The DTI had four key objectives that were to be delivered by the Companies Act 2006:
To enhance shareholder engagement and a long term investment culture;
To ensure better regulation and a ‘Think Small First’ approach;
To make it easier to set up and run a company; and
To provide flexibility for the future.
The hardest questions, but ones that I received regularly during the course of the Companies Bill’s progress through Parliament (when I led for the opposition team on the Bill Committee), were will this Act work and will it be good for business? To me these questions encapsulate the objectives of the Act. If they can be answered in the affirmative then the Act will have achieved its objectives.
At 1,300 clauses long, covering a huge number of subject matters of varying novelty and complexity - the temptation is just to say - for the most part – yes, the Act does work and yes it is good for business. I do think it is an improvement on the 85 Act - although there are various issues where the jury is still probably out.
The Bill was designed to separate the private and public regimes and present the Act in a more user friendly way. The general feedback that I receive is that this has been accomplished - although, again, more comments are likely to come through following the recent October partial implementation.
I am sure that today’s conference will shed light on this issue – but I think it is fair to say that on some of the new areas, we need to wait and see, particularly where implementation is not until later.
Furthermore, despite the implementation SIs being amongst the most technically challenging that I have ever seen, it would be fair to say that I have not been receiving many complaints - which would seem to point to either an effective DBERR consultation or not many understanding the SIs.
That was of course until Stephen Timms MP announced on 7 November that most of the 1 October 2008 provisions will be put back to 1 October 2009. This has been poorly received by the business community.
Of course, other than facilitating home grown enterprise, the UK is undeniably now the location of choice for many international businesses. So, how is the new Act likely to affect our hard-won success?
If the Act does manage to have a positive effect on our competitiveness then it will be good for business and thus, at least partly, have achieved what I feel to be a key objective.
So I shall highlight some of the main issues that have arisen and some pointers for where the main pressure points are likely to be on the potential of the Act to be good for business.
Bureaucracy and Red Tape
The first point is that we will have to be very careful that the Act does not create more unnecessary red tape and bureaucracy. One feared outcome is the increase in the volume of paper which may need to be generated in relation to board minutes, for instance, evidencing that directors have properly promoted the “success of the company”.
These measures could make compliance with the law into more of a time-wasting tick-box approach not least because the Act does not give clarity as to how to evidence such decision making processes. Such moves would, I believe, not be well received by business.
Corporate Governance and regulation
With regard to the regulatory environment, it is important for the UK to recognise our strengths and work at maintaining them. For example, the UK’s “light-touch” regulatory approach was recognised during the course of the Act as key not only to attracting international businesses to Britain but also to stopping British businesses relocating offshore.
Britain is now generally seen by international investors as a more welcoming regulatory environment than the United States. During the lead up to the Companies Bill, the US passed the Sarbanes-Oxley and Patriot Acts. The wide criticisms of Sarbanes-Oxley coming out of the U.S. were helpful from our point of view in dispelling moves from the Unions and the Left to adopt a more prescriptive or “pluralist” approach to directors’ duties and corporate governance in the Act.
The UK is consistently the clear leader in global corporate governance rankings and our regulatory standards are ones to which many foreign companies apply - but we need to keep in mind - that this position needs to be worked at.
We need to be watchful that further regulation coming from pressures within Parliament or Brussels does not strangle or stifle innovation. There is still some cause for concern here as we wait and see how effectively the new duties of directors and the provisions relating to the Business Review work.
But, for the most part, the Act recognises that the right place for corporate governance is the Combined Code for main list companies - operating on its comply or explain principles. I therefore believe that in this regard the Act is good for business but that the position may require some rigorous defence in the future.
The Companies Act originally included provisions for the now defunct Operating and Financial Review which instituted a mandatory non-financial reporting regime for listed companies.
The Government proposed it, then they pulled it and then they half proposed it again and then finally amended the Business Review provisions in clause 417 only two days before the Bill’s final reading and then with hardly any consultation.
This I could see was no way to move ahead on promoting corporate responsibility in any sense of the term - let alone on a consensual basis. What ended up in the Act is a political fudge and requires clearer thought and policy.
I was therefore delighted when David Cameron asked me to form a Conservative Responsible Business Working Party to review this important area. And one of the basic things that this initiative is questioning is whether legislation and regulation are necessarily the best ways to institute improvements in responsible business practice? We hope to produce our report before the year end.
One of the lessons which I learnt from the shenanigans of the OFR review, was that while it was obvious that Government could retain the role of co-ordinator - promoting responsible business much more could productively come from business itself.
This issue is likely to form one of the key ongoing areas of political discussion in relation to the Act as there were many on the Labour benches who wanted a more prescriptive mandatory reporting approach. We supported a more measured and voluntary approach - looking to encourage best practice rather than drive standards down to the lowest common denominator and the tick box mentality implicit in mandatory reporting.
