FCA introduces stricter rules for premium listed companies with a controlling shareholder

Corporate governance scandals at companies such as Eurasian Natural Resources Corporation and Bumi, where minority investors saw the value of their shares plummet partly as a result of transactions entered into with controlling shareholders and their associates, have prompted the FCA to tighten up the eligibility criteria and continuing obligations that apply to premium segment companies in order to protect investors from abuse at the hands of a controlling shareholder.

Following changes to the Listing Rules on 16 May 2014, premium listed companies with a “controlling shareholder” must ensure that all future transactions and arrangements between the company or any member of its group and the controlling shareholder or any its associates are conducted at arm’s length and on normal commercial terms. Controlling shareholders will be less able to force through appointments to the board of “compliant” directors because the (re-)election of every director who is unconnected to a controlling shareholder will be subject to a vote by independent shareholders, as well as by a majority of shareholders overall.

At the time of IPO, and on an ongoing basis, the FCA will seek greater assurance that the company is able to operate its business independently from the controlling shareholder: admission to, or continuation on, the premium segment may not be permitted where, for example, the company is dependent on the controlling shareholder for financing, or the controlling shareholder or any of its associates“appears to be able to influence the operations of the [company] outside its normal governance structures or via material shareholdings in one or more significant subsidiary undertakings”. And de-listing a premium segment company altogether, or transferring it down to the standard segment, will normally similarly require approval by a majority of independent shareholders, as well as by 75% of shareholders overall.

What is a controlling shareholder?

A controlling shareholder is a person who controls, either alone or in conjunction with any other person who is “acting in concert” with it, 30% or more of the votes in the company.Votes that are held indirectly – e.g. via a nominee, controlled company or chain of controlled companies – should also be counted. Where the aggregate percentage of votes controlled by a person and its concert parties reaches 30%, each concert party will itself also be treated as a controlling shareholder.

“Acting in concert” is not defined in the rules, but the definition in the Takeover Code is likely to be used by the FCA, at least as a starting point. Under the Takeover Code, persons are acting in concert with each other if, “pursuant to an agreement or understanding (whether formal or informal), [they] co-operate to obtain or consolidate control of a company”. A person and each of his “affiliates” (broadly, companies in which the person has majority control) are deemed to be acting in concert with each other. The Takeover Panel also operates a presumption that certain categories of person are acting in concert with each other, although it is possible to persuade the Panel that in particular circumstances the presumption should be rebutted.

Under the new Listing Rules, a person’s “associates” (broadly, for an individual, members of his family, and family-controlled companies; and for a corporate, other companies in the same group) are not automatically deemed to be acting in concert with the person: instead, it will depend whether, as a matter of fact, there is an agreement or understanding between the person and a particular associate that they will co-operate to control the company (usually by voting together on shareholder resolutions).

Companies will therefore need to determine whether they have one or more controlling shareholders: this will entail them trying to ascertain whether certain shareholders are acting in concert with each other and, if necessary, making written submissions to the FCA. The FCA says that it expects companies to have in place systems and controls that enable them to make “reasonable efforts” to identify controlling shareholders, just as they would identify substantial shareholders under the existing rules. Certainly it seems clear that all companies should conduct themselves, or obtain from their registrars, brokers or another third party, regular analysis of their share register; but whether a company needs to go further – for example, to send out section 793 notices to investigate beneficial ownership, or to engage a corporate intelligence firm to investigate connections between certain shareholders who are suspected of acting in concert – will depend on the circumstances.

Relationship agreements

Requirement for relationship agreement

A premium listed company with a controlling shareholder must put in place a “relationship agreement” with the controlling shareholder that includes a commitment that all future transactions between the company or any member of its group and the controlling shareholder or any its associates will be conducted at arm’s length and on normal commercial terms. The controlling shareholder must also agree that neither it nor any of its associates will do anything that could prevent the company complying with its obligations under the Listing Rules – e.g. the obligation to seek the approval of independent shareholders for a non-ordinary course transaction with the controlling shareholder or one of its associates – or that could “circumvent the proper application” of such rules. Other terms can be included in the agreement provided they do not conflict with the terms expressly required by the Listing Rules.

The requirement for a relationship agreement effectively reinstates a rule that was dropped in 2005.

Shareholder approval and publicity

Entry into a relationship agreement, or the amendment of any existing relationship agreement, to comply with the new rules will not be treated as a transaction with a related party that requires shareholder approval under chapter 11 of the Listing Rules. The relationship agreement need not be published and its precise terms can remain confidential.

Compliance and sanctions

For financial years ending on or after 1 September 2014, the company will have to confirm every year in its annual report that it has complied with the relationship agreement and, as far as it is aware, that the controlling shareholder and its associates have also done so. If any independent director dissents from this confirmation, the FCA will treat the agreement as having been breached. If the relationship agreement is breached, or no agreement is put in place, the FCA is unlikely to be able to impose obligations on sanctions on the controlling shareholder(s) but the company will become subject to “enhanced oversight measures”: until a clean compliance statement is given, all transactions between the company or any member of its group and the controlling shareholder or any its associates will require approval by the independent shareholders, even if the transaction is small or in the ordinary course of the company’s business.

