Progress being made on identifying CFD holders?

It looks as though – finally – there is some progress on requiring disclosure on cash settled derivatives, such as CFD’s. These instruments – beloved of hedge fund managers and others wishing to short a stock – cause major difficulties for investor relations professionals. The rules across the EU and further afield do not require investors holding derivatives to disclose their ownership, except in takeover situations. With up to 30 or even 40% of a company’s stock being held through CFD’s,

Now however some hope can held out. First, the Committee of European Securities Regulators has launched a consultation in which it proposes ….”CESR could examine, when advising the European Commission on possible implementing measures of the TD, …Application of the notification of holdings regime to stock lending and to derivative products.” The consultation closes on September 14th, and we will be responding.

Next, the Italian regulators announced its implementation of the Transparency Directive. The announcement included .. “The bill also tightens disclosure rules on shareholdings, with investors having to declare underlying stakes held through derivatives.”

And lastly, the FSA is coming closer to a decision on its approach on CFD’s and derivatives. A representative of Capital Precision will be meeting with the FSA shortly to get an insight into their ideas. Obviously, we will keep you posted.

So, progress on various fronts this last couple of weeks. Now all we need is for US regulators to adopt a Section 793 approach….

The “unstoppable” rise of hedge funds is behind Dutch proposals on 1% disclosure. But regulators are missing the point.

The world of shareholder disclosures hit a new level this week with proposals from regulators in Holland calling for disclosure of share ownership at the 1% level – down from the current 5%. If passed – and it seems that many are in favour – it would be the world’s lowest level for triggering disclosure.

The motivation seems to be the desire for greater insight into the activities of activist investors, and potentially into private equity buyouts. Whilst the concept has been floated for a while in Holland, it has sat on the back burner till now. However there seems to be a real chance of this happening. Regulators presented their proposals at a recent meeting of private equity and hedge fund executives, regulators, worker and employer representatives and board members from companies targeted by hedge funds or buy-out funds. As can imagined, the proposals got a mixed reception.

One organisation representing shareholders called instead for a 3% threshold, mirroring the position in the UK and Germany.

The timing may be a coincidence, but there appears to be open season on leveraged buyout deals at the moment, in the banking and industrial sectors.

My own view is that whilst this is an important development, there are 2 elements missing that would limit the effectiveness of a 1% - or indeed 3% - regime. First, the exclusion of derivatives. With equity swaps, CFD’s and their equivalents being non material for the purposes of disclosure, and given the (ever increasing) role they play in the strategies of hedge funds, the AFM should look at including these instruments as part of the change to the disclosure levels.

Second, the absence of a pre-emptive right to demand the identity of the beneficial owner – getting behind the nominee names. Regulation like this exists in so many countries now – the UK, France, South Africa, Australia, that it is becoming best “regulatory” practice.

The AFM and the Dutch central bank would do well to consider these whilst they are enhancing the Dutch disclosure regime.

Wider disclosure of shareholdings in Germany – AND inclusion of stock options.

As of January 2007, the rules on shareholdings disclosure in Germany have changed. They raise both an opportunity AND an obligation for issuers.

A shareholder acquiring more than 3% of the voting rights of an issuer publicly traded in Germany must publicly disclose if it exceeds or falls below this threshold.

The 3% threshold follows the UK minimum; previously the German level had 5%. Under the new rules, a shareholder must publicly disclose an acquisition or disposal of voting rights whereby the proportion of voting rights held by such shareholder reaches, exceeds or falls below the thresholds of 3%, 5%, 10%, 15%, 20%, 25%, 30%, 50% and 75%.

First the opportunity. For purposes of calculating the percentage held, investors must disclose any stock options which can be exercised and transferred into voting stock unilaterally by the holder. The acquirer must notify the issuer, the German regulator (BaFin) and the company who must tell the market by disseminating such information to the media Europe-wide. The inclusion of stock options as “material” will create more transparency for companies – and the market – on who the issuers' major shareholders are. And it will make it more difficult (for hedge funds for example) to acquire covertly major holdings in the voting rights of a public company.

Now the compliance obligation - Europe-wide publication. In the future, insider information, information on directors’ dealings, financial reports and other information that must be publicly disclosed, may be required to be disseminated by the issuer to a European-wide audience rather than only within Germany, depending on who the shareholders are and where they are located.

Federal Legislation. The disclosure requirements for publicly traded issuers will no longer be stipulated on a state level by one of the 8 Germany exchanges, but in the future will be included in the federal German Securities Trade Act. Accordingly, in the future the BaFin rather than the exchange authorities on the state level will be responsible for enforcing it. It is not clear yet how they will do this, or what penalties might be applied.

This raises again the issue of knowing who and where your shareholders are. If the issuer is unaware of this, he may – unknowingly - be in breach of the new rules on transparency.

13F – a poor substitute for a 793 – is under threat

It is a constant misapprehension that we live in an era of a global financial services market. The media is constantly telling us that when the US catches cold, Europe sneezes, and that the markets are intimately linked.

