With institutional shareholders playing a growing role in corporate governance, dialogue between boards and shareholders is increasingly common in the U.S. and Europe. Talking with boards is essential to institutional investors’ stewardship functions, and engaging with institutional investors has become a focus of listed companies’ communication strategies. Empirical analysis shows that private discussions with directors have become institutional investors’ preferred method of engagement, and they resort to shareholder proposals, public criticism, and similar practices only if private conversations fail.
Nevertheless, meetings between directors and institutional investors raise legal concerns in the U.S. and the EU, because they may lead to the disclosure of material non-public information to selected shareholders. In the U.S., disclosure of material non-public information runs contrary to the selective disclosure regime set out in Regulation Fair Disclosure (Regulation FD) and can violate rules against insider trading. Similarly, the EU market abuse regime may discourage dialogue between directors and major shareholders by requiring public disclosure of inside information and prohibiting anyone receiving inside information from trading in the issuers’ securities.
In an article forthcoming in the Virginia Law & Business Review, I provide a comparative overview of recent developments in director-institutional shareholder dialogue in the U.S. and the EU and warn that legal constraints should not be overstated, because neither jurisdiction definitely prohibits board-shareholder dialogue. First, insider trading and disclosure rules apply only to the communication of material non-public information. Therefore, as has been recognized by the SEC and European lawmakers, they do not hamper dialogue that does not include inside information but might still be useful to institutional investors. Furthermore, when fulfilling their stewardship functions, institutional investors are primarily interested in communicating their views and do not want to receive material non-public information that would stop them from trading securities issued by the companies they invest in. Consequently, neither director-shareholder dialogue that does not involve inside information nor sessions where directors merely listen to institutional shareholders would violate insider trading or disclosure rules.
However, there are costs to complying with such rules, since issuers and investors must adopt procedures to block communication of material non-public information. Corporate governance and stewardship codes and good practice standards drafted by corporate governance experts and institutions outline a practical framework for reducing the risk of violating disclosure rules while facilitating board-shareholder engagement. For example, European corporate governance and stewardship codes make clear that director-institutional shareholder dialogue should result in all board members having equal access to information. It is therefore important that the board’s chair ensure that all directors receive timely notice of any dialogue with institutional investors. Allowing, for example, a board member to speak directly with the shareholders that elected him or her might create dissension or mistrust among directors. Boards should, of course, have the flexibility to make decisions on a case-by-case basis, but individual board members should rarely be allowed to meet privately with institutional shareholders.
Still, the provisions of codes and statements of best practice are not binding, and they create only a limited safe harbor. It makes sense in principal to enact legislation that would exclude specific corporate governance topics from the limits of Regulation FD or the EU Market Abuse Regulation. Such a safe harbor would be problematic, however, especially under EU law, which embraces equal access to information, and the European Court of Justice has held that some corporate governance issues can constitute inside information. A better option would be for the SEC and the European Securities and Markets Authority to provide more detailed guidance to boards and shareholders on what topics can be discussed between boards and shareholders and the proper procedures to follow. Though such a solution would not create a safe harbor, it would nonetheless help reduce compliance costs for issuers and institutional investors.
This post comes to us from Giovanni Strampelli, an associate professor of commercial law at Bocconi University, Milan. It is based on his recent article, “Knocking at the Boardroom Door: A Transatlantic Overview of Director-Institutional Investor Engagement in Law and Practice,” available here. A version of this post appeared on the Oxford Business Law Blog.