Efficient enforcement of Shareholder Transpareny Rules – Lessons from

Antitrust Leniency

Dr. Dirk Zetzsche, LL.M. (Toronto) Center for Business & Corporate LawHeinrich Heine University Düsseldorf

The IssueS

hareholders

Management

InformationalAdvantage

Bid-related information(mandatory, voluntary)

Stock Price

Bidder

Art. 9 – 16 of Transparency Directive

Shareholder ≤ 5%, 10%, etc.

notifies Issuer discloses Public

Art. 5 Takeover Directive

Shareholder & persons- acting in concert

- acting on behalf ofcontrols Issuer

All outstanding voting shares

Mandatory Bid

Defined by MS (30%, 1/3)

I will not address ...

Efficiency / Desirability of - Disclosure- Takeovers- the European Mandatory Bid Rule

Stock Price Reactions to Disclosure of Major Shareholdings

Fair Stock Price in the Context of Takeovers

(Desirable) Design of Shareholder Transparency Rules

Structure

A. Circumventive Schemes

B. Inefficiency of Traditional Enforcement

C. A Self-Enforcing Scheme

D. Real-World Issues

The Issue

‘Surprise attacks’ on issuers may - circumvent information and pricing

process of takeover bids- increase risk of shareholder

expropriation through ‘unfair pricing’

Disclosure of Major Holdings Mandatory Bid upon control

acquisition

Some investors do not play by the rules. How can we make them play righteously?

Equity Strategy (Wolf pack)

TargetHF 5

HF 3

HF 2

HF 1

HF 8

HF 7

HF 4

HF 6

Service Strategy

Continental

Schaeffler(Swap Long-Leg)

8%

RBS

N.N.

DreBa

CoBa

MLCoordinator

UniCredit LBBW

CrS

TRS (28%)

Hedging Agreements (Swap Short-Leg)

UBS28%

+ ?

Cash-Settled Total Return Equity Swap / CFD

• Fees• Interest on virtual bond at EURIBOR / LIBOR• Making good for decreasing stock price

Short Party(bank)

Target company (issuer)

• Stock price increase• Dividends

Long Party(investor)

B. Inefficiency of Traditional Enforcement

Ex ante enforcement

Market supervision (trading patterns)

Compliance & Whistle blowing by investment firms

Investigation of suspicious behaviour

Ex post enforcement

Civil sanctions (investor suits)

Administrative Penalties (fines)

Criminal Sanctions (market manipulation, insider trading)

Ex-ante Enforcement depends on Efficiency of Ex-post

Enforcement

Without hard evidence any enforcement action is futile

Participants rely on non-formal (‚oral‘) agreements

Key Issue: ‚Efficient‘ Enforcement

1) Market participants are required to disclose their shareholdings which they hold indirectly through the equity strategy or the intermediary-based strategy

2) There is no evidence other than the scheme participants’ testimony.

3) The longer the acquisition strategy remains undisclosed, the larger is the proportion of the target’s share that the members of the scheme can assemble without the market noticing.

4) Stock prices will respond to first time disclosure of major shareholdings by significant abnormal returns.

5) Once the major shareholding has been disclosed the stock price remains higher than prior to the disclosure.

Assumptions

Incentives (present)

• Financing follow-up acquisitions• Reputation• Hostage to one-sided termination right in derivative contracts

• Announcement Effect• Reduced Price for Target‘s Shares

Profit

S

hare in

Issu

er‘s E

quity

Dura

tion of S

ecrecy

C. A Self-enforcing Scheme: Equity Strategy

Returns can only be obtained if strategy succeeds no member may disclose its

holding or the plan too early

Generate prisoner’s dilemma => risk of cheating

Incentive: Re-direct wealth inside the group as premium for first disclosing member

Redistribution

Stock Price Conti June – September 08

01020304050607080

pre-disclosu

re (t0)

pre-disclosu

re (t1)

