IDENTIFYING RELATED PARTY

1
IDENTIFYING RELATED PARTY TRANSACTIONS POLICY
TRADEOFFS
OECD CORPORATE GOVERNANCE ROUNDTABLE MOSCOW Novemb
er 12, 2004
JOSEPH A. McCAHERY Professor of Law Tilburg
University ECGI
2
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

3
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

4
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)

5
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

6
(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 systemfront end costs
• Restricted impactdoes not impact all firms
  equally
• Administrative Liability for non-notification
• Interested parties must disclose 20
• Administrative measures needed
• Follow best practiceadopt codes, internal
  systems

7
(2) Board approval

• Anglo-Saxon some Continental European
  jurisdictions encourage board approval of
  conflicted transactions
• 1) supplies strong protection from shareholder
  challenge
• JSC Lawaffiliated parties identified in
  transaction, Board votes (1000 only independent
  directors)
• Remedies for transactions w/o approval--void or
  damages
• Tradeoffsex ante v. ex post
• Lower transaction costs for parties to bring
  claim
• Improve quality of directors

8
(3) Fiduciary Duties

• Similar approaches in common law and civil law
  jurisdictionsless willing to review conflicted
  transactions approved by board
• But, US has more developed case law
• Duty of loyalty proscribes mangers from entering
  self-dealing or unfair transactions
• 1) Courts review conflicted transactionsbut
  less willing to review decisions approved by
  disinterested director
• 2) Incentives for direct and derivative
  shareholder suits (procedural obstacles are
  high outside US)

9
(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

10
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