Does the Shareholder Rights Directive proposal support value-enhancing related party transactions and limit value-shifting related party transactions? In the study ‘The Duties of Large Shareholders in Transactions with the Company’ we cast doubt that the proposal will be helpful in this respect and suggest an alternative approach.
In our study we start with an assessment of related party transactions between the large shareholders and the Euro STOXX small 200 companies. For this assessment, we made use of the notes to the accounts of companies providing information about related party transactions with shareholders. These transactions are common and a significant number of these transactions are material compared to the size of the company. Companies report a wide variety of transactions with their major shareholders. However, the reporting takes place in different ways. Some companies provide an overview of the financial considerations related to the shareholder transactions. Other companies consolidate all transactions that took place with the related shareholder and disclose only the net considerations on consolidated level or summarize their relationship with their major shareholders. Similarly, while some companies explicitly state that all transactions occurred at arm’s length, some companies report the conditions of the transactions with the shareholders.
We find that the information that companies disclose regarding the transactions with the shareholders generally do not allow to assess whether all transactions took place at arm’s length, let alone whether the transactions are fair to the company and in the company’s interest. That finding underpins the European Commission opinion that the disclosure requirements in IAS 24 and the national rules are, for listed companies, not sufficient to address appropriately the potential conflicts of interests that result from these transactions.
The European Commission included in the proposal for a new shareholder rights directive an alternative regime for related party transactions. The current version of the proposal for a new shareholder rights directive allows the Member States having the non-interested shareholders approve the material transactions with related parties or making use of procedures involving the administrative or supervisory body ‘in accordance with procedures which prevent a related party from taking advantage of its position and provide adequate protection for the interests of the company and of shareholders which are not related parties, including minority shareholders’. However, the proposal will be unlikely to overcome the major concerns of the capital market regarding conflicts of interest within companies. The proposed process for entering related party transactions is complex and the many opt-ins and opt-outs will barely harmonize the many different current Member State processes.
We suggest involving the external auditor and the audit committee in the assessment of the appropriateness of the related party transaction. The external auditor’s duties already include the audit of the related party transactions. Consequently, these duties can be broadened so as to include the reasonable assurance that the envisaged related party transactions are substantively fair transactions.
Under the Audit Regulation (EU) No 537/2014 and Audit Directive 2014/56/EC, the audit committee of the company is provided with specific duties both regarding the audit of the financial statement as well as regarding the work of the external auditor. The audit committee must monitor the (performance of the) statutory audit of the annual and consolidated financial statements. Consequently, the audit committee is familiar with the work of the auditor. As the committee is composed with board members, it is also familiar with the operational activities of the company and can efficiently evaluate the transaction before approval. The composition of the audit committee can guarantee the independence of the members as to the transaction submitted for approval. To conclude, the audit committee can serve as the body that approves the related party transaction. This procedure can help mitigate the conflicts of interests in related party transactions.
My study ‘The Duties of Large Shareholders in Transactions with the Company’ will appear in Shareholders’ Duties (ed Hanne S Birkmose), published by Kluwer Law International.
Christoph Van der Elst is a Professor of Business Law and Economic at Tilburg University and Ghent University.