described short selling as 'a
legitimate and worthwhile trading technique which contributes to market
liquidity, efficiency and price discovery'.[103]
This latter point refers to the capacity of the market to respond quickly to
restore equilibrium where a stock has been overvalued.
3.127
In evidence to the committee, ASA commented that companies significantly
affected by short selling have often been subjected to some 'initial distress'
that caused them to be targeted.[104]
They told the committee that:
Per se, short selling is not a problem, but it depends upon what
basis it is done and what other activities are going on around it. If you short
sell because you genuinely believe that a company is overvalued, and it is, and
the price drops then that is an effective way of correcting overvaluation. If
you short sell because you have insider information or you have spread a market
rumour, which is untrue, and then you trade off of that then obviously that is
to the disadvantage of all other shareholders.[105]
3.128
In the context of shareholder engagement, two main areas of concern
relating to short selling were raised with the committee:
- The
knowledge of shareholders (and the market generally) that shares in a
particular company had been lent; and
- Institutions'
monitoring and control of stock lending by interposed entities and its
disclosure to fund members; and the appropriateness of obtaining fund member
consent.
Market disclosure of stock lending
3.129
The committee heard concerns about a lack of transparency of stock
lending for covered short sales, rendering the undesirable practices that
sometimes complement short selling difficult to regulate.[106]
It should be emphasised that concerns raised during the inquiry related to
disclosure, rather than the activity itself. The committee recognises that no
widespread campaign to have short selling prohibited entirely exists.[107]
However, disclosure is critical to regulators being able to identify and
prosecute instances of insider trading and the dissemination of untrue rumours
that may be associated with short selling.[108]
3.130
While the Corporations Act requires naked short sales to be disclosed to
the market, ambiguity in the definition of short selling in section 1020B of
the Corporations Act has allowed covered short selling to occur undisclosed.
Australasian Investor Relations Association suggested that the Corporations Act
be amended to provide for the mandatory disclosure of covered short selling,
adding that the ASX should disclose stock lending through the CHESS clearing
and settlement mechanism.[109]
They stated that with up to 40 per cent of a company's stock on loan at any
given time, engagement with those with an interest in the company is difficult.[110]
This issue was discussed in more detail at paragraph 3.13.
3.131
AICD agreed that disclosure of stock lending for the purpose of short
selling is appropriate.[111]
3.132
On 28 April 2008, the Minister for Superannuation and Corporate Law,
Senator the Hon. Nick Sherry, stated that he considered short selling to be 'an
important financial tool in promoting market efficiency and encouraging true
stock prices'. He did reiterate, however, that the loophole would be addressed:
In the interests of transparency, the Government will pursue
legislative change to the Corporations Act to address any ambiguity around
covered short selling and the requirement for disclosure.
Treasury and ASIC are currently investigating the best
legislative option to address these issues.[112]
3.133
In conjunction with the government's decision to close the covered short
selling loophole, the ASX released a consultation paper on 28 March 2008 inviting comment on a range of improvements to the Listing Rules, including:
-
facilitating the transparency of short selling volumes pending
legislative change; and
- deterring irresponsible naked short selling by increasing the fee
attached to a failure to deliver shares on time.[113]
3.134
With respect to addressing problems in the long-term, the ASX also
recognised the need to address the 'definitional ambiguity' referred to during
the committee's inquiry:
The legislative definition of the transactions which need to be
reported as short sales should capture both sell orders submitted when the
seller does not own the amount of securities being offered and sell orders
submitted when the seller only owns the securities through a borrowing
agreement and is subject to a contractual obligation to return the securities
to the lender.
