1

Some Aspects of Corporate Capital Structure with Particular Reference

to Listed Companies

Dan Prentice

dicembre 2008

© Luiss Guido Carli. La riproduzione è autorizzata con indicazione della fonte o come altrimenti specificato. Qualora sia richiesta un’autorizzazione preliminare per la riproduzione o l’impiego di informazioni testuali e multimediali, tale autorizzazione annulla e sostituisce quella generale di cui sopra, indicando esplicitamente ogni altra restrizione

Dipartimento di Scienze giuridiche

CERADI – Centro di ricerca per il diritto d’impresa

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Introduction

The corporate form is used pervasively in the United Kingdom. In

2005 there were 1,968,000 private companies ('Ltd')1 and 11,600 public companies ('Plc')2 on the companies' register.3 In the year 2004-2005 there were 332,700 new private companies incorporated and 1,100 public companies.4 The rate of new incorporations has been significant: it is estimated that since 1997 new incorporations have risen by over 60 per cent and the number of foreign firms incorporating in the UK has more than quadrupled5. A salient feature of UK company law is ease of access to the corporate form. No barriers of any substance are placed in the way of obtaining corporate status.6 There is a 'free market' rationale for ease of incorporation – provided parties are aware that they are dealing with a limited liability company they can protect their own interests.7 To the extent that the corporate form can be abused, control of abusive practices is by means of a liability rule applied ex post and by an ex ante rule that is designed, for example, to ensure economic viability.8 Occasionally, UK company law will use a property rule to protect the interests of the dramatis personae of company law. One example of this are the provisions on shareholder pre-emption rights9 which use a property protection rule, the conferral of a right of pre-emption, rather than a liability rule, that is, an ex post legal remedy where a shareholder

1 This is the default category, unless a company adopts the public company form it will be a private company: Companies Act 2006, s.4 (hereafter 2006 Act). 2 A company must explicitly provide for public company status in its constitution: 2006 Act, s.4(2). 3 See Companies In 2004-2005, Report for the year ended 2005 (DTI, Oct. 2005), Table A2 (hereafter "the 2005 Report"). 4 Ibid. Table A2, at p.14. 5 Hansard, House of Lords, Vol. 677, at 180 (2006). 6 The Registrar of Companies offers a one-day incorporation service. It is not uncommon for the large London law firms to incorporate companies in batches so that when the need arises they can take the company off the "shelf", hence the common reference to shelf companies. Such companies are treated as "dormant" companies and are exempted from the regulatory provisions of the 2006 Act until they commence trading; see 2006 Act, s.1134. 7 See Companies Act 1985, s.349; Griffin, Section 349(4) Of The Companies Act 1985: An Outdated Victorian Legacy (1997) JBL 438. This justification is not without its difficulties: it does not address the issue of involuntary creditors (tort victims) or day-to-day normal trade creditors. 8 For example, the Insolvency Act 1986, s.212 (misfeasance proceedings by liquidator), s.213 (fraudulent trading), and s.214 (wrongful trading) are all ex post sanctions. There is no ex ante requirement such as minimum capitalisation. See Prentice, Corporate Personality, Limited Liability and the Protection of Creditors in Rickett and Grantham, Corporate Personality in the 20th Century (1998), Ch.6. 9 2006 CA, ss.574-593. These implement the Second Directive on Company Law (79/91/EEC), Article 29.

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has been unfairly treated by a particular allotment.10 Other than in the area of capital maintenance,11 UK law relies on ex post liability rules to curb the misuse of the corporate form, rather than ex ante quality control rules.12

A second feature of English company law is that it is enabling; that is,

it leaves considerable autonomy to the draftsman of a company's constitution as to how the central matters of a company's activities, namely, distribution of profits, allocation of losses, and allocation of control are dealt with13. The draftsman of the corporate constitution does not have a completely free hand but there is a larger measure of freedom in drafting a company's constitution that the vast bulk of the Companies Act 2006 would suggest.14

Finally, the courts have played their role. Soon after incorporation by

registration was introduced in the nineteenth century, the courts recognised the one person company in the justifiably famous case of Salomon v Salomon & Co Ltd.15 The courts have consistently upheld the rigour of this doctrine by declining to pierce the corporate veil, except in the most flagrant cases of fraud.16 Nor have the courts countenanced the development of doctrines of attribution which would result in the individuals active in the management of the affairs of a company being legally liable for the acts of the company.17

As of 2005 the economic significance of UK listed firms18 was relative

to the economy:

10 See, The Impact of Shareholders' Pre-Emption Rights on A Public Company's Ability to Raise New Capital (3rd Nov. 2004, DTI, www.dti.gov.uk/cld/current.htm); Pre-Emption Rights: Final Report (Feb. 2005, DTI, www.dti.gov.uk/cld/public.htm). 11 The capital maintenance rules are relaxed for private companies: see 2006 Act, s.656 (reduction of capital); s.691 (financial assistance). 12 It is interesting to note that when limited liability was introduced in 1855 it was initially proposed that limited liability companies should possess a nominal capital of £50,000, but this was rejected: see Formoy, The Historical Foundations of Modern Company Law (1923) at 117. 13 This assumes that the company is solvent. Insolvency law is prescriptive as regards hierarchy of claims and asset distribution where a company is insolvent. 14 This Act has 1264 sections and 16 Schedules. There is also subordinate legislation. 15 [1897] A.C. 22. See Cooke, Turning Points of the Common Law (1977), Ch. 1. 16 See Cooke, ibid. See, e.g., Adams v Cape Industries Plc, [1990] Ch. 433 (where the veil was not pierced although a subsidiary was set up solely to minimise the risk to its parent of US asbestos claims). 17 See Meridian Global Funds Management Asia Ltd. v Securities Commission [1995] 2 A.C. 500. 18 These are companies listed on the London Stock Exchange (the "LSE").

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Listed firms have become smaller as a percentage of total registered firms: TABLE 2 Listed firms smaller as percentage of total registered firms

05

101520253035

As percentage of total firms

Net Value Added/GDP

As percentage of total employees

As perctotal

TABLE 1UK listed firms

5

Listed firms, however, have been rising in value: TABLE 3 Rising in value

Also, the financial services industry has become a dominant sector of the UK economy: TABLE 4 Sector's share of UK GDP

02468

10121416182022

1995 1997 1999 2001 2003 2005

Sector's share of UK GDP% of GDP

Pro fessional ServicesFinancial Services

6

The Sunday Independent, 15 Oct. 2006 (p.11, Business) As has been pointed out with respect to these statistics:19

"Professional services such as accounting, legal and management consultancy are now running a little under 4 per cent of GDP. Most of that business is off the back of international finance, so you could say that the total for financial and associated services is now more than 12 per cent of the GDP. That compares with manufacturing, which was down to 13.6 per cent last year. On these trends, financial services will be larger than manufacturing in three years' time, making Britain almost certainly the first large economy where they cross over."

Listed Companies and Ownership Structure. As of July 2006, there were 3,203 companies listed on the London Stock Exchange20 and 1,564 listed on AIM.21 In 2004, the equity22 market value of the Stock Exchange was approximately £1,971,636 million.23 There is also a substantial foreign corporate presence on the London Stock Exchange.

19 The Sunday Independent, 15 Oct. 2006 (p.11, Business) 20 These facts are taken from the London Stock Exchange's website. Of the companies listed on the Stock Exchange, 326 were overseas companies. For market value see Table 8. 21 AIM is the junior market for newstart companies that do not qualify for listing on the main exchange. See note Table 15. 22 This does not include debt. 23 Stock Exchange fact sheet.

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TABLE 5Market value of International companies listed on the London

Stock Exchange 1970-2004

0

500

1000

1500

2000

2500

3000

3500

4000

31.3.

