The duty of disclosure is one of the most significant duties in securities laws. Its purpose is clear: enabling the public shareholders to receive credible information on the company’s practices in a full and efficient manner, one that will enable investors to make educated decisions about their holdings, and thus creating confidence in the Israeli capital market.
The duty to point out a conflict of interests from which a personal interest could be derived is incumbent both on the company and on the shareholder tinted with such personal interest. Situations in which the shareholder also holds the company’s bonds simultaneously, often involve complex decisions between conflicting interests.
However, the Securities Authority’s intervention in these situations has to be educated, in a way that preserves the capital market’s flexibility on one hand, while safeguarding the investing public’s interests on the other.
Background
The duty of disclosure is one of the most significant duties in securities laws, and its purpose is clear: enabling the public shareholders to receive complete and credible information on the company’s practices, in a manner that will enable making educated decisions about their holdings, and thus increase confidence in the capital market.
Therefore, recent years have seen repeated debate in issues regarding decision making processes in public companies, in emphasis on struggling public companies.
Conflicting interests in these companies are varied, with controlling shareholders versus minority shareholders; company’s management versus its shareholders; and shareholders versus bondholders[1]. In each such intersection there are two separate groups, which in relevant cases are situated at opposite ends of the debate with conflicting interests.
The difficulty increases even more in cases related to factors situated in two different interests groups (e.g. shareholders also holding company bonds) using one hat to benefit themselves when wearing their other hat.
Moving away from the individual to the larger picture – shareholders also holding company bonds
It seems there is no need to elaborate about the conflicting interests of the shareholders versus bondholders. The problem is that in most cases, during a company’s proper current practices, in all of the organs trusted with decision making in the company (i.e. in the shareholders meeting and the company’s board of directors) shareholders representatives are the ones making the decisions and navigating the company and its actions[2].
The anomaly, at least the fear of it, occurs when a shareholder also holding company bonds is in an intrinsic conflict of interests in making a decision of injecting capital into the company. Thus, the more the capital injection takes place in non-trivial circumstances, including issuing shares at a low share price, or alternatively injecting a high interest owners’ loan, than on opposite ends of the debate we expect to see distinct groups of shareholders on one hand that will oppose that move, and on the other hand bondholders that will support it.
An anomalous vote will appear, for example, in a case in which shareholders will support the injection of a loan to the company in the form of bonds in terms preferable to those of the market. A deeper examination will reveal that these shareholders also hold company bonds, a fact posing them in a distinct conflict of interests and raises a grave concern for personal interest in approving the irregular loan.
A similar case was discussed in the Securities Authority’s decision 2009-01-261027 that dealt with Zim Integrated Shipping Services Ltd. (hereinafter: “Zim“) and Israel Corporation Ltd. (hereinafter: “Israel Corporation“). In that case, the concern of a conflict of interests arose since institutional entities holding shares of Israel Corporation also held bonds of Zim, a subsidiary owned almost fully by Israel Corporation.
In its decision, the Securities Authority has set two tests to determine when these institutional entities will not be classified as having a personal interest when deciding on Israel Corporation’s injection of monies into Zim: (1) what is the decisive consideration in the institutional entity’s decision; (2) examining the institutional entity’s creditor interest as a bondholder vis-à-vis its share interest as a shareholder.
In that context, it is important to note that as per the instructions of section 276 of the Companies Law, 5759 – 1999 (hereinafter: the “Companies Law”) shareholders are personally bound to inform the company prior to the general meeting’s assembly whether they have a personal interest in the vote and insofar as them not informing as such they will not be authorized to vote in the meeting.
In trying to decide in similar situations, the extent of the Israeli capital market’s centralization has to be added to the considerations, as well as the danger of debilitating the capital market from making crucial decisions from fear of the Authority’s attack of actions necessary to rescue corporations in need of an immediate capital injection.
That is, the Securities Authority’s real difficulty as a regulator is in examining the cases in which to interfere. Meaning, the Authority choice not to approve such decision making will only happen in cases in which the shareholders’ holding rate is significant, as is their bondholding rate.
Furthermore, the Authority must intervene in complex circumstances, under which there are distinct cases in which the shareholder’s vote is tainted by a conflicting interest, for example: injecting the company with capital under exaggerated terms, a short period prior to company bond repayment, situations in which the company has not fully examined alternative funding means etc.
The Authority’s intervention in cases that are not substantial will serve no interests group in the company and might even cause significant harm to the capital market’s function.
Summary and conclusions
Sophisticated capital markets include various players often holding varied securities of the same company (or a subsidiary etc.)
The mere holding of securities, differing in essence and nature, is legitimate to say the least, however, it opens the door to many manipulations while using the rights given to holders of a particular security (say, company shares), in order to influence other securities (say, bonds).
The duty of full disclosure is one of the most basic duties in securities laws, aimed at creating an efficient and transparent capital market laying in front of the public the proper information necessary to make educated decisions, in order to increase the public’s trust in the capital market. However, there is an intrinsic difficulty in a regulator’s intervention in the capital market, which has to occur only in exceptional cases justifying such intervention.
[1] That is also true regarding subsidiaries’ bondholders or shareholders.
[2]Parenthetically we will note that bondholders can try and cope with hurtful shareholders decisions in other ways: receiving tangible securities, determining substantial events (including deviation from financial covenants) as triggers to a loan prepayment, receiving the right to appoint observers in the company organs etc.