IDENTIFYING RELATED PARTY
TRANSACTIONS: POLICY TRADEOFFS
OECD CORPORATE GOVERNANCE ROUNDTABLE
MOSCOW
November 12, 2004
JOSEPH A. McCAHERY
Professor of Law
Tilburg University &
ECGI
1
Two Views and Four Points
• Related Party Transactions
– Play important and legitimate role in economy
– But if left unchecked, could foster opportunism
• Points
– (1) Through related party transactions, controlling
shareholders and managers may extract private benefits of
control
– (2) Potential for abuse and high cost of regulating these
transactions has led to a range of regulatory strategies
– (3) Strategies and techniques include: mandatory
disclosure, board approval, fiduciary duties, shareholder
voting
– (4) Russian law definition of related party usefully
supplemented by IAS 24
2
Identifying related parties
• Broader definition recommended
– Purpose: tighter definition of what constitutes
affiliated party required
• Various legislative strategies available, but
no simple formula
– Establish main classes of persons that constitute
affiliated or related party
– Examples include FASB 57
– Avoid transplants approach, tailor to local
circumstances
3
Mandatory Disclosure
• Main pillar of regulation of conflicted transactions in
most jurisdictions
– US securities law (SEC S-K,(all major
transactions, 5%); item 402 (executive
compensation); 404 (certain relationships &
related party transactions)
– Accounting rules (GAAP: SFAS 57 (related party
disclosure): all material transactions between
firm & officers
– State law: fiduciary duty law requires disclosure
of conflicted transactions
– Sarbanes-Oxley 16(a): officers must disclose
trades in companies shares (w/in two days)
4
Mandatory Disclosure (2)
• Prompt, continuous updating of information on
related party transactions to market
– Procedures to facilitate accuracy and speed
• Wide range of available strategies for accountants
and auditors to facilitate disclosure
– Tool kit approach to identify conflicted
transactions: asset sales that diverge from
market value, etc.
– Company directors: extended audit
5
(1) Effective Enforcement
• EU & US Experience
• Effective enforcement tools needed
• Presumption: clear, open, effective disclosure
– Trade-offs
• Capital market implications
• Facilitates other regulatory tools and institutions
• But may create burdens
– May be costly for companies
– Centralized disclosure system—front end costs
– Restricted impact—does not impact all firms equally
• Administrative Liability for non-notification
– Interested parties must disclose 20%
– Administrative measures needed
– Follow best practice—adopt codes, internal systems
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(2) Board approval
Anglo-Saxon & some Continental European
jurisdictions encourage board approval of conflicted
transactions
• 1) supplies strong protection from shareholder
challenge
– JSC Law—affiliated parties identified in
transaction, Board votes (1000+ only independent
directors)
• Remedies for transactions w/o approval--void
or damages
Tradeoffs—ex ante v. ex post
Lower transaction costs for parties to bring
claim
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Improve quality of directors
(3) Fiduciary Duties
Similar approaches in common law and civil law
jurisdictions—less willing to review conflicted
transactions approved by board
But, US has more developed case law:
Duty of loyalty: proscribes mangers from entering selfdealing or unfair transactions
1) Courts review conflicted transactions—but
less willing to review decisions approved by
disinterested director
2) Incentives for direct and derivative
shareholder
suits (procedural obstacles are
high outside US)
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(4) Fiduciary Duties in Russia
• Provide basis for shareholders to obtain
remedies
– Legal requirements to act reasonably and in good
faith, Corporate Governance code
– Incentives to bring actions weak
– Lower cost of capital if good enforcement culture
develops
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Shareholder Voting
• Shareholder voting (alternative to board approval)
– Fr: (Art L. 225-40 Code de commerce)—requires
shareholder approval of conflicted transactions
– Other jurisdictions have less demanding rules: US, UK
– Voting: Neither costless nor perfect, but may work well in
some circumstances
– OECD: calls for more shareholder input into
extraordinary transactions
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