70

31.12

.72

31.12

.74

31.12

.76

31.12

.78

31.12

.80

31.12

.82

31.12

.84

31.12

.86

31.12

.88

31.12

.90

31.12

.92

31.12

.94

31.12

.96

31.12

.98

31.12

.00

31.12

.02

31.12

.04

Year ending

Mar

ket v

alue

(£bn

)

The major source of funds for non-financial companies are internal funds which far exceed the other sources of funds (loans, bonds and shares) as the following two Tables illustrate. TABLE 6

0

10

20

30

40

50

60

70

1970-79 1980-89 1990-2001

Buckle & Thomson, The U K financial system ( 2004), at 94

Perc

enta

ge o

f tot

al

Internal fundsUK loansCorporate bondsOrdinary sharesOverseas funds

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The London Stock Exchange is the fourth largest stock market in the world, and the third largest in terms of turnover.24 TABLE 8 Domestic equity markets, 2005 Domestic

market Capitalisation (£ billion)

Share of world total (%)

Market Capitalisation/GDP (%)

LSE 1,773.7 7.5 143.4

Deutsche Boerse 708.2 3.0 44.4

Euronext 1,569.9 6.6 85.1

Nasdaq 2,090.3 8.8 144.8

NYSE 7,720.1 32.6 144.8

24 Buckle & Thompson, op. cit., at 164.

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Since privatisation, the state plays virtually a non-existent role as an

economic actor in the private corporate field. Privatisation has "reduced the contribution of government-owned companies from 12% of UK GDP in 1979 to less than 2%" in 2006.25 Institutional investors (pension funds, insurance companies, collective investment schemes and life insurance companies) dominate the market. Since the 1960s individual share ownership has dropped from 50% to under 20%. The facts are clear:26

TABLE 9 2004: Ownership of listed firms

25 Glyn, Capitalism Unleashed, at p.38. 26 Institutional Investment in the United Kingdom (Myners Report, 2001), at p.27.

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TABLE 10 Changing owners of UK Plc

Another significant feature of the UK market (in fact world markets) are share buy backs. These probably indicate that managers are signalling that they consider their stock to be is undervalued by the market and thus they constitute significant market information from insiders. Also, worldwide, buy backs are a corporate distribution mechanism. In the UK the facts are27:

"Since 1995, buy back activity has been booming in the UK – listed companies have already spent £45 billion repurchasing shares here this year (against £32 billion last year and £9 billion in 2000). The figure for 2000 was a 600% increase on the total value of UK buy backs in 1995. By year end, UK companies will have returned close to 3.5% of their total market capitalisation via buy backs (i.e. about the same amount as they pay in dividends)."

The following table sets out buy back activity in the US and other countries:

27 Statistics provided by Greg O'Mahoney, one of my graduate students.

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TABLE 11 Buyback activity in US vs other countries

There are a number of reasons for the increase in buy back activity.

The market expects dividend policy to be consistent and, because of this expectation, buy backs offer companies greater flexibility as compared with dividends as a means of shareholder return. A dividend reduction or non-payment produces adverse market reaction, whereas buy backs can be suspended, cancelled or not repeated without the same adverse effect. Buy backs are a means of returning cash without committing a company to do so indefinitely. There are tax advantages, dividends are taxed as income, whereas gains on shares sold in buy backs are treated as capital gains which are more favourably treated for tax purposes. Also, buy backs help managers to achieve remuneration targets. Buy backs (contrary to finance theory) raise a company's EPS even if profits are flat and a company's EPS will often be a factor in the determination of senior management's remuneration. A buy back can be used as a take-over defence, in that if existing controller-shareholders do not participate in the buy back they will increase their percentage holding with the consequential protective effect that this provides against hostile bids. Institutional Investors

A primary factor in the functioning of the UK stock market has been the growth of institutional investment.

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TABLE 12 The institutionalisation of the UK equity market End Year

Institution 1963(%) 1975(%) 1981(%) 1989(%) 1994(%) 1997(%) 1998(%) 1999(%)

Pension funds 6.4 16.8 26.7 30.6 27.8 22.1 21.7 19.6

Insurance companies

10.0 15.9 20.5 18.6 21.9 23.5 21.6 21.6

Unit trusts, investment trusts & other financial institutions

12.6 14.6 10.4 8.6 10.1 10.6 9.0 9.7

Banks 1.3 0.7 0.3 0.7 0.4 0.1 0.6 1.0

Total UK institutions

30.3 48.0 57.9 58.5 60.2 56.3 52.9 51.9

Individuals 54.0 37.5 28.2 20.6 20.3 16.5 26.7 15.3

Other personal sector

2.1 2.3 2.2 2.3 1.3 1.9 1.4 1.3

Public sector 5.1 3.6 3.0 2.0 0.8 0.1 0.1 0.1

Industrial & commercial companies

5.1 3.0 5.1 3.8 1.1 1.2 1.4 2.2

Overseas 7.0 5.6 3.6 12.8 16.3 24.0 27.6 29.3

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Pension schemes. A major feature of the UK securities market is the prevalence and strength of funded occupational pension schemes28. The following figure shows the holdings of the major private pension schemes29: TABLE 13 Larger UK Pension Funds 2004

28 Funded schemes involve contributions from both employer and employee. The growth of private pension schemes reduces the burden on the state to provide state pensions and as a matter of social policy in the UK pension provision is seen as being partly a private sector responsibility. 29 P&I/Watson Wyatt World 300, http://www.pionline.com/page.cms?pageId=530

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In European terms, pension assets are relatively large in the UK as a proportion of GDP:

TABLE 14

Pension assets relative to GDP for European countries

Fund $ billionBT Group 56,969British Coal Pension Scheme 41,672Universities Superannuation 41,198Electricity Supply Pension 34,380Consignia Pension Schemes 31,628Shell Contributory Pension 27,499Royal Bank of Scotland Group 26,436Railways Pensions 26,431Scottish Public Pensions 23,650Lloyds TSB Group 22,467BP 22,380Barclays Bank U.K. 21,489Lattice Group 20,978British Airways 20,969BAE Systems Pension Scheme 18,877Corus U.K. 15,492HSBC Bank 15,024

14

020406080

100120140

of GDP

Also, in world terms, UK pension holding in equity are relatively substantial.

TABLE 15Equity holdings by pension funds in 1999

0

10

20

30

40

50

60

70

80

US Japan Australia Netherlands UK

Country

% o

f por

tfol

ios i

n eq

uitie

s

International EquitiesDomestic Equities

Myners, op. cit., at para. 1.20

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There are other significant "institutional investors"; life insurance companies, collective investment schemes such as unit trusts, and OEICs,30 investment trusts, and life insurance companies. Because of historically high records of inflation, institutional investors adopted the policy of investing in equity rather than debt. Unit trusts and OEICs. The following Table sets out as of 1999 the value and growth of collective investment schemes:

TABLE 16Growth in authorised funds under management

0

50

100

150

200

250

300

1992 1993 1994 1995 1996 1997 1998 1999

Year

Val

ue (£

bn)

1999 prices

The top ten UK unit trusts/OEICs managers were:

30 Open Ended Investment Companies, these are open ended collective investment schemes that use the corporate form: see Open-ended Investment Companies (Investment Companies with variable capital) Regulations (SI 1996/2827).

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TABLE 17

Investment trusts. Also of importance with respect to institutional investing are investment trusts. Investment trusts are closed-ended investment vehicles that take the form of a company which invests in other companies.31

31 Of course other institutions will invest in investment trust companies. It has been estimated that two-thirds of investment in investment trusts is institutional: see Myners, op. cit., at para. 1.37.

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TABLE 18Market capitalisation and total assets of investment trust

industry

0102030405060708090

100

1992 1993 1994 1995 1996 1997 1998 1999

Myners, op. cit . at para. 13.8.