Well, this is certainly NOT true when it comes to identifying who owns which listed company. Whilst in the UK – and several other markets – issuers have the right to demand the details of the beneficial ownership of their equity issues (see "From 212 to 793 – the world in two parts"), the world’s largest market (the US) has to rely on quarterly filings known as 13-F’s.

And yet evidence is emerging that even these modest disclosures are under attack from the hedge fund industry.

Congress passed Section 13(f) of the 1934 Securities Act in 1975 in order to increase the information available to the public regarding the securities holdings of institutional investors. Generally, Section 13(f) requires that institutional investment managers, that use “instrumentalities of interstate commerce” and manage over $100 million or more of specified securities, must file Form 13F.

If the manager is required to file Form 13F, the form must be filed no later than 45 days after the end of each calendar quarter. Form 13F must include the issuer name of all Section 13(f) securities, a description of the class of security listed, the number of shares owned, and the fair market value of the securities listed at the end of the calendar quarter. Small positions consisting of fewer than 10,000 shares of a given issuer are not required to be listed where the value of all of the fund’s holdings of that issuer is less than $200,000.

What does this mean in practice? Essentially, if you are an IRO seeking to find out who owns your shares, the newest information you can possibly get is a month and half out of date – and potentially nearly four months old.

In the days of fast position building, shorting of stocks and the leveraged fund, this is an absurdly long time.

Contrast that with the 793, where the issuer has the unrestricted right to demand the identity of an issuer, at any time.

So with this distinction, who is arguing that even a 13F filing is too much information, and why? Inevitably it is a hedge fund. Enter Mr Philip Goldstein, of Bulldog Investors hedge fund complex, which now runs $240 million in four hedge funds, and another $90 million as a sub-advisor to other managers. They crossed the 13F reporting threshold earlier this year and are due to make its first filing any time soon (February 2007).

Mr Goldstein says that putting the portfolio information in the public domain amounts to the appropriation of valuable trade secrets without compensation: “There is no rational relationship between the disclosure scheme of 13F and any legitimate government interest”. And the other argument goes: Filing a Form 13F runs counter to hedge funds’ desire to keep their positions confidential. Moreover, by examining a series of Form 13F filings, it may be possible to work out hedge funds trading strategies. As a result, hedge fund managers seek to avoid Section 13(f) requirements.

And they are pitching the SEC to win an exemption.

This would be very bad news for companies and their IR professionals seeking to manage an outreach programme to institutions. As we argue elsewhere in this blog, knowledge of the underlying owners of the business is the heart of good IR, and we believe that an orderly market as a whole has a right to know whether a company is the target of an activist strategy, and the extent of that ownership.

To do otherwise would run counter to the SEC’s own rules of disclosing material information – rule 10b-5.

The SEC should consider very carefully the consequences of any exemption before deciding.

Why stock borrowers should make disclosures

It started as a simple convenience of “borrowing” stock by those who had lost their certificates, to settle trades. Now stock lending is a huge business. However, as it has grown, it has developed – some would say unwanted – side effects.

As I have argued elsewhere in this blog, good IR starts with knowing who your shareholders are. Without that, how can you analyse where you are strong and weak, how can you reach out to new share holders: and very importantly how can you manage the process where a major issue is up for voting?

Whether it is board changes, a contested takeover, corporate responsibility issues – or more and more in connection with executive compensation, investors will seek to express their views. And IRO’s and their advisors will seek to predict outcomes.

However, to do so companies need to know who owns their stock – AND to know who can vote it.

Enter the rise and rise of so called empty voting. This phenomenon, the subject of recent research by two professors at the University of Texas, has highlighted the practice whereby speculators may gamble that a company's stock will drop, and then vote for decisions that will ensure that it does -- without their ever having to own any stock themselves. Some outside interests have used the strategy to hide their voting power within a company until the last moment. Others of course deny that this practice exists – or at least is commonplace.

The practice can cause challenges for IRO’s.

First, some investors are not aware that their stock is being lent, meaning that they may have problems voting their intentions. IR’s seeking to build relationships, and with a significant vote coming up, can be misled.

Second, stock being lent in volume is sometimes an indicator that a company’s equity is being shorted, perhaps by a hedge fund.

The third issue is whether there may be some element of double counting of votes. For voting effected through Crest, this should not be a problem, as Crest ensures accurate counting. However where the vote is exercised through a proxy form, companies need – especially in a tight vote - to ensure that votes are being exercised properly.

The FSA is promising to consult on the wider issue of disclosures of “non material” positions, including stock lending. And one of the largest pension-fund managers, Hermes, is said to have called for regulators to outlaw voting altogether by borrowers of shares.

And in the EU, shareholder democracy is being reviewed (watch this space for comment on that).

Meantime, the challenges in identifying and managing voting intentions by investors who have lent their shares, continue. And companies that do not fully understand the impact of lent stock on their register, may find themselves on the wrong side of a vote. Regulators should act soon to mandate the disclosure of borrowed stock positions.

Shareholder identification and its connection to a successful world economy.

That’s a heck of leap isn’t it? Well I am going to try and prove it to you!

