14-05-2019

3. Discussion and analysis of jurisdictions studied. 3.4.2 Shareholder votes

A more specific measure taken in relation to shareholder votes in the UK was the introduction of a requirement that independent directors be appointed by independent shareholders under a dual voting arrangement, and that this would require, for issuers with a controlling shareholder, appropriate changes in their constitutional documents - discussed in Section 3.6.4 «Appointment of independent directors» and Appendix II.1.2. This serves two purposes: it gives shareholders a stronger incentive to attend meetings and to exercise their vote, and it establishes a clear line of accountability of independent directors to independent shareholders - the argument being that it is those shareholders they should be taking into account when exercising their role. Another example of shareholder empowerment, particularly when considered in light of the foregoing development, is the introduction of paragraph B.7 to the UK CG Code, to the effect that FTSE350 company directors should be put up for election every year. According to oral testimony before a Parliamentary Committee, «most companies have adopted this». The Department of Business, Innovation & Skills (BEIS) also have a strong shareholder- driven mandate in view of some recent high-profile shareholder actions in relation to executive remuneration, as discussed in Appendix II.2.1.

These requirements have all been introduced within the last few years, indicating an active engagement of the regulators in developing mechanisms that put more power into the hands of shareholders.

However, there are nuances to the question of the appropriate level of shareholder involvement in the affairs of a company. The experience in the United States presents a somewhat different matrix of problems than the UK but which are nevertheless informative as regards the context in Hong Kong. The specific question of the appointment of INEDs is discussed in Section 3.6.4 «Appointment of independent directors».

In the United States, it has been a long-standing fundamental right of shareholders under State law to participate in meetings. This encompasses not only the right to vote but also the right to make proposals to be voted on by members. However, as discussed in Appendix III.7.2, the SEC's view is that the proxy statement process impedes those rights and the SEC has been struggling for over half a century to facilitate shareholders exercising their rights. Different State laws provide for different shareholder rights, for example, neither Delaware nor New York guarantees that shareholders have any right to call a meeting, whereas California does. However, as noted elsewhere, since most listed issuers are incorporated in Delaware that is the State law of reference for present purposes.

Actual in-person meetings of shareholders are now, in effect, only a necessary formality. The primary means by which shareholders are in practice able to express their views is now by way of proxy exercised either in response to an issuer's proxy statement that explains to shareholders the matters for discussion at the meeting, or through the solicitation of proxies by initiating a proxy contest.

The question of giving shareholders appropriate access to the contents of the proxy statement, i.e. to give them the right to insert proposals on it, has been a significant battleground. A fundamental CG concern in this regard is that in the absence of an effective means for shareholders to nominate and elect or remove directors to or from the board, accountability of the board to shareholders is diminished. There is a wider set of arguments that the United States in this regard has fallen behind standards in other countries and that this ultimately represents an important competitiveness problem for United States issuers. Some academic literature also suggests a relationship between board accountability and effectiveness.

Conversely, a concern that has been expressed over shareholder-nominated appointments is that directors so appointed may represent the interests of select shareholders rather than the interests of the company as a whole. Shareholder activism via proxy contests can lead to undesirable outcomes, a feature that is also beginning to appear in the UK markets. This issue is discussed further under Section 3.6.4 «Appointment of independent directors».

This issue was a concern of Dodd-Frank, which empowered the SEC to make rules addressing shareholder access to company proxy materials. The authority was an important means of overcoming a previous court ruling in 1990 that the SEC lacked the authority to regulate corporate governance through the proxy rules. In 2010 the SEC introduced a new proxy access rule - Rule 14a-11 - designed to facilitate the rights of shareholders to nominate directors to a company's board. In a rule that sought to address the perceived problem of short-term shareholders pursuing short-term interests at the cost of longer term corporate prosperity, an issuer was required to include the nominees of long-term shareholders in their proxy materials together with the nominees of management. However, the rule was again successfully challenged in court, this time on the basis that the SEC had failed to adequately assess the economic effects of the rule.

Nevertheless, developments over the past decade or so have strengthened the voice of shareholders in companies. This includes SEC rules that facilitate the use of electronic shareholder forums, enhanced disclosure requirements concerning the nominating committee of the board, the information required to be included in proxy statements which includes matters such as appointment of directors and executive compensation, many larger companies moving to majority voting in place of plurality voting in director elections, and that many State laws - including Delaware where most listed issuers are incorporated - now clearly allow constitutional documents of companies to set out shareholder rights to nominate directors. Indeed, there have been ever growing waves of shareholder-initiated proposals to amend bylaws to allow proxy access and a significant number of United States companies have amended bylaws in one form or another.

Hong Kong

In contrast, the discussion surrounding shareholder involvement in Hong Kong is relatively inactive. Shareholders in Hong Kong incorporated issuers have clear powers under section 566 of the CO to call meetings and to propose matters to be discussed and voted on. Given that most issuers are not incorporated in Hong Kong, significant reliance is placed on the SFC/HKEX Joint Policy Statement together with MBLR 19.05(1)(b), which, as discussed in Section 3.2.1 «Application of local laws and regulations», work to ensure that shareholders receive equivalent standards of investor protection including as to their rights to call meetings, propose resolutions and to vote.