Valu

e (£

bn)

Total assets (1999 prices)

Market capitalisation(1999 prices)

TABLE 19 Largest investment trusts

Myners, op. cit., at para. 1.41

Trust Name Manager Total Assets (£m) Foreign & Colonial Foreign and Colonial 3126 Witan Henderson Global Investors 2051 Alliance Alliance 2020 Scottish Mortgage Baillie Gifford 1918 Edinburgh Investment Edinburgh 1797 Scottish Investment Trust Scottish Investment Trust 1569 Fleming Mercantile Chase Fleming 1157 Monks Baillie Gifford 923 RIT Capital Partners Rothschild J 840 Merrill Lynch European Merrill Lynch 835 Fleming Japanese Chase Fleming 823 Murray International Murray Johnstone 770 Fleming Overseas Chase Fleming 749 Govett Strategic Govett 722 TR European Growth Henderson Global Investors 710

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Life insurance. Life insurance companies are also substantial market investors. Life insurance as originally conceived was a means of providing for a policy holder's dependants but it has evolved into a saving and investment business.

0

200

400

600

800

1000

1200

Value (£bn)

TABLE 20The growth of life insurance assets 1989-1999

1999 …

Myners, op. cit., para. 1.22

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TABLE 21 Major life insurance companies 1999

Group Assets (£bn) Share (%) Prudential 113.2 12.8 Legal & General 93.7 10.6 CGNU 88.1 9.9 Standard Life 61.4 6.9 Lloyds TSB 58.0 6.6 AXA 44.1 5.0 AMP 37.6 4.2 Zurich Financial Services 35.4 4.0 Equitable Life 32.6 3.7 RSA 29.7 3.4 Friends Provident 29.2 3.3 Barclays 27.5 3.1 Halifax 23.3 2.6 Aegon 21.3 2.4 CIS 19.7 2.2 Royal London 17.2 1.9 Britannic Assurance 14.7 1.7 Abbey National 14.7 1.7 Scottish Life 9.1 1.0 Scottish Provident 8.7 1.0 Sun Life of Canada 8.6 1.0 National Westminster Life 8.2 0.9 Windsor 7.2 0.8 Canada Life 6.9 0.8 Skandia 5.8 0.7

Myners, op. cit., para. 1.26

Blockholders

There are very few blockholders in the large listed companies, shares are widely dispersed.

20

TABLE 22 Blockholders

TABLE 23 Shareholdings dispersed in UK Plc: Percentage of shares controlled by top, top 5 and top 10 shareholders*

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Listing London Stock Exchange (LSE). It is not proposed to go into listing in any great detail.32 To be listed on the main market (the LSE) the following conditions apply:33

• Minimum of 25% of the listed shares must be in public hands • Normally a three year trading record required • Prior shareholder approval required for substantial acquisitions and

disposals • Pre-vetting of admission documents by the UKLA • Minimum market capitalisation (£700,000 for shares and £200,000 for

debt) • It is also necessary to provide details of the experience and expertise of

the company's directors • Sponsors needed in connection with the listing application

Alternative Investment Market (AIM). There is a secondary London market, AIM, which is designed to provide market access for companies that lack the commercial pedigree or size to be listed on the LSE – it is for smaller growing companies both national and international. AIM is a substantial market which in 2005 had a market capitalisation of approximately £50,000 million.34 TABLE 24

32 See Listing Rules, Conditions for Listing, UKLA. The rules are extensive and it would not be possible to go into them in detail. 33 On being admitted to the LSE, a company will have to comply with the listing rules that are extensive. 34 Joining AIM: A Professional Handbook (2005, White Paper) at 8.

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The significant features of AIM are:

• No minimum tranche of shares has to be in public hands • No trading record requirement • No prior shareholder approval for most transactions35 • Admission documents not pre-vetted unless a prospectus is to be used

for EU passport purposes • No minimum market capitalisation • It is necessary to have a nominated adviser (a "nomad")36 to guide and

monitor the company that is listed on the exchange Although AIM is designed to enable companies that do not have the size or pedigree to participate in the main market, there is substantial institutional investment in the market as the following Table shows. TABLE 25 Institutional Investor

# of Investments

Investments (US$M)

Institutional Investor # of investments

Investments (US$M)

Fidelity 113 $1,212 Gartmore 65 $343 Artemis 94 $790 Tiger Resource 3 $328 Schroder Invt Mgmt

45 $596 Jupiter Asset 44 $316

Foreign & Colonial

112 $525 Landsdowne 20 $293

Merrill Lynch 46 $428 Aviva 39 $284 UBS 38 $396 JPMorgan 36 $272 Framlington 56 $389 Prudential 28 $241 Invesco 51 $388 Henderson Global 28 $203 Goldman Sachs 46 $365 Deutsche Asset 21 $186 RAB Capital 58 $359 Morgan Stanley 20 $182 Source: London Stock Exchange, Trade Statistics, December 2005 Figures converted at a rate of £1.00 = $1.75 Debt market. There is an active secondary corporate bond market, which includes government bonds ("gilts").37 The characteristics of this market, as compared with the equities market, are:38

35 Reverse takeovers and substantial disposals do require shareholder approval. 36 There are proposals to tighten up certain regulatory aspects of Aim: see Financial Times, October 2, 2006, pp.21 and 22. On admission a company will be subject to AIM Rules set out by the LSE: see Canaccore Adams, AIM: A Global Financing Alternative for Small-Cap Companies, at p.03. 37 See Trading transparency in the UK secondary bond markets (FSA, Sept. 2005) 38 Ibid., at para. 1.15.

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(a) a very large population of less liquid or illiquid bonds (b) a relatively large average trading size and low trading frequency (c) the short life liquidity of many bonds (with relatively active turnover in

the first few days or weeks following a new issue but a rapid decline in trading activity thereafter)

A central feature of the market is dealer-provided liquidity, unlike equity, which is electronic order-book trading.39 What is interesting is the current very low participation of retail investors in this market. It is estimated that "just 1% of UK households are direct holders of UK government securities (gilts), and even fewer hold corporate bonds".40 However, individuals invest in collective investment schemes which invest heavily in the government and corporate bond market41, and accordingly individuals are indirect participants. There appears to be a growing appetite for corporate bonds and this has given rise to regulatory concerns.42 Regulatory Reform Securities Markets. The major driver in the development of the securities markets has been the growth of institutional investors and their investment policy of investing significantly in equity. Coupled with this, there has been a fundamental organisational restructuring of the market. The latter involved two significant events. The Reforms of 1986.43 The 1986 reforms were designed to create a competitive market in securities trading. In 1979 the then Conservative Government referred the rulebook of the London Stock Exchange to the Restrictive Trade Practices Court (the cartel court). The Stock Exchange rules had a number of anti-competitive features. For example, there was an agreement regulating commissions and this, importantly, was not only opposed by the government but also by the institutional investors who, as large investors and repeat players, were antipathetic to fixed minimum commissions. There was also a separation between jobbers and brokers, the former executing the orders and a the latter placing the orders, dual capacity was not permitted. There were also restrictions on foreign ownership of stock broking firms. An

39 Ibid. 40 Ibid., at para. 2.13. 41 Ibid. It appears that in 2003 Italian households' direct investment in bonds accounted for 42% of total Italian retail savings and investments during 2003. Why the difference? 42 See Financial Times, 13 Oct. 2006, at 19. The concerns mainly relate to transparency with respect to the terms of covenants, breach of covenants and waiver of covenant breach, those close to the market will be aware of these but not retail investors. 43 Financial Services Act 1986.

