A FRAMEWORK FOR DISCLOSURE AND REGULATION OF RELATED PARTY TRANSACTIONS

1
A FRAMEWORK FOR DISCLOSURE AND REGULATION OF
RELATED PARTY TRANSACTIONS

• Robert D. Strahota, Assistant Director
• US SEC Office of International Affairs
• Prepared for
• 5th Meeting of the South East Europe
• Corporate Governance Roundtable
• Ohrid, Macedonia
• June 10-11, 2004
• The Securities and Exchange Commission
  disclaims responsibility for any private
  publication or statement of any SEC employee or
  Commissioner. This presentation expresses the
  author's views and does not necessarily reflect
  those of the Commission, individual
  Commissioners, or other members of the staff.

2
FINANCIAL VS. NON-FINANCIAL DISCLOSURE

• Both are necessary
• Adopt IAS No. 24 re Related Party Transactions
• But recognize its limitations
• Related party disclosure in financial statements
  is generally limited to disclosure that is
  material to the financial statement presentation
  as a whole
• Non-financial disclosure requirements should be
  based upon a lower materiality threshold so that
  all transactions that are material to an
  assessment of the integrity of management are
  required to be disclosed

3
WHO SHOULD BE COVERED?

• U.S. Approach
• CEO and next four highest paid officers
• All directors
• All officers and directors as a group
• More than 5 beneficial owners of equity voting
  securities
• Immediate relatives and family members of the
  above
• Entities in which these persons are officers,
  directors or owners of more than a specified
  percentage of the equity

4
WHAT SHOULD BE COVERED?

• All items of remuneration
• From the issuer, subsidiaries and affiliates
• Other persons?
• All financial interests and transactions
  involving the specified persons and the issuer,
  subsidiaries or affiliates. For example
• Loans (to and from)
• Sales of products and services (to and from)
• Leases (to and from)
• Both direct and indirect interests and
  transactions

5
WHAT SHOULD BE DISCLOSED AND WHERE?

• Material terms of each transaction, including the
  persons interest
• A representation as to the fairness of the
  transaction compared to an arms length
  transaction (between unrelated parties under no
  compulsion to deal with each other)
• Transactions since at least the beginning of the
  issuers last fiscal year (even if the
  transaction has been discontinued or the
  potential conflict no longer exists e.g. a loan
  has been repaid)
• Disclosure should be made in offering and listing
  particulars documents (perhaps for three years
  instead of one year), in annual reports, in
  informational materials relating to the election
  of directors, and in information relating to
  transactions requiring a shareholder vote where
  an interest or conflict exists with respect to
  the matter being voted upon

6
DISCLOSURE VS. PROHIBITED TRANSACTIONS

• Some transactions may pose such direct conflicts
  or instances of self-dealing that they should be
  prohibited. For example
• Personal loans to executive officers and
  directors
• Insider trading
• Short-term trading and short sales regardless of
  whether inside information is used
• Affiliated party transactions in investment funds
  and pension plans
• Conflicts that render an auditor not independent

7
MECHANISMS FOR MONITORING, DETECTION AND APPROVAL
OF RELATED PARTY AND CONFLICT OF INTEREST
TRANSACTIONS

• Monitoring
• Internal accounting control requirements
• Codes of ethics or corporate conduct
• Audit and compensation committees comprised of
  independent directors
• Approval Delaware corporate law approach
• Related party transactions excluded from the
  business judgment rule
• Approval by a disinterested majority of directors
• Approval by shareholders. Query, should an
  interested shareholder be entitled to vote?
• If approvals not obtained the interested party
  bears the burden of proving the fairness of the
  transaction, if it is challenged

8
REMEDIES

• Derivative lawsuits
• Shareholder lawsuits difficult unless class
  action permitted
• Government lawsuits to recover on behalf of
  shareholders
• Governmental pre-approval or injunctive remedies
• Importance of equitable remedies
• Disgorgement
• Accounting
• Appointment of receivers
• Bar voting of unreported significant
  shareholdings
• Officer and director bars
• Freeze assets
• More than actual damages for certain violations
  e.g. insider trading
• Criminal sanctions burden of proof and
  prosecution problems
• Problems with incompetent or corrupt judicial
  authorities