In “exceptional circumstances” – which might include where a breach is one-off and/or caused by factors outside the control of the company or controlling shareholder – the FCA may be prepared to dispense with or modify the enhanced oversight measures.

Multiple controlling shareholders

Where there are multiple controlling shareholders who are all part of the same “camp”, it will not be necessary for each of them to sign a relationship agreement if (broadly) the “lead” controlling shareholder takes responsibility for ensuring that they and their associates comply with the terms of the agreement.

Grace period for existing premium listed companies to comply

Where an existing premium listed company already has a controlling shareholder on 16 May 2014, it has six months (until 16 November 2014) to put in place a relationship agreement that complies with the new rules. Similarly if, after 16 May 2014, a premium listed company comes to have a controlling shareholder, it will have six months from the occurrence of that event to put in place a relationship agreement.

Dual voting on the election of independent directors

When a director who is determined by the board to be “independent” for the purposes of the UK Corporate Governance Code is proposed for election or re-election, his appointment will have to be approved by a majority of the votes cast by independent shareholders(i.e. excluding the controlling shareholder and its concert parties), as well as by a majority of the total number of votes cast (by all shareholders). This is referred to by the FCA as “dual voting”. For the election of each independent director, companies can choose whether to put two resolutions - one on which only independent shareholders can vote, which would need to be taken on a poll, and one on which all shareholders can vote, on a poll or a show of hands - or only one resolution (which would need to be taken on a poll).

If the election of an independent director is approved by the shareholders as a whole, but not by the independent shareholders, or vice versa, the board will need to decide what to do: if it continues to believe that the director should be elected, it must put a further resolution not less than 90 days, and not more than 120 days, after the AGM.Passing of the second resolution need not be subject to approval by a majority of the independent shareholders, so the controlling shareholder will ultimately be able to use its votes to force through the appointment of its chosen independent director. Pending such resolution, an existing independent director can remain in office.

Whether one or two resolutions are put, the company will need to ensure that its constitution allows such dual voting - i.e. that dual voting is not prohibited by, or inconsistent with, its articles of association. Where the articles do not allow dual voting, a premium listed company with a controlling shareholder will have to put a resolution to amend its articles at the next AGM held after 16 May 2014 (but disregarding any AGM the notice for which had already been sent out on 16 May 2014, or that is/was sent out within three months of that date). Similarly, where a premium listed company in that position comes to have a controlling shareholder after 16 May 2014, it must put a resolution to amend its articles at the next AGM held after it acquires a controlling shareholder (but disregarding any AGM the notice for which has already been sent out when that event occurred, or that is sent out within three months of that event occurring).

To enable independent shareholders to make a properly informed decision about whether to approve the election of an independent director, an AGM circular sent out after 16 August 2014 will have to include more information than previously about the relationship between the company and each independent director, including a description of “any existing or previous relationship, transaction or arrangement the proposed director has or had with the company, its directors or the controlling shareholder and its associates”. Boards are expected to make a judgement about which relationships and transactions may be too historic or insignificant to merit disclosure.

Other changes

A number of other changes were also made to the Listing Rules on 16 May. These include:

• clarification on how the free float rule applies to premium listed companies(although the main requirement for 25% of the shares to be in public hands immediately following admission and at all times afterwards has not been changed);
• the introduction of rules designed to prevent a shareholder using votes attached to unlisted shares to force through, or defeat, resolutions on certain matters that under the Listing Rules must be put to a shareholder vote; and
• the introduction of two new Listing Principles for premium listed companies.

Practical considerations

All premium listed companies will need toensure that their systems and controls enable them to make “reasonable efforts” to identify any controlling shareholders: this should include monitoring the share register, and notifications made by major shareholders (3% and above),for indications that shareholders who may be acting in concert control together 30% or more of the voting rights. If the company suspects that certain shareholders are acting in concert, it will need to consider whether and how to investigate further; and in some cases it may need to consult the FCA as to whether a particular person will be treated as acting in concert.

Premium listed companies that already have a controlling shareholder will need to:

• Put in place a relationship agreement, or amend any existing one, to comply with the new rules.
• Monitor compliance by the company and controlling shareholders with the relationship agreement, include an appropriate compliance statement in the annual report, and consider how to deal with any anticipated or past breaches.
• Check whether the articles allow dual voting on the election of independent directors. If not, they will have to put a resolution to amend the articles at the next AGM held after 16 May 2014 (but disregarding any AGM the notice for which had already been sent out on 16 May 2014, or that is/was sent out within three months of that date).
• In relation to the (re-)election of each independent director, decide whether to put two resolutions or a single one.
• Explain in the AGM circular that the (re-) election of each independent director is subject to dual voting.
• Include in the AGM circular the information specified in the new rules about each independent director and his relationship with the company, controlling shareholder etc.
• Decide what to do if the appointment of an independent director is approved by shareholders as a whole, but not by a majority of the independent shareholders, or vice versa.

Premium listed companies with a class of unlisted shares that carry a right to vote on all, or substantially all, shareholder resolutionshave two years (until 16 May 2016) to either amend their articles so that such shares cannot be voted on the matters specified in the new rules or to obtain a dispensation from the FCA.

Source materials

See the FCA’s Policy Statement PS 14/8 published on 16 May 2014, which includes the FSA Instrument made on 1 May 2014 that amended the Listing Rules.