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associated factor was the growth of American Depository Receipts (ADRs). American financial institutions created trusts of UK companies' shares and then issued the beneficial interests in the trust but not, of course, the underlying security. This, among other things, enabled American charitable institutions and endowments to invest in the ADRs which were American investments (i.e. an American trust interest) and thus they could comply with restrictions on the scope of their permissible investments requiring them to invest in American securities. However, dealing in New York was cheaper than in London and ADR business involving the securities of English companies moved to the USA. Post 1986. The 1986 legislation set up a regime which was highly legalistic, involved a strong element of self-regulation for the different sectors of the financial and securities markets. Regulation was thus specialised and informed as regards different types of financial institution and activity, and involved functional supervision by different regulatory bodies who dealt with the discrete aspects of financial market activities.44 This type of supervision was, however, highly fragmented. Because of the development of financial conglomerates it was perceived as being inefficient as a financial conglomerate would need to register with, and be supervised by, different regulators. It was also in many ways organisationally incoherent as there was a complete blurring between financial products and accordingly functional supervision made little sense45. What was considered to be needed was a regulatory structure that provided a more coherent regulatory focus. It was because of these perceived shortcomings that the UK enacted the Financial Services and Markets Act 2000 which made provision for a single financial markets regulator, the Financial Services Authority ("FSA"). As has been rightly stated,46 the FSA is probably "the broadest financial regulator in the world; combining prudential, conduct of business and market conduct regulation across the full range of financial services, including banking, securities, investment management and insurance". There is thus a single regulator for all financial products and financial trading activities. Growth of technology. The third factor in the development of the Stock Exchange has been the increased sophistication and use of technology. The Stock Exchange has moved to an order-driven auction market for the FTSE

44 For example, securities trading, banking, insurance, etc. were subject to different regulators. See, Spencer, The Structure and Regulations of Financial Markets (OUP, 2000), at pp.37-39, 241-245. 45 See commentary on life insurance, supra. 46 Briault, The Rationale for a Single Financial Services Regulator (FSA, OP2, 1999). See also Financial Services Authority v Fradley [2005] EWCA Civ 1183 at [3]: "The FSMA is a portmanteau statute dealing with all kinds of investment activity, not just activities in traditional investments such as securities", per Arden LJ.

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100 index, has attempted to provide a market for its more illiquid securities,47 and there is an electronic system for settlement.48 The major drivers for regulatory reform. There are a number of factors which explain the current UK regulatory structure of the financial markets. The initial, and critical factor, was the policy in the 1980s to dismantle the cartelised structure of the market. There has also been a drive to make the LSE a dominant world exchange. The result of this can be seen in the relationship of market capitalisation to GDP.49 A telling example of the determination to protect the position of the LSE is the recently introduced Exchange and Clearing Houses Bill 2006. This is designed to protect the LSE, should it be acquired by a foreign stock exchange, for example, an American exchange, against the possibility of the application of the law of the foreign acquirer's jurisdiction. There is the possibility that the acquiring exchange could be obliged to export its regulatory constraints and apply them to the LSE and accordingly to companies listed on the exchange. In other words, acquisition of the LSE by a foreign exchange would not only result in a change of ownership of the LSE but also in a change of the law applicable to the Exchange's operations. For example, if the LSE were to be acquired by NASDAQ there is the risk that the USA regulatory authorities would compel NASDAQ to comply with their regulations as regards any exchanges that NASDAQ controlled.50 The Exchange and Clearing Houses Bill 2006 empowers the FSA to direct that a proposed alteration to the rules of a recognised stock exchange which is "excessive" or "disproportionate" must not be put into effect. Broadly what this is designed to ensure is that the LSE regulatory regime will reflect UK and Community regulatory standards.51

There are other factors which the LSE exploits: it possesses a large and deep pool of capital, an open and transparent market, and industry expertise because of the "clustering" of companies in particular market areas. The corporate governance structure established by the LSE for listed companies is also vitally relevant; the UK is "ranked as the leading country in terms of corporate governance".52 Also, the LSE has benefited from "regulatory

47 See Overview of Markets and Data (London Stock Exchange). 48 See Buckle & Thompson, op. cit., at pp.168-170. Of course, other EU bourses have also moved in this direction. 49 See Table 2 (CHECK) 50 NASDAQ has made a bid for the LSE: see Financial Times, 21 Nov. 2006, p.1. Also, this does not raise long arm jurisdiction issues as the US regulator would be regulating an entity subject to its jurisdiction by reason of residence. 51 How to protect City from US-style red tape put on fast track, Financial Times, Nov. 13, 2006. 52 The Cost of Capital An International Comparison (Oxera, 2006), at 5. This is due to the Combined Code on Corporate Governance (Financial Reporting Council, June 2006). Companies listed on the main exchange have to comply with this Code or explain why they

26

competition". For example, in the IPO market, "London tops the IPO table":53

TABLE 26 Market Performers IPO value in first three quarters of 2006 LSE €15.2bn NYSE €13.3bn Nasdaq €8.9bn Euronext €4.6bn AIM €4bn Deutsche Borse €4bn This relative success as compared with the world's major exchanges, NYSE and NASDAQ, is attributed to the Sarbanes-Oxley Act in the US and the more rule based regulatory structure which prevails in the US as opposed to the more principle based structure of the UK. Lastly, there is considerable market innovation.54 Influence of crisis. To the extent that crises have influenced regulatory reform, this has had to be analysed in three respects as regards the UK: (i) market structure, (ii) product design, (iii) consumer protection - inappropriate financial products being sold to investors.

(i) Market structure. This involves the issue of whether the market structure is in some way deficient (market failure) and regulatory intervention is needed. A major driver for reform of the structure of the UK financial market was the anti-competitive structure of the market, arguably the purest form of market failure.55 The growth of multi-functional financial institutions also obviously creates problems particularly with respect to market abuse; for example, with respect to information controls corporate advisory should not pass on confidential information to market trading. There are other issues that

do not. The Code sets out extensive provisions with respect to board structure and director's responsibilities. 53 Observer, Business, (12.11.06), at 38. 54 The two most important recent developments have been hedge funds and private equity: see Hedge Funds and the FSA (2002, FSA); Private Equity: a discussion of risk and regulatory engagement (2006, FSA). 55 XXX

27

have been the subject of debate and regulation with respect to market structure. One such issue is investment research and conflicts of interest.56 In one study it was found that the "proportion of 'buy' recommendations made by firms acting as corporate brokers/advisor to the subject company (FTSE 100 companies) is, at 80%, almost twice as high as the proportion of 'buys' where an analyst does not work for a corporate broker".57 There is a vast range of regulatory and statutory rules and principles58 which are designed to deal with abuse that could arise from market structures, this creates a considerable regulatory intensity but it probably has been effective.59 (ii) Product design. There may be certain financial products (broadly defined) that are simply so complex that, no matter what the level of disclosure, "consumers may be unable to make sensible investment decisions because they are unable to grasp the key risks presented by the product".60 There are also the issues of volatility and illiquidity but these, although rightly identified as separate issues, are ultimately factors that go to complexity. A UK example of a complex investment that was unsuitable for the retail market is arguably the split capital investment trust (Splits). A Splits was an investment trust with a basket of different types of securities: (i) zero dividend preference shares, (ii) income shares, and (iii) capital shares. It was described as:61

"An investment trust with more than one class of share. Zero dividend preference shares (Zeros) have a target redemption value to be paid to shareholders on a set date in the future, as long as the Split has enough money. Income shares pay dividends. Capital shares do not pay an income or have a target redemption value. Their value will depend on how much money remains in the company after Zeros and Income shares have been redeemed and any borrowings repaid".