However, the Minister did announce that Government will review this issue in two years time - so it is very much a live issue. To that extent, I would hope that as voluntary corporate responsibility initiatives become increasingly widespread and more publicised, the culture of corporate responsibility, which would include voluntary reporting, will spread.
Corporations and professional practices that involve themselves in best practice CR now – will be ahead of the game – and I predict that this will become much more of an issue demanded from customers and clients in years to come. So if I leave you with a message today - can I suggest understanding and acting on CR now rather than waiting for Government imposed mandatory reporting.
In practice, many elements of CR will currently be carried out, even if not articulated, by your firms and your client companies. This is because good CR is invariably linked with good business and this approach should be complimentary to the basic premise, which is under attack from the left, that a company’s first duty remains to shareholders.
As I believe that to achieve its objectives the Act must be good for business I will now analyse some important themes relating to company members.
Shareholder’s rights
The Act represents a significant improvement in simplifying the process of general meetings and enhancing shareholder democratic rights, for instance in relation to proxies and written resolutions. There are certain new aspects though which are yet to be tried and tested, for instance the provisions relating to the practicalities of shareholders’ rights to require directors to obtain an independent report on any poll taken at a general meeting .
The question of shareholder security was not addressed in the Bill, until the Lords stages following opposition pressure, and then significant amendments were introduced mainly as a result of the activities of animal rights activists and so-called illegal share selling boiler rooms, which some of you may unfortunately have experience of.
It was however decided by Parliament not to go down the route of restricting access to companies’ registers of members, in an attempt to maintain the good traditions we have of shareholder transparency.
The new provisions, in clauses 113-121 which came into effect in October 2007, therefore have a presumption of access - with companies then having the right to ask the court to restrict access. However, the complimentary provisions which will provide that companies will only have to notify significant shareholders in their annual return have not yet come into effect.
However, under transitional arrangements, the 85 Act provisions continue to apply to requests for a copy of or to inspect a company’s register of members until the company has submitted an annual return made up to a date after 30 September 2007. How these provisions will work in practice will be interesting and perhaps today’s conference will provide some insight into how they are being dealt with.
I understand that this impracticality is due to Companies House needing what I calculate to be some 27 months to reset its systems. This, by the way was the same reason given as to why directors’ historic home addresses could not be deleted - despite the director being allowed on to the private register.
And this again is the reason for most of the delayed October 2008 implementation to 2009. Frankly, I do not see this as good enough. I return here to the key objectives – in order to meet those objectives the Act does, of course, have to work in practice.
The Government also conceded to pressure from investors and opposition parties introducing what is now Part 9 of the Act to give voting and information rights to beneficial owners of fully listed shares who are not on the shareholder register because their shares are held in the name of a nominee.
We calculated at the time that over 50 per cent. of all private shareholdings were administered by nominees which corresponded to an estimated Ł100 billion worth of share capital. That meant, in our age of PEPs, ISAs and CREST, that individuals had increasingly lost their rights in the companies in which they had chosen to invest their money. We strongly believed that the law should reflect the modern status of beneficial holders.
However, the details of how these provisions will work do involve a degree of complexity and I think we will need to keep an eye on whether further regulations will be required to achieve the desired effect here.
Myners SVWG Group Report
Whilst supporting shareholder rights Clause 1277, providing enabling legislation for institutions to declare how they vote their shares, was opposed by us in the House and whilst we fully support and encourage institutions being transparent and see this as a way of promoting shareholder democracy - a voluntary approach is preferable to our minds.
I was therefore pleased to see Paul Myners’ fourth report to the Shareholder Voting Working Group (SVWG) of this July concluding that considerable progress was being made by participants in the voting chain.
He noted that more votes are being cast - voting levels now exceed 60% in PLCs - and that more consideration is given to voting at Company meetings. He recommended companies should carry out tracing exercises in relation to their 2007 AGMs to determine where votes were lost.
I can say that promoting share ownership, shareholder participation and voting transparency are important issues for the Conservatives and so between us and the Government, I would say that you should expect what is in the Act to be a step rather than a destination. The Act is a step in the right direction but it remains to be seen to what extent this objective will be achieved.
Private equity
So information going to private investors and information coming from institutions were covered in the Act - but are likely to be revisited. But what about information from private companies?
For those of you that still might be thinking that the Act is going to put corporate legal policy issues on the back burner for a while - let me briefly touch on private equity. In recent months, this industry has faced the full glare of the media spotlight, and much of this has been unsympathetic.
The press has often compounded the negative image originally propagated by trade unions and now generally picked up by the left by repeating inaccurate assertions about the so-called special beneficial tax treatment that private equity receives, the lack of transparency and concerns about regulation.