Amid the everyday challenges and opportunities of running businesses in the 21st century, today’s CEO’s are concerned about many things. How to get the best out of people, managing an increasingly complex regulatory environment. The impact of the global trade environment on multi-national businesses is favourable, with emerging markets seen as an opportunity. Customer interaction requires significant technology investment, as do energy and people related costs.

So investment in capabilities and assets continues to play a vital part in growing and sustaining businesses all over the world. Good relations with existing investors and well balanced programmes to reach out to new ones, are vital as ever.

And here’s the challenge. Unless you know who your shareholders are – and not just some street name or nominee, showing themselves on the shareholder register for technical reasons – how can you mount an effective relationship building programme? How can you tell how they will vote, their short or long term intentions, changes to their investment mandate or investment managers, and whole host of other issues that it raises? How can you build an effective programme targeting other, new investors, with similar characteristics to your existing shareholders – who have already proved that your investment profile matches their requirements?

Much of the problem in solving these issues is connected to disclosure. I will argue through this blog that in an enlightened market, disclosure of shareholdings is at the centre of a fair market, building market confidence, protecting all investors and eliminating financial crime.

The challenge is that the disclosure rules, which underpin these aims, are a patchwork of differences all over the world.

Thus my mission is to try to help regulators, issuers, investors, analysts and the media to be aware of the effects of these differences, and to encourage those responsible to look at creating beneficial regulatory regimes for all concerned.

Where this becomes a very serious issue is in the area of cross border transactions. As it currently stands there are a number of countries with Disclosure Laws that can have complete visibility of who holds their shares and who is buying and selling stock at each stage of the transaction. The companies within these regulatory environments have a clear advantage over companies in countries where there are no supporting disclosure laws.

For instance if a French company and a German company go into a hostile takeover situation, the French company can leverage NRE Legislation to know exactly who holds their shares and who to go to to get support during the transaction, who has the voting power and who is influencing the buying and selling activity. However the German company has no such law to obtain the same visibility and is therefore effectively “trading blind” and at a huge disadvantage to its rival. The only view they have is historic and not nearly reliable enough to base a defence strategy upon.

Countries that have this huge advantage include France, the UK, Ireland, Norway, South Africa, Australia, Singapore, Hong Kong, Finland etc. Until other countries step up and create their own versions of these Disclosure Laws they are only making their companies unnecessarily vulnerable.

I would much appreciate your views and encourage you to join in the debate. Hey, we might even change world order; next stop Davos!

Knowing who holds your shares is easy, right?

Surely, all that is necessary is to look at the shareholder register (if you have one!), and there is the name address, contact name and investment profile of all the investors in your company.

Well, if only. However before I get carried away on to “how”, lets talk about “why”. Why is knowing your shareholders details so essential?

Lets start with an analogy. If you are at the centre of a maze, and you want to pass a common message to a group of people also in that maze, how can you do so, unless you can find them? And the rules of shareholder disclosures under which investors are obliged to tell the company who they are, vary from country to country. And tracking them is very like a maze.

At the heart of any investor relations strategy are some simple concepts, all of which are jeopardised if you cannot name your shareholders.

o Seek optimal valuation over time. If the heart of good IR is achieving the most accurate valuation, a key tool is doing so is communication. Future value drivers of the business communicated with sufficient insight and detail is going to help drive the valuation.
o Minimize share-price volatility. The ideal investment in your business lies in trading based on real business insight, not on rumour and speculation, anchored by a stable, geographically balanced, and well distributed shareholder base.
o Ensure favourable access to capital. One of the most frequently asked questions is how does one measure the effectiveness of an IR campaign. What is the internal rate of return on an investment in a programme? For me, the cost of capital vis-a-vis your peers, creating a genuine competitive advantage, and ready access to liquidity as required. Communicating clear and credible future business plans are essential parts of this strategy.
o Managing corporate actions. Event driven IR – combating or encouraging large scale transactions such as a takeover, getting away a rights issue, or a proxy fight – demands intimate knowledge of the attitudes of shareholders.

In every one of these objectives, the absolute start point is a thorough - and accurate – understanding of who a company’s shareholders are. There are of course many IR activities driven by knowledge of your shareholders, whether it be increasing institutional meetings, increasing research coverage, understanding institutional voting intentions (see “Empty voting) etc, however much of the need for knowing your shareholders comes from one of the above strategies.

Or to put it another way, NOT being able to identify shareholders when the FD comes calling with one of these challenges, is not a career enhancing move.

We have always argued that if nothing else, Investor Relations is primarily a marketing function and with any marketing activity the corner stone is knowing your customer. If you do not know who is the customer (for your stock) how can you know what is motivating them to buy (or sell), what their objectives are for buying, where they are, whether or not they could they buy more, where there are other like minded potential “buyers”, it goes on.

As with any marketing activity the primary goal is creating demand and increased demand in your shares will naturally force up the price.

I bet the average company spends millions on marketing their products or services. It is a shame they don’t spend the same on marketing their stock.

Maybe the board would treat IR differently if they realised the direct knock on effect that increased demand would have to their share options value!