Splits proved to be something of a disastrous investment and the firms involved in promoting them agreed to compensate investors.62 Another example, of what might be considered an unsuitable product, would be hedge funds which currently can only be retailed to high

56 Conflicts of interest: Investment research and issues of securities (FSA, Oct. 2003). See also Coffee, Gatekeepers (OUP, 2006), chap. 7; Spencer, op. cit., at pp.127-132. 57 Investment research: Conflicts & other issues (FSA, July 2002). 58 Ibid., chap. 5. 59 See, e.g., FSA, Annual Report 2005/2006 at p.18. 60 Wider-range Retail Investments Products (FSA, 2005), at para.2.2. 61 Ibid., at p.4. 62 See Split Capital Investment Trusts (Splits), www.fsa.gov.uk/consumer/10_WHATS_NEW/ FIRMS/splits/mn_splitcaps.html

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value individuals or sophisticated investors.63 It is difficult to take a dogmatic position on the topic of product design, but the policy should be to permit retail trading in as wide a range of investments as possible provided there is adequate disclosure, and a risk matrix can be developed with respect to the product.64 (iii) Consumer protection. There have been a number of examples of systemic mis-selling, that is, a situation where the financial services industry has promoted inappropriate products, or there has been inadequate explanation of the risks of the product. There have been scandals, the two most important being with respect to endowment mortgages65 and pensions. The latter, pensions mis-selling, involved the pension industry persuading investors to transfer from occupational pension schemes to personal pensions which was often to the disadvantage of the investor. As a result of the mis-selling, the industry has paid £10 billion by way of compensation as of 1999, sacked or retrained their representatives, and moved from commission reward systems to a fixed salary/bonus system.66 As financial services are a credence good where the public "assess the long-run performance of the industry as a whole (essentially by relying on the law of large numbers) than to assess the quality of an individual supplier".67 The response of the financial services industry to this has been the (i) establishment of minimum standards and barriers to entry, (ii) monitoring, and (iii) industry compensation schemes.68 These control factors are partly industry driven and FSA driven.69

63 See supra, note 5. 64 This is not without its difficulties: see Kay, Amaranth and the limits of mathematical modelling, Financial Times, Oct. 10, 2006, at 17. 65 See Progress Report on Mortgage Endowments (FSA, Oct. 2000). An endowment mortgage is an interest-only mortgage with the capital sum being paid on maturity from investment of the mortgagor's periodic payments in an endowment. It is a long term investment and if the stock market fails to fulfil the expectations at the time the endowment policy is entered into, the value of the policy on maturity will not cover the mortgage debt obligation. 66 See Spencer, op. cit., at 35. 67 Ibid., at 34. A credence good is a good where its quality may never be established even ex post after the outcome is observed, for example, legal advice, or the advice of your dentist to have a filling ("ear to ear dentistry"): see Spencer, op. cit,. at 7; Bishop and Prentice, Some Legal And Economic Aspects of Fiduciary Remuneration (1983) 46 M.L.R. 289 (dealing with trustee remuneration where judging the quality of the advice of the trustee is difficult to assess). 68 See Spencer, op. cit., at 34-35. This also applies to other "credence good" providers, e.g., lawyers. 69 See FSA, High Level Standards, Principles for Business and the FSA Handbook (somewhat misnamed, 2 metres of paper) which provide extensive protection to investors.

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Ownership structure Meetings – shareholders and directors. As has been pointed out, institutions dominate the market for shares in listed companies. Shareholdings are widely dispersed.70 It is the registered member who has the right to vote and under current UK law a company "a trust of shares shall not be entered into a company's share register".71 This has important implications for shares held by a custodian who will be the registered member and it will be the custodian, not the underlying beneficial owner, who can exercise the rights of the shareholder. This will change to a minor extent when the Companies Act 2006 is brought into effect. Section 146 of the Act provides that where shares are admitted to a regulated market and are held on behalf of another person, for example, by a custodian, the member of the company, that is, the custodian, may nominate the other person to enjoy information rights.72 Also, as is often the case, a company's articles of association confer information rights on the non-member beneficial owner and a shareholder can always appoint a proxy.73 A theme of the Companies Act 2006 is technology in the operation of a company's affairs – this will result in the abandonment of "physicality" for corporate governance, namely, meetings and written records. The Companies Act 2006 makes extensive provision for electronic communications and the exercise of shareholder rights electronically.74 These provisions are somewhat detailed in nature but the eventual outcome is that over time shareholders will participate electronically in the affairs of listed companies. Listed companies must hold an annual general meeting, shareholders, provided they satisfy the relevant statutory criteria, can require directors to summon general meetings75 or require the company to circulate statements.76 The reality is that the agenda of meetings will be determined by the board, counter-proposals will not be forthcoming from shareholders and, because of proxy voting, the outcome of any meeting will be inevitable – confirmation of the board's proposals as shareholders normally cast their vote in favour of the board's recommendations. However, the annual general meeting is seen as having a disciplinary effect, it is the occasion on which the board has to account and the English financial press is very inquisitive.

70 See Gugler et al, Corporate Governance and Globalization, 20 Oxford Review of Economic Policy 129, Tables 13 and 14. 71 CA 1985, section 360. 72 These are defined in section 146(3). It is important to note that many institutional investors hold their shares through custodians: see Myners, Review of the impediments to voting UK shares (January 2004). 73 2006 Act, section 331. 74 See Schedules 4-6 of the 2006 Act. 75 2006 Act, section 310. 76 2006 Act, section 321.

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The board of directors' management powers are a function of the company's constitution. UK company law unlike, for example, the US, does not statutorily vest management jurisdiction in the board and it would be possible to vest management jurisdiction in the shareholders. However, articles of association of companies will invariably provide that "the business of the company shall be managed by the directors who may exercise all the powers of the company".77 Once this authority is vested in the board, the shareholders cannot instruct the board as to how they exercise their jurisdiction78 - the only options open to shareholders are to remove the directors79, or alter the board's jurisdiction clause in the company's articles. However, it is inevitable that management powers will be vested in the board as this recognises the professionalisation of management. Shareholder Rights Minority shareholders. This is a vast topic. The following only touches the essential. As pointed out earlier, the dominant shareholders in a listed company will be institutional. The institutions will expect a return on their investment in the form of dividend and capital gain and this will automatically accord a measure of protection to "private" minority shareholders as they will be entitled to parity of treatment as regards their rights. The general principle of UK law is that all shareholders must be treated fairly (as opposed to equally) but this still makes it difficult for the majority to make alterations to a company's constitution that reallocate entitlements in their favour to the disadvantage of the minority.80 There can be problems where a company wishes to delist as there will be no liquid market for the company's shares thus strongly prejudicing the minority. However, in this situation the problem, so far as it has manifested itself in litigation, has been that of minority hold out, the minority attempting to obtain an excessive amount for their shares.81 Companies can alter their constitutions, but this requires a special resolution (three quarters of those present and voting) and the majority must act "bona

77 Cite to draft of new Articles of Association for public companies. 78 Automatic Self-Cleansing Filter Syndicate Co. v Cunninghame [1906] 2 Ch. 34. 79 2006 Act, s. 169 (a majority shareholder can vote a director out of office and this power cannot be restricted). 80 Mutual Life Insurance Co of New York v The Rank Organization Ltd [1985] BCLC 11; Re BSB Holdings Ltd (No. 2) [1996] 1 BCLC 155. Both cases involved unsuccessful shareholder actions against corporate conduct which the shareholders considered prejudicial. 81 Rock Nominees Ltd v RCO (Holdings) plc [2004] 1 BCLC 439, (the minority's conduct referred to by the judge at first instance as "blackmail"). The phenomenon of minority shareholders "oppressing" the majority is not uncommon as in many corporate restructurings the majority will often want complete control and this places the minority in a hold out position. There can be perfectly valid commercial justifications for wanting complete control, and as a share is a claim to a future dividend stream the minority can be casted out at a fair value without causing them any prejudice.

