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.
FINANCIAL VS. NON-FINANCIAL DISCLOSURE
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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
WHO SHOULD BE COVERED?
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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
WHAT SHOULD BE COVERED?
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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
WHAT SHOULD BE DISCLOSED AND WHERE?
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Material terms of each transaction, including the person’s interest
A representation as to the fairness of the transaction compared to
an arm’s length transaction (between unrelated parties under no
compulsion to deal with each other)
Transactions since at least the beginning of the issuer’s 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
DISCLOSURE VS. PROHIBITED TRANSACTIONS
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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
MECHANISMS FOR MONITORING, DETECTION AND
APPROVAL OF RELATED PARTY AND CONFLICT
OF INTEREST TRANSACTIONS
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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
REMEDIES
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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