Disclosu

re (t2)

post disc

losure (t

3)

post disc

losure (t

4)

Conti'sShare Price

17 € / Sh, or +20%

3 Explanations for the Announcement Effect

Lesser Managerial Agency Costs due to better Shareholder Monitoring due to a greater level of

Concentrated Ownership

Acquisition signals Under-Evaluation of the issuer‘s Shares which was Dectected by the Acquirer Investing in these Shares; other Investors Internalize the Signal

by Purchasing these Shares

Acquisition May Result in Mandatory Bid at Favourable Terms / a Competing Bid

Equity Strategy: Redistributing the Announcement Premium

• Redistribution of Announcement Premium („Information Value“) on the shares held by the pack to the member disclosing the scheme (referred to as Premium Claim [PC])

• If there is not stock price response then there was no value to the information

• Trust / Reputation (Long-term) Profit (Short-term)

Issue 1: Finite vs. Infinite Games

Funds are finite players (7 bis 12 yrs)

Fund Managers are finite players

Issue 2: Perverse Incentives?

PC1 – TC1 – ∑(P2-n) > 0

Who has the best incentives to disclose?

Proactive Factors include size of prey, knowledge, time of membership, last game situations Player with the smallest share of

the pack Player with the best knowledge of

the members (‘spider in the web’) Player with the shortest

membership (no reputation to loose, no risk investment in trustworthiness of others)

In the last game you can only win. Being excluded from future wolf packs does not harm

Who has the best incentives to disclose?

Counter-Factors include Risk of exclusion from future

wolf packs (‘the lonely wolf’) Being the second (‘winner

takes all’) => undisclosed regulatory action

Lack of hard evidence (‘in writing’) => hampers enforcement

What is the likely response of Wolf Pack Members?

Require immediate disclosure (legally bullet proof)? No premium, no wolf packing

Restrict membership?- to (apparently) trustworthy members- by size (probability of cheating increases with size)

Reduces effectiveness of the pack

Require deposit of new members ( Increases costs of participation, renders wolf packing less profitable

Combinations of the above?

C. A Self-Enforcing Strategy: Service Model

Originator not incentivized

Banks: „Perennial Players“- Profit from individual transaction low- Investment in client-oriented reputation (ML, DB)

But- Kicking out a competitor (?)

! Information by non-involved parties („rumours“)!

PC may incentivize „Market Detectives“

„honest“ whistle-blowers

Disciplin: Market Abuse / Securities Fraud Rules

Service Strategy: Premium Claim desirable?

Banks should be stable and financially sound

Large wealth transfer may hurt bank stakeholders (deposit holders etc.)

Systemic Issues

D. Real-World Issues: Consider TC

TargetHF 5

HF 3

HF 2

HF 1

HF 8

HF 7

HF 4

HF 6

Regulator notifies

lien on share value

LitigationPC1 – TC1 – ∑(P2-n) > 0

Equity Strategy (Wolf pack)

HF 5HF 3

HF 2

HF 1

HF 8

HF 7

HF 4

HF 6

Regulator notifies

lien on premium

Der

ivat

ive

Litig

atio

n

D. Real-World Issues: Evidence False Rumours

(Lesser) premium (10-20%) for second, if supported by further evidence ( lower premium for first)

Standard of Evidence / Preliminary Proceedings

Evidence Filtered by Regulators

Exclude Instigator / Originator / Organizer ...

Lessons from • Antitrust Leniency• False Claims Act

• Protected Disclosure (‚Whistleblowing‘)

Conclusion

Equity Strategy• Corporate Incentive

• Corporate and Individual: - Leniency

- Protection from SL

Service Strategy• Individual Incentive

• Application of Market Abuse / Securities Fraud Rules

Equilibrium likely !Equilibrium unlikely, but better

than the current state !

Thanks!

Dirk.Zetzsche@uni-duesseldorf.de

Please visit CBC‘s working paper series at SSRN