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fide in the interests of the company".82 The control that this latter principle imposes is indeterminate but it is a significant constraint and limits the extent to which alterations could be made to the prejudice of minorities. Institutional shareholder collective action. Even with respect to institutional investors, there is a collective action problem. The institutions cumulatively will have considerable "voice" but individually they will not be so effective, and "exit" may not be an option as this could imbalance their portfolios and produce a fall in the value of their investment. To address this issue, the institutions have set up the Institutional Shareholders' Committee (the "ISC") which is composed of representatives of the major institutional trade associations.83 The ISC has set out its policy as to how its members will exercise their shareholder powers: this deals with the monitoring of companies, the strategy of intervention, the policy on voting, and their relationship with the board and senior management. Their policy provides inter alia:84 "3. Monitoring performance

Institutional shareholders and/or agents, either directly or through contracted research providers, will review Annual Reports and Accounts, other circulars, and general meeting resolutions. They may attend company meetings where they may raise questions about investee companies' affairs. Also investee companies will be monitored to determine when it is necessary to enter into an active dialogue with the investee company's board and senior management. This monitoring needs to be regular, and the process needs to be clearly communicable and checked periodically for its effectiveness. Monitoring may require sharing information with other shareholders or agents and agreeing a common course of action. As part of this monitoring, institutional shareholders and/or agents

will:

• Seek to satisfy themselves, to the extent possible, that the investee company's board and sub-committee structures are effective, and that the independent directors provide adequate oversight; and

• Maintain a clear audit trail, for example, records of private meetings

held with companies, of votes cast, and of reasons for voting against 82 See p.38. 83 The current membership is the Association of British Insurers, the Association of Investment Trust Companies, the National Association of Pension Funds and the Investment Management Association. 84 Institutional Shareholder Committee – The Responsibilities of Shareholders and Agents – Statement of Principles (Sept. 2005).

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the investee company's management, for abstaining, or for voting with management in a contentious situation".

For example, a topic on which the institutional shareholders have been

active is with respect to pre-emption rights. UK institutional investors see pre-emption rights as an important property right in that it prevents the transfer of value from existing shareholders to new investors.85 To protect their rights they support the activities of the Pre-Emption Group which broadly is an institutional investors group which sets out the guidelines as to the circumstances in which its members as shareholders will agree to an issue of shares on a non-pre-emption basis. Under these guidelines they will normally agree to disapplication of pre-emption rights where the share issue is no more than 5% of the company's issued share capital in any one year and not more than 7.5% in any rolling three year period.86 Another (unarticulated) reason for insisting on pre-emption is that it provides the shareholders with a considerable disciplinary weapon, the "price" to the company of additional equity financing could be management or policy change,87 as the need to raise new equity under a strict pre-emption regime places the shareholders in a commanding position. Voting rights. English company law does not mandate that voting rights be attached to a share, there is no requirement of one vote per share88. There is a range of techniques that can be used to confer differential voting rights: (i) multiple classes of shares where the classes have different voting rights, (ii) voting right ceilings which limit the number of votes exercisable by a single shareholder, for example, irrespective of the number of shares held, a shareholder can only exercise X number of votes, (iii) non-voting shares, (iv) golden shares which, for example, enable the holder to block a change of ownership or other shareholder actions,89 or (v) shares that can only vote in specified circumstances, for example, preference shares with voting rights only where there has been a failure to declare a dividend. The justification for permitting differential voting is that there should be freedom of contract and shareholders holding non-voting shares will not be disadvantaged as the price paid for the shares will reflect the fact that the shares are voteless. Also, voting 85 See reports cited in note 8. See also Principles, Pre-Emption Group Principles: "Pre-emption rights are a cornerstone of UK company law and provide shareholders with protection against inappropriate dilution of their investments". 86 See Principles, rules 8 and 9. 87 The other articulated argument in favour of pre-emption is the prevention of the dilution of voting control but this plays a very marginal role given the volume of new cash equity offers that would have to be made to reduce institutional shareholders control and, also, has to be premised on the basis that the institutions would not through the market be able or attempt to maintain their percentage of holdings. 88 See Are dual-class shares your cup of tea?, Financial Times, 13 Nov. 2006, at 19. 89 An example would be a "golden share" that blocks the takeover of a Stock Exchange.

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restrictions facilitate the retention of family control and enable the holders to take a long-term view of the company's business. Non-voting shares do present a potential for minority shareholder oppression but this, to a great extent, is minimised by the strong minority oppression remedies provided by English company law.90 Shareholder rights and minority protection. The rights of shareholders are predominantly a function of a company's constitution. A company's constitution constitutes a contract between the company and its members and the members inter se.91 Rights are vested in shareholders individually but shareholders can enter into binding shareholder agreements92 and certain acts, such as an alteration to the company's constitution, require shareholder collective action93. The major shareholder rights, the right to vote, the right to dividends and the right to a return of capital on the dissolution of the company, will be set out in the company's constitution. A company can issue debt, this cannot entitle the debt holder to participate in shareholder meetings but it could entitle the debt holder, for example, to appoint a director. A share is perceived as an item of property the rights to which a shareholder can exercise in his own economic self-interest.94 This has been made subject to an important qualification by section 239 of the 2006 Act. This provides that on a resolution of the shareholders to ratify a breach of duty by a director, a resolution is only effective if any votes cast by the relevant director or any member connected with him are disregarded in determining whether there has been majority approval.95 English company law provides for strong minority shareholder right protection. The 2006 Act, as did its predecessors, enables a shareholder to petition for relief where the company's affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of the petitioner.96 Where the petition is successful, the court has extensive remedial powers,97 but the most common remedy is to order the oppressors, normally the majority shareholder, to purchase the shares of the minority at fair market value, in other words, the court order provides for exit.98 Although this remedy applies to all companies it is seldom (if ever) invoked with respect to public (listed) companies as shareholders can exit through the market which is 90 See ss. 961-965 of the 2006 Act. 91 See s. 34 of the 2006 Act. 92 Puddephatt v Leith [1916] 1 Ch 200. 93 S. 21, 2006 Act. 94 North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589 (director could vote as a shareholder to ratify his breach of duty as a director). 95 Under the previous law an interested director could vote his shares in the ratification vote: ibid.. 96 2006 Act, s. 961. 97 2006 Act, s. 963. 98 See Shareholder Remedies (Law Commission Consultation Paper 142), Appendix E.

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the remedy normally granted by the courts under the minority protection provisions; the majority purchase the shares of the minority at a pro rata value rather than a discounted value, that is, the market price.99 Majority shareholders do not owe minority shareholders any fiduciary duty. However, if the majority alter the company's constitution they must act bona fide in the interests of the company.100 This is a very diffuse test and it is difficult to give it a precise meaning.101 What is clear is that it does not preclude an alteration to a company's articles of association that causes commercial disadvantage to minority shareholders.102 However, it would preclude an alteration to a company's constitution which enabled the majority to acquire the shares of the minority even at a fair value. Gombotto v WCP Ltd illustrates the issue103. In that case IEL held 99.7% of the shares of WCP. The constitution of WCP was altered so that any shareholder who held 90% of WCP's shares (this was obviously IEL) could acquire compulsorily the shares of other shareholders at a price of $1.80 per share. It was agreed that the fair market value was $1.36, so there was a significant premium. The alteration to the constitution was carried by the votes of the minority shareholders, the majority shareholders abstained from voting; thus 75% of the ·3% minority shareholders voted for the alteration empowering the compulsory acquisition of their shares. The justifications for the change, which were not disputed, were tax savings and administrative efficiency. The alteration was challenged by holders of 15,898 shares (the issued share capital of WCP was 16,929,441 shares) approximately ·1%. The court held that an alteration authorising expropriation could only be justified if there was some good corporate reason for doing so and, on the facts of the case, there was no such justification. Although an Australian case, Gambotto is generally accepted as reflecting English law. What it embodies is a strong "proprietary" perception of the nature of a share, a share is not simply a nexus of contracts, but an item of property. It is possible, however, to perceive a share "as a 'capitalised' dividend stream which entails that, provided the compensation paid to a shareholder being expropriated results in no diminution in his investment return as compared with holding on to the share, there has simply been no prejudice".104 Also, in the case of listed companies the Listing Rules require equality of treatment for all shareholders: "A company having listed shares must ensure