It is surely right that private equity firms should look to adapt their new business models in ways that emphasise their positive potential as a good force in society with greater transparency. But the negativity and thoughtless nature of the attacks in the US as much as the UK have been staggering.
From the Companies Act standpoint - there are challenges here because the premise behind the Act is that the higher levels of non-financial reporting and disclosure are predominantly allocated to companies that are public, rather than large.
This implies that private companies - no matter how big can essentially keep their affairs private. But companies in today’s world would in practice be ill advised not to listen to and inform stakeholders other than shareholders - not least with the Act’s Part 10 changes.
From a UK viewpoint, I think that any further changes by Government or legislation, should be made with great care so as not to send this or any other business sector overseas. The recent spate of very large buyouts is a relatively new phenomenon in the UK – and this has significantly increased the profile of private equity in terms of its association with popular brands – but also with large unionised work forces and much higher levels of debt.
I have no doubt that solving the carried interest tax issue will not in itself lessen the political attacks on the private equity industry and that a more public focused, transparent, corporate governance type model will be required. It does now seem that the private equity industry realises this and, via the Walker review, is proposing changes to the way it operates - we shall see how this develops and its future implications for the Act.
Director’s Duties
Within Part 10 of the Act, the seven codified directors’ duties are set out in sections 171-177. The duties are expressed to be based on common law rules and equitable principles. But regard still also has to be had to the corresponding common law rules and equitable principles when interpreting and applying the new duties.
The aim was to make the duties simpler but the effect could be confusion, especially where the codified duties conflict with equivalent or complementary common law duties. The key duty, as set out in section 172, is promoting the success of the company for the benefit of the members as a whole and when directors comply with this duty, they must have regard to a number of stakeholder factors.
Fears about the new procedural burden are weighing on numerous directors and company secretaries’ minds. The concern is the uncertainty over how to make decisions on key issues without recourse to longer board papers, minutes and records or a box ticking approach of making reference to the consideration of all the factors in the board minutes.
It rather reminds me of Margaret Hodge MP, the DTI minister at the time, who repeatedly commented during the Parliamentary passage of the Act that new director’s duties were simply a codification process rather than any marked change and then later announced, in relation to section 172 (2), that “enlightened shareholder value” marks a “radical, historic and vital cultural change in the way in which companies conduct their business.” So please take your pick of interpretations.
As I said in a speech on the matter to the Minister: “A flexible system is to be replaced by an inflexible one… On the one hand, the Government have said that there will be no change in the common-law position; yet on the other hand, they have introduced the concept of enlightened shareholder value, which all legal experts agree will alter the common-law position of acting in the best interests of the company.”
I believe that there is a fundamental gap in the Government’s train of thought: either they are introducing a new concept—enlightened shareholder value — which is an extension of the common law, or they are simply codifying the existing common law.
My understanding is that most corporate lawyers are advising that board minutes do not need to be fundamentally changed – whilst many banking lawyers are saying that each duty heading should be addressed and minuted. Ultimately, it will be for the courts to determine how far the new duties extend as there is scope for interpretation and differing applications in practice.
But any settled case law will take time to develop - so watch this space. Whether this is an area which may lead to the Act not achieving its objectives I can not yet be sure. However, it is certainly the case that such confusion can not be good for business.
Derivative claims
One aspect that may link to this could be the new derivative claims regime.
Under Part 11 of the Act, brought into force in October 2007, there is a new regime for derivative claims. That is where a shareholder brings a claim on behalf of the company against a director or auditor.
The new regime is more extensive and easier to use than the common law exceptions to the rule in Foss v Harbottle. I believe that a later speaker will discuss the technicalities of Part 11.
However, as a politician, I would note that you should not assume that only significant shareholders will wish to use this process to recoup company funds for the company. That may be the case - but just as likely it may be a single share owning activist who may wish to use the deep pockets of his or her cause to promote that cause publicly in court even in relation to matters arising before he became a member - and the pre-hearing, which is meant to protect the company, could be used as another bite of the cherry of publicity or as a means of applying pressure to management.
It does seem likely to me that more derivative claims will be brought to test the new regime, particularly in the context of large listed companies who were rarely exposed to such actions in the past. We must hope that the courts, when they do consider the first test cases, apply a sensible approach. But, clearly, this will be an area requiring continued review and it remains to be seen whether it is good for business.
To conclude, I am afraid that I am unable to give you a definitive answer as to whether I believe that the Companies Act has yet achieved its objectives in all respects. For the most part it is an improvement on the 85 Act but there are outstanding issues – where we shall have to wait and see. This is not only in relation to the Act itself but also how the Act responds to what is still a rapidly changing political climate in terms of corporate policy.
Jonathan Djanogly MP
Shadow Minister - Corporate Governance