The HK CG Code has not as yet followed the approach in the UK as regards the frequency of director re-election. The HK CG Code instead provides for retirement by rotation every three years. The election of directors is closely tied to the interrelated topics of board refreshment as a mechanism of management accountability to shareholders (see Section 3.6.3 «Board refreshment»), as well as the information made available to shareholders in relation to the performance evaluation of directors and the board as a whole (see Section 3.3.3 «Board evaluation», which led to Recommendation C4.1.1 «Board evaluation»). The question of whether the HK CG Code should develop higher CG standards for certain larger companies is discussed in Section 3.7.7 «Differentiation of CG requirements».

Other changes made in the UK, such as dual voting, are regarded in the Hong Kong context as almost radical, and this likely arises out of the significantly different makeup of investors in the Hong Kong market, in which around half of companies possess a controlling (>30%) shareholder and around a third possess a majority (>50%) shareholder (see Appendix II.1.2).

However, Hong Kong is not without its structural problems as regards shareholder voting. Most publicly-owned shares in Hong Kong are held through a nominee arrangement (HKSCC Nominees Ltd, a subsidiary of the SEHK) and this does create proxy issues in practice. This does not challenge shareholders exercising their rights to the same extent as in the United States where the problems are more fundamentally legally systemic in nature - Hong Kong's problem is more operational in nature. This system has often been criticized as a deterrent to shareholders attending or casting their votes at general meetings of listed issuers. To attend, the shareholder must instruct the nominee to appoint them as its proxy (or corporate representative). To vote, the shareholder must give the nominee its voting instructions. These instructions must be given to the nominee in sufficient time for it to process the instruction in time. Together with the delays in shareholders receiving corporate communications, which need to be processed through the nominee, this materially shortens the amount of time provided by statute that a shareholder has to form its views. These arrangements clearly add meaningful hurdles to the concept of shareholder participation. Indeed, it was a key observation of the Kay Review, undertaken in the UK (see Appendix II.2.1), that shareholder engagement is diminished by shareholders holding through a custodial system, which creates barriers and uncertainty, rather than directly. Based on the Kay Review's recommendation, BEIS is exploring a cost effective means of implementing an electronic shareholder register.

The Securities and Futures and Companies Legislation (Uncertificated Securities Market Amendment) Ordinance gazetted in March 2015 provides a framework for the introduction of a securities market that will enable shareholders to hold, transfer and vote shares under a paperless system. However, this Ordinance is not yet in force pending the preparation of detailed subsidiary legislation.

In Singapore, some shares are also held by nominees (e.g. banks or other intermediaries), and only registered legal owners can vote. However, the 2013 amendment to the CA allows intermediaries to appoint more than two proxies to vote by show of hands. The CG Code also has similar rules (see Appendix V.7.1).

Mainland China has also devised means of facilitating beneficial owners to vote via online voting.

However, the main problem for investors in each of Singapore, Mainland China and Hong Kong is that they are minority shareholders, and most listed companies are subject to the influence of majority or controlling shareholders. So, while having the right to vote assists minority shareholders express their voice, it has a limited ability to solve many of the problems minority shareholders face. Something else is needed to protect minority shareholders.

Like Hong Kong and the UK, the Exchanges in Singapore and Mainland China also do not allow companies with dual class share structure to be listed. This is ostensibly for the protection of minority shareholders based on the one-share-one-vote principle. However, some voices in the market argue that this principle stifles the development of an alternative public market for innovative companies seeking to raise funds. Thus, the Hong Kong and Singapore Exchanges have been actively considering the issue, as has the corresponding industry regulators in each jurisdiction (see discussion at Section 3.5.2 «Weighted voting rights» below).

Discussion

As discussed in Section 3.5.1 «Voting rights generally», dual voting represents a public law amendment of private rights. While the SFC has in the past expressed strong disapproval of the introduction of dual class voting shares, it is expected that any suggestion of dual voting rights imposed by the regulator would be met with similarly strong resistance by the controlling shareholders that dominate ownership of listed issuers. Interviewees were quite divided on the question of whether dual voting would be desirable in Hong Kong. The cultural background together with the traditional predominance of family controlled issuers suggested to some that an «outside» director may simply introduce disruption in the operations of the board. Similarly, there was concern that if independent directors were to be appointed by independent shareholders then there would be a risk that those directors would pursue the interests of a minority group to the exclusion of the interests of the company as a whole. However, the makeup of the market is changing very considerably, and it is arguable that the expectations of investors are evolving together with the market and international practices. Nevertheless, there is some doubt as to whether the introduction of dual voting would be supported by the requisite regulatory mandate.

A more significant opportunity to engage shareholders rests in the reform of the means by which shareholders hold their shares. As already discussed above, the framework for a scripless system is in progress that will enable more direct contact between issuer and shareholder both as regards the timeliness of notifications and the ability to vote as legal owners of the shares. Note however that while the new law will apply to Hong Kong companies, it will only apply to non-Hong Kong companies as and when the necessary approvals or laws of their home jurisdictions are in place and the Government is currently initiating discussion on this with Mainland China, the United Kingdom, Cayman Islands and Bermuda.