99 See Prentice, The Theory of the Firm: Minority Shareholder Oppression: Sections 459-461 of the Companies Act 1985 (1988) 8 OJLS 55. 100 Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656. 101 See Constable v Executive Connections Ltd [2005] 2 BCLC 630. 102 Greenhalgh v Arderne Cinemas Ltd [1957] Ch 286 (diminution in the pre-emptive rights of shareholders). 103 (1995) 16 ACSR 1. See Prentice, Alteration of Articles of Association – Expropriation of Shares (19960, 112 L.Q.R. 194, at 199. 104 Prentice,

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equality of treatment for all holders of such shares who are in the same position".105 Disclosure of shareholder voting: institutional investors. There has been much discussion on compelling large institutional investors to disclose the manner in which they exercise their voting rights, the argument being that economic power implies obligation, many shares are held on behalf of others who are considered to have an entitlement to have their interests protected by the exercise of votes and voting can, it is claimed, enhance the value of shares106. The Companies Act 2006 enables regulations to be enacting obliging institutions to disclose information relating to the exercise of their voting rights.107 The regulations can cover, inter alia, (i) institutions to which the obligation applies, (ii) shares to which the obligation applies, and (iii) the information that has to be provided:

(i) Institutions to which obligation applies. The institutions to which the obligation can be made to apply are institutional investors such as unit trusts, pension schemes, investment trust companies, OEIC and companies carrying on long-term insurance business.108

(ii) Shares to which obligation applies. The obligation can be applied to shares traded on a specified market.109 What is interesting about the definition of the classes of shares with respect to which voting disclosure can be required is that it can cover interests in shares held by way of depository receipts or under a collective investment scheme.110 Thus where the institutions subject to the regulations hold shares through another investment vehicle (which is not uncommon) the regulations can require them to disclose the voting of these vehicles.

(iii) Information that has to be provided. The relevant regulations can make provision requiring disclosure of the way in which shares are voted, instructions given by the institution as to how its shares are to be voted and, where votes are exercised on the instructions of another person, exactly what these instructions were.111

105 Listing Rules, rule 9.16. See also Directive 2001/34/EC, Article 65. 106 See Company Law reform: disclosure of shareholder voting, (PLC, Volume XVII, June 2006). 107 2006 Act, sections 1241-1245. See also policy of the Institutional Shareholders Committee, supra, at XXX-XXX. See Nolan, Indirect Investors: A Greater Say In The Company (2003) JCLS 73. 108 2006 Act, s. 1242. 109 The market will be specified in the regulations but they will obviously cover shares listed on major stock exchanges. 110 2006 Act, s. 1245. 111 2006 Act, s. 1244.

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Litigation. This involves two separate issues (i) private litigation and (ii) litigation and investigation by the regulatory authorities. Private litigation: The starting point for understanding the role of litigation in the administration of civil justice in the UK is the "English costs rule", almost invariably the loosing party pays the winning party's costs as well, of course, as having to bear their own costs.112 Such a rule obviously acts as a strong disincentive to litigation. The UK system does not permit contingency fees but does permit conditional fees; conditional fees are the lawyer's normal fees, to be payable only on the successful outcome of the litigation, but can include an "uplift" above the lawyer's normal fee. The extent of the uplift is subject to regulation.113 Thus the lawyer shares the risk of failure but the client additionally bears the risk of having to pay the other party's costs. The general posture of English private law is that it is hostile to litigation.114 Shareholders litigation is uncommon in the UK.115 There is no substantial plaintiffs' bar because of the disincentive effect of the cost rules and any financial remedy will be in favour of the company in which the shareholder will only benefit pro rata. English statutory law now provides for a derivative action.116 Although this provides a clearer structure for the bringing of derivative actions, it will probably not lead to a substantial increase in shareholder litigation. As regards listed companies there is little litigation and the 2006 reforms will probably not alter this. Regulation and litigation by public authorities: The Department of Trade and Industry (the DTI) is the government department responsible for the oversight of corporate affairs. It carries out investigations pursuant to its investigatory powers under the Companies Act 1986,117 the power is not widely used but has deterrent effect. The DTI can also petition to wind up companies on public interest grounds.118 It can also seek the disqualification of directors on the grounds of their unsuitability to act as directors.119 A person can also be

112 The US rule is that normally each party bears their own costs. 113 See Chitty on Contracts (29th ed.) at para. 16.056; the maximum uplift is 100% of the lawyer's normal fees. 114 Cite To Atiyah and Summers [XXX]. 115 The position with respect to private companies is different where the structure of section 459 of the Companies Act 1985 (the minority oppression provision) makes litigation more possible because the remedies provide for exit and this is the normal remedy: see … . 116 See 2006 Act , Part 11, chap. 1. This is the first time that a derivative action is provided for by statute, previously it was by rules of court. 117 See xxx at 8. 118 Insolvency Act 1988, s. 124A. 119 See ibid., at pp. 36-40.

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disqualified from acting as a director (taking part in the management of the company) for up to fifteen years and it is a widely used regulatory sanction.120 Investor Protection

As regards the rights of investors, these are protected predominantly by the Financial Services and Markets Act 2000 ('FSMA'). FSMA provides the "individual" investor with an extensive range of remedies.121 Importantly, it enables the Financial Services Authority ('FSA') to seek restitution orders in favour of investors who have suffered a loss because of breach financial markets regulations.122 The FSA also has a vigorous consumer protection policy and it can, inter alia, impose financial sanctions on those who are in breach of financial market regulations.123 Disclosure Legislation. The Companies Act 2006 imposes extensive disclosure obligations on public companies; arguably the dominant regulatory theme of the Act, as with its predecessor, is disclosure. The IAS requirements apply. Public companies have to produce annual accounts which have to provide a true and fair view of the company's assets, liabilities, and financial position.124 The accounts have to be audited, circulated to the members, the holders of the company's debentures and every person entitled to receive notice of general meetings.125 There are special rules for quoted companies. For example, there are detailed requirements for such companies as to what has to be included in the directors' annual report.126 The matters on which disclosure has to be made cover: "(i) details of the company's capital structure; (ii) any restrictions on the transfer of securities;

(iii) details of significant direct or indirect holdings of the company's securities;

(iv) details of any person who holds securities that carry special rights with regard to control of the company;

(v) any restrictions on voting rights;

120 See 2005 Report, Table D1 (there was 1,317 disqualification orders in 2004-05). 121 S. 150 – referred to as "private persons" (section 150(5)). Generally the remedial structure of FSMA protects the individual investor and does not give rise to liability between market participants as it was considered that providing remedies to such investors would produce excessive litigation. 122 FSMA, s. 384. 123 Russen, Financial Services (OUP, 2006), Ch. 5. 124 2006 Act, Part 16, chaps. 1-4. 125 2006 Act, s. 426. 126 2006 Act, s. 959.

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(vi) agreements that may result in restrictions on the transfer of securities or on voting rights;

(vii) any rules on the appointment and replacement of directors, or on amendment of the company's articles;

(viii) the powers of the directors, including any relating to the issuing or buying back of shares by the company;

(ix) any significant agreements that take effect, alter or terminate on a change of control following a takeover bid; and

(x) any agreements for compensation for loss of office or employment as a result of a takeover bid."

Quoted companies have also to make available on a website their annual accounts and reports and any statement of preliminary results which it is required by the listing requirements to make. Access to the website must be free of charge.127 Listing rules. The listing rules of the LSE also impose on listed companies continuing obligations to make disclosure of significant company events. The listing rules contain specific obligations of disclosure, for example, alterations to capital structure128 or alterations in major share holdings.129 More importantly, are the general rules of disclosure. The listing rules provide: "General obligation of disclosure for companies

9.1 A company must notify the Company Announcements Office without delay or any major new developments in its sphere of activity which are not public knowledge which may:

(a) by virtue of the effect of those developments on its assets and

liabilities or financial position or on the general course of its business, lead to substantial movement in the price of its listed securities; or

(b) in the case of a company with debt securities listed, by virtue of the effect of those developments on its assets and liabilities or financial position or on the general course of its business, lead to substantial movements in the price of its listed securities, or significantly affect its ability to meet its commitments.

