In a corporate governance landscape characterized by the growing importance of institutional shareholder engagement, board-shareholder dialogue is becoming an increasingly common practice both in the US and in Europe. Board-shareholder dialogue is essential in order to enable institutional investors to fulfil their stewardship functions. Engagement is also core to listed companies’ communication strategies, since the growing demand for engagement by institutional investors has rendered traditional investor relations insufficient. Empirical analysis shows that private discussions with directors have become one of the most popular measures of shareholder engagement by institutional investors, and that other public mechanisms (such as shareholder proposals or public criticism) are used only if interventions behind the scenes fail.
Nevertheless, director-shareholder dialogue occurs within an area of tension between corporate governance trends and financial markets law. Private meetings between directors and institutional investors raise concerns with respect to the legal framework of financial markets both in the US and in the EU, as they may lead to the disclosure of material non-public information to selected shareholders. In the US, disclosure of material non-public information runs contrary to the selective disclosure regime set out in Regulation Fair Disclosure (Regulation FD), and can lead to infringements of the rules on insider trading. Similarly, the EU market abuse regime seems to hinder dialogue between directors and key shareholders as it requires public disclosure of inside information, and prohibits anyone receiving inside information from trading in the issuers’ securities.
Against this background, in a recent paper, I provide a comparative transatlantic overview of recent developments in the area of director-institutional shareholder dialogue in the US and in the EU, with the aim of showing that constraints deriving from US and EU financial markets law should not be overstated, as they do not definitely prohibit board-shareholder dialogue. First, insider trading and disclosure rules only apply to the communication of material non-public information. Therefore, as has been recognized by the SEC and by European lawmakers, they do not hamper dialogue as long as it does not concern inside information. Insider trading and disclosure rules allow institutional investors to gain an informational advantage from dialogue with directors, as long as this does not entail the disclosure of inside information. Furthermore, when fulfilling their stewardship functions, institutional investors are primarily interested in communicating their views or concerns to investee companies and do not want to receive material non-public information so that they may freely trade securities issued by investee companies. Consequently, neither two-way director-shareholder dialogue not involving the disclosure of inside information nor ‘listen-only' sessions where directors learn about the positions of institutional shareholders violate insider trading and disclosure rules.
However, detecting the transfer of material information raises compliance costs (even if there is lack of recent empirical evidence demonstrating the level of compliance costs associated with insider trading and public disclosure rules), since issuers and investors need to adopt specific procedures in order to avoid the communication of material non-public information. Recommendations from corporate governance and stewardship codes, as well as good practice standards drafted by corporate governance experts and institutions, outline a practical framework that reduces the risk of violating disclosure rules and favours board-shareholder engagement. For example, European corporate governance and stewardship codes make clear that director-institutional shareholder dialogue should avoid information asymmetries within the board. It is therefore crucial that all board members be informed in good time concerning any dialogue with institutional investors, and, in this respect, a key role should be played by the board’s chair. The possibility for an individual board member to engage in direct dialogue with the shareholders that proposed or approved his/her election can restrict the board’s cohesiveness and undermine trust among directors. Moreover, whilst a flexible approach is theoretically preferable, allowing for case by case decisions as to which non-executive directors should be involved in the dialogue based on the issues to be discussed, an individual board member should only ever privately meet with institutional shareholders in exceptional cases.
However, the provisions of codes and statements of best practice are not binding, as issuers and institutional investors are free to decide not to adopt them, and only stipulate a limited safe harbour. The proposal for introducing a legislative safe harbour by explicitly providing a list of corporate governance topics that are excluded from the scope of application of Regulation FD and EU Market Abuse Regulation should be supported in principle. Still, the introduction of such a safe harbour would seem to be far from unproblematic, especially under EU law, which embraces the theory of equal access to information, and considering that the European Court of Justice has held that some corporate governance issues can constitute inside information. Instead, the SEC and the European Securities and Markets Authority (ESMA) may consider the provision of more detailed guidance to boards and shareholders concerning (corporate governance) topics that can be discussed within board-shareholder dialogue and procedures to be followed. Even if such a solution would not establish a proper safe harbour, it could help reduce (at least in part) compliance costs for both issuers and institutional investors.
Giovanni Strampelli is Associate Professor of Commercial Law at Bocconi University, Milan.