The legislative gap or loophole that currently exists in
relation to short selling is that the prohibition is widely considered not to
extend to sales of securities at a time when the seller owns such securities,
even if the seller only owns them by virtue of having entered into a typical
stock borrowing arrangement.[114]
3.135
Australasian Investor Relations Association advised the committee that
the beneficial owner tracing provisions under section 672 of the Corporations
Act were not typically able to be used to identify instances where stock has
been lent.[115]
The role of institutions
3.136
Although the complex share ownership arrangements institutions enter
into (discussed above at paragraph 3.13) mean that they do not directly lend
their shares, institutional investors still have the authority to direct fund
managers as to whether they want their stocks lent or not. This decision is
taken in the context of trustees' legal authority to manage the assets of the
fund on behalf of their members and their responsibility to perform this task for
the benefit of fund members; that is, to maximise returns on members'
investments. ASFA explained that share lending is undertaken responsibly on the
basis of risk/reward calculations in accordance with these obligations.[116]
3.137
Treasury also advised that share lending must comply with trustees'
legal obligations:
[Superannuation funds] are under fiduciary and statutory
obligations to deal with the funds in a way which best promotes the ultimate
beneficiaries, the investors in the super funds. We would argue that that
fiduciary obligation would involve trustees reviewing the appropriateness of
investment practices, such as scrip lending, and redetermining those policies
from time to time as market conditions change.[117]
3.138
AFSA explained that approaches to stock lending varied between funds;
some engaging in the practice and others not. They also indicated that, as
beneficial owners, the funds were subjected to minimal risk:
...the whole issue is one whereby superannuation funds, in terms
of their individual situations, have been reviewing what they have been doing
and what the risk-return structure is for them in how they do it. Generally,
superannuation funds do not have direct dealings with the ultimate borrowers of
the stocks. Often the arrangements are through their custodians, so their
counterparty risk is with the custodians. It has been an activity with very
minimal risk for the superannuation funds. Whether individual funds undertake
such activity has been a matter for individual funds.[118]
3.139
The question of whether fund trustees should obtain the consent of their
members before lending stock was raised at the committee's hearings. ASFA
indicated that the present arrangement, whereby fund members delegate
management authority to trustees, does not require consent to be provided. They
added:
Whether it should be is basically a matter for parliament to
decide. The mechanics of getting that informed consent, either in general or on
specific issues, would be challenging.[119]
3.140
The Investment and Financial Services Association (IFSA) supported this
view of the fiduciary approach:
What flows from that is that you have basically given that right
to the person who is acting as the fiduciary in that capacity to exercise and
to make those day-to-day decisions on your behalf in your best interest.[120]
3.141
ASA emphasised the benefits of disclosure in this area. They told the
committee that in addition to observing their fiduciary obligation to maximise
returns to members, institutional investors should disclose their lending
policies:
...institutional shareholders should have a clear policy about
securities lending, which can be accessed, and they should also be clearly
considering the relationship between risk and return when lending those
securities and only take that decision if it fits with their policy in terms of
their appetite for risk.[121]
Committee view
3.142
The committee is of the view that while short selling is a legitimate
trading tool, it is necessary to ensure it is appropriately disclosed to the
market to ensure that undesirable practices that potentially accompany short
sales can be identified by regulators. Further, the committee does not oppose
institutional investors lending their stocks to maximise returns, but considers
that funds should be required to disclose their stock lending practices or
policies to members.
3.143
The committee also notes that the Australian Government is examining
this issue with a view to implementing legislative change to address disclosure
matters.
Margin lending
3.144
Concerns associated with company directors holding shares tied to margin
loans were also topical during the course of the inquiry. In basic terms,
margin lending refers to the technique of borrowing to invest, thereby
increasing returns when shares increase in value. The risk attached to margin
loans is that borrowers also increase their exposure to losses; the potential
for increased profits is accompanied by increased risk. If the value of the
shares borrowed against declines to a specified level, lenders will intervene
and make a margin call. This requires the holder of the loan to reduce debt as
a proportion of the value of their shareholding by injecting cash to reduce
borrowings, or to purchase additional shares.
3.145
A potential problem with margin lending arises when shareholders are
unaware of situations where directors are facing possible margin calls on their
own shareholding in the company, which can often be substantial. Such
information has the potential to provide a trading advantage to those who are
aware of it, while ordinary shareholders remain oblivious until it is too late.
Thus, a company director's undisclosed exposure to margin loans significantly
increases the potential for insider trading.
3.146
On 29 February 2008 the ASX released a statement on director-shareholder
margin loans, which stipulated that such arrangements may be of material
significance under Listing Rule 3.1 and subject to market disclosure
requirements:
Where a director has entered into margin loan or similar funding
arrangements for a material number of securities, ASX advises that listing rule
3.1, in appropriate circumstances, may operate to require the entity to
disclose the key terms of the arrangements, including the number of securities
involved, the trigger points, the right of the lender to sell unilaterally and
any other material details. Whether a margin loan arrangement is material under
listing rule 3.1 is a matter which the company must decide having regard to the
nature of its operations and the particular circumstances of the company.[122]
3.147
CSA informed the committee that this guidance was inadequate:
...there is a call from the market for greater clarity as to when
a director or an executive should disclose when they hold shares tied to a
margin loan. It appears that the current continuous disclosure definition of
materiality under listing rule 3.1 is inadequate and that the market requires
greater clarification.[123]
3.148
The committee notes reports that the Australian Government has prepared
a green paper proposing that ASIC takes over the regulation of margin lending
practices.[124]
Committee view
3.149
The committee does not consider that leaving an assessment of the
materiality of a director's margin loan arrangements to the company itself is
sufficient. The government's corporate governance green paper should clarify
this important disclosure issue.
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