127 2006 Act, ss. 436-438. 128 Listing Rules, rule 9.10. 129 Ibid., rule 9.11.

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9.2 A company must notify the Company Announcements Office without delay of all relevant information which is not public knowledge concerning a change:

(a) in the company's financial condition; (b) in the performance of its business; or (c) in the company's expectation as to its performance; which, if made public, would be likely to lead to substantial movement in the price of its listed securities."

Enforcement. Company statutory reporting obligations are enforced by the DTI. For the year ending 2005, there were 4,558 prosecutions for failure to deliver annual accounts, and 2,266 prosecutions for failure to deliver annual returns, with convictions being obtained in over 50% of the prosecutions.130 Where there is default by the company in filing its statutory accounts a member or a creditor can seek a court order directing the directors to file the accounts but this right appears never to be invoked.131 The UK Listing Authority132 enforces the listing rules and it can impose a financial sanction or publish a censure where there has been breach of the rules.133 Also, there would be a strong likelihood that a company's advisors would cease to act if the company persisted in not complying with the listing rules. Breach of the listing rules does not give rise to an individual remedy. Thus, the normal mechanism for enforcing disclosure obligations is administrative intervention either by the DTI or the UKLA. Market for corporate control. Statistics. There is a very active M & A market in the UK.

130 2005 Report, Table D3. 131 2006 Act, s. 460. The reasons for this are probably under pressure the directors comply and there is no "material" benefit to a member or a creditor from a successful action. 132 This is the FSA. 133 Listing Rules, rule 1.8. The directors can also be fined or censured, see rule 1.9. Also, where listing particulars are defective offences may be committed under sections 83, 85 or 98 of FSMA.

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TABLE 27 Total number of M&A deals

TABLE 28 M&A value relative to GDP

41

The Takeover Panel Report for year ended in 2006 provides the following statistics on takeover activity:134

2005-2006 2004-2005

OUTCOME OF PROPOSALS

Successful proposals involving control 123 99

Unsuccessful proposals involving control 14 9

Proposals involving control withdrawn before issue of documents

4 2

10 4 Proposals involving minorities, etc. 151 114

The FSA estimated that:135

"In the first half of 2006 the total value of UK mergers and acquisitions was £69.bn, an increase of 40% on the same period in 2005. Buyout activity almost trebled in value in the first half of 2006 compared to the same period in 2005, reaching £34.4bn, or 50% of total M&A activity".

134 The Takeover Panel, Report and Accounts for the year ended 31 March 2006. These types of figures have been repeated annually. 135 Private equity: a discussion of risk and regulatory engagement (FSA, Nov. 2006) at para. 2.8.

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TABLE 29UK M&A Half Year Trend - Value

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

H1 2005 H1 2006

Val

ue (€

m)

UK Buyouts

Total UKM&A

Shares in a listed company must be freely transferable which makes a market for corporate control feasible.136 The City Code on Takeovers and Mergers. Take-overs are regulated by the City Code on Takeovers and Mergers (the Code). The principles of the Code, which are reflected in the 13th Directive,137 are:

(a) equality of treatment for all shareholders in a company subject to a takeover offer. General Principle 1 provides that "All shareholders of the same class of an offeree company must be treated similarly by an offeror". Thus, for example, if the terms of an offer are revised the shareholders who accepted the original offer before the revision must be offered the revised consideration.138

(b) directors are prohibited from taking any defensive action to

frustrate a bid. Principle 7 of the Code sets out the non-frustration principle:

"7. At no time after a bona fide offer has been communicated to the board of the offeree company, or

136 LSE, Listing Rules, r.3.15. This is also required by EU legislation: Directive 79/279/Eec, Schedule A, 11.2. 137 Directive 2004/25/EC. 138 City Code, rule 32.3.

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after the board of the offeree company has reason to believe that a bona fide offer might be imminent, may any action be taken by the board of the offeree company in relation to the affairs of the company, without the approval of the shareholders in general meeting, which could effectively result in any bona fide offer being frustrated or in the shareholders being denied an opportunity to decide on its merits."

Greater detail is given to this principle by Rule 21.1 of the

Code which provides:139 "21.1 When Shareholders' Consent is Required

During the course of an offer, or even before the date of the offer if the board of the offeree company has reason to believe that a bona fide offer might be imminent, the board must not, except in pursuance of a contract entered into earlier, without the approval of the shareholders in general meeting:- (a) issue any authorised but unissued shares or transfer or sell, or agree to transfer or sell, any shares out of treasury; (b) issue or grant options in respect of any unissued shares; (c) create or issue, or permit the creation or issue of, any securities carrying rights of conversion into or subscription for shares; (d) sell, dispose of or acquire, or agree to sell, dispose of or acquire, assets of a material amount; or (e) enter into contracts otherwise than in the ordinary course of business. The notice convening such a meeting of shareholders must include information about the offer or anticipated offer.

139 See also rule 37.3 on redemption of shares in the offeree company.

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Where it is felt that an obligation or other special circumstances exists, although a formal contract has not been entered into, the panel must be consulted and its consent to proceed without a shareholders' meeting obtained."

However, directors of the target are free to solicit a rival bidder

to come forward. In the case of a rival bid the target shareholders still have the final say in determining whether the bid is successful and, of course, a rival bid will increase the price to be paid to the offeree shareholders.

(c) The third important feature of the Code is the mandatory bid

principle, which is a very strong implementation of the equality of treatment principle. Rule 9.1 provides:

"(a) any person acquires, whether by a series of transactions over a period of time or not, shares which (taken together with shares held or acquired by persons acting in concert with him) carry 30% or more of the voting rights of a company; or (b) any person who, together with persons acting in concert with him, holds not less than 30% but not more than 50% of the voting rights and such person, or any person acting in concert with him, acquires additional shares which increase his percentage of the voting rights, Such person shall extend offers, on the basis set out in Rules 9.3, 9.4 and 9.5, to the holders of any class of equity share capital whether voting or non-voting and also to the holders of any class of voting non-equity share capital in which such person or persons acting in concert with him hold shares. Offers for different classes of equity share capital must be comparable; the Panel should be consulted in advance in such cases."

then such a person must extend offers140 to the holders of any

class of equality share capital whether voting or non-voting and also to the holders of any class of voting non-equity share

140 The terms of the offer are regulated by rules 9.3 – 9.5.

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capital in which such person or any number of the concert party holds shares.

Panel on Takeovers and Mergers. The Panel on Takeovers and Mergers (the Panel) is responsible for the content of the Code and its enforcement. Originally the Panel was a non-governmental body but subject to judicial review.141 However, because of the need to implement the Takeover Directive the Panel and the Code have been given a statutory foundation. The legislation replicates the predecessor structure of the Panel as regards it rule making powers,142 its enforcement powers,143 the imposition of sanctions,144 and the very limited scope for judicial intervention. Section 923(1) of the Companies Act 2006 provides that with respect to breaches of the Takeover Code which is now statutory:

"(1) Contravention of a rule-based requirement or a disclosure requirement does not give rise to any right of action for breach of statutory duty."

This precludes any action for damages by a person who claims to have suffered damage as a result of breach of the Code. The Panel can bring injunctive proceedings with respect to breach of the Code and it is specifically provided that, other than the Panel, no person "has a right to seek an injunction" to prevent a contravention 145. The justification for precluding any legal action by an individual for breach of the Code even thought it has been given a statutory foundation is to preclude litigation being used as a tactical ploy to frustrate a bid.146

141 R. v Panel on Take-overs and Mergers, ex p. Datafin Plc [1987] QB 815. Judicial review does not empower the court to review a decision on its merits but it can quash a decision of a public body which is wholly unreasonable. 142 2006 CA, ss. 909-911. 143 2006 CA, ss.910-913. 144 2006 CA, ss.919-920. 145 2006 CA, s. 922(3). 146 XXX