Modernisation of German securities law

United Kingdom

Three new laws reforming German securities law are intended to restore investor confidence in the integrity, stability and transparency of the stock markets

Three new statutes are designed to rid German listed companies of two related problems perceived to have been highly damaging to investor confidence over many years:

  • “raptorial shareholders” - taking advantage of the fact that lodging a claim to set aside shareholder resolutions prevented the resolutions from taking effect, unscrupulous shareholders have become adept at exploiting shareholders’ meetings for their own economic advantage, using disruptive and filibustering tactics to bully the directors and provide artificial grounds for claims. Companies attempting fundamental structural changes have been especially prone to this form of blackmail.
  • shareholder apathy - as a corollary, many shareholders no longer bother to attend shareholders’ meeting or to make their views known. As a result, whether fairly or not, directors and supervisory board members can come to seem more focused on their own interests than those of the shareholders, particularly in their management of the company’s assets.

Improving attendance at shareholders’ meetings

Previously, a shareholder’s right to attend and vote at a shareholders’ meeting usually depended on his depositing his shares well before the meeting. This often led foreign institutional investors in particular to believe – mistakenly – that their shares could not be sold while they were on deposit. It followed that some shareholders, particularly if they had large holdings, preferred to forego their right to attend meetings rather than (as they supposed) freeze their right to sell.

Under the new Company Integrity and Modernisation of the Right of Avoidance Act (Gesetz zur Unternehmensintegrität und Modernisierung des Anfechtungsrechts) (UMAG), however, shareholders only have to register to attend meetings (and, if they hold bearer shares in listed companies, provide proof of ownership through their depositary bank as at the record date, which is 21 days before the meeting). Shareholders can still attend meetings even if they sell their shares after the record date, so there can be discrepancies between share ownership and the right to attend. Anyone buying a large holding of bearer shares in the 21 days before the meeting should therefore get written assurance from the seller that he will exercise the voting rights in accordance with the buyer’s instructions.

Running the shareholders’ meeting

Under German law, every shareholder attending the meeting is entitled to request information on the company’s affairs to the extent necessary to form an objective view of the topics on the agenda, and to address the meeting.

This, of course, has laid companies open to raptorial shareholders. Resolutions passed after midnight on the day of the meeting are of no effect, so a shareholder determined to prolong the meeting by launching into long-winded speeches and producing interminable lists of questions could bring very real pressure to bear on the directors. The situation was made worse by the fact that interrupting a speaker or any failure by the directors to answer questions fully could give the shareholder grounds for a legal challenge.

Under the UMAG:

  • the board may post information on frequently asked questions on the company’s website. If this information has been continually accessible on the website at least seven days before the beginning of the meeting the board can refuse to provide information on these questions in the meeting.
  • shareholders can adopt a provision in the company’s articles of association authorising the chairman to impose a reasonable restriction on the time available to shareholders for speaking and asking questions. In this way, the chairman can ensure that the meeting does not usually last more than between four and six hours.

It remains to be seen whether these measures will succeed in reducing the length of shareholders’ meetings and provide a forum for shareholders to exchange views. In the past, raptorial shareholders have usually managed to get round any restrictions directed against them.

Action to set aside/release procedure

There are new restrictions on the ability to file claims to set aside resolutions passed at shareholders’ meetings. Those who spotted a lucrative chance to file such a claim used to be able to buy shares just before a meeting. Under the new law, a shareholder may only file this type of action if he bought the shares before the agenda was published.

The legislation includes what is known as a release procedure (Freigabeverfahren). If an action to set aside is filed against a capital increase resolution or a resolution consenting to an intra-group agreement (in particular, a control and profit transfer agreement, i.e. an agreement by which a listed company submits the management of the company to another enterprise and undertakes to transfer its profits to that other enterprise), the court may, if the company files an application in fast-track proceedings, rule that the action to set aside will not prevent the resolution from being entered in the commercial register (in other words, from taking effect). This type of order is only possible, however, if the action is inadmissible or obviously unfounded, or if the company’s interest in the resolution is deemed to take priority over the interest of the shareholder who filed the action.

The UMAG also provides, as a disincentive to raptorial shareholders (and the board, too, perhaps), that any settlement of an action to set aside must be published, along with details of any payments made or promised.

Directors’ and officers’ liability

In a change designed to boost the entrepreneurial initiative of board and supervisory board members and promote a greater willingness to take decisions, the UMAG expressly incorporates the business judgement rule into securities law, which the courts have already applied in past cases. If directors and officers meet certain tests they are not liable for errors of business judgement.

The rule applies to directors’ decisions if they qualify as entrepreneurial decisions that relate to future developments and are, therefore, based on forecasts (i.e. estimations that cannot be verified by a court), and if the action taken:

  • is based on reasonable information. The need for information must be judged individually according to the type and significance of the transaction in question, the time available for making the decision and the chances and risks associated with it
  • serves the good of the company, i.e. aims to increase its earnings capacity and its competitiveness
  • is not driven by special interests or external influences, and particularly not by the individual interests of directors and officers
  • is taken in good faith.

The business judgement rule applies only to entrepreneurial decisions, and not to breaches of duty arising from statute, the articles of association or supervisory board resolutions.

Making claims against directors

As a rule, only the company, not the shareholders, can make liability claims against directors and officers. The UMAG has not changed this, but it has changed the system under which claims against directors had to be filed by the supervisory board and claims against the supervisory board had to be filed by the directors – a rare event in either case, no doubt due in some cases to the closeness built up between the two boards. This is likely to change in future.

Under the UMAG, shareholders can file the company’s claims for compensation directly against directors and officers as long as the following conditions are met in preliminary proceedings:

  • the relevant shareholders hold in aggregate at least 1% of the share capital, or a nominal amount of €100,000 of the share capital
  • they bought their shares before the time when they should have been aware of a potential claim for compensation based on published information
  • the company has not filed a claim itself despite a reasonable period being set
  • there are no overriding reasons associated with the good of the company that preclude a claim for compensation, and
  • there are circumstances which justifiably suggest that the company has suffered a loss as a result of a lack of integrity or gross breach of the law or the articles of association.

As shareholders can contact one another through the so-called shareholders’ forum on the internet with a view to filing an application, and raptorial shareholders are known to have bought shares in all listed German companies in anticipation of the UMAG, only the last of these conditions protects directors and officers from being swamped with liability claims. A court will only admit a liability claim against a director or officer if it considers that the director or officer has committed a serious breach of duty. But the expected volume of these preliminary proceedings alone is likely to hinder directors and officers in their work.

Appointment of a special examiner

German securities law enables shareholders to have certain business procedures examined by a special examiner, who has comprehensive investigatory and inspection rights. If the shareholders in a shareholders’ meeting decide by a majority to reject an application to appoint a special examiner the minority can instead apply to the court to have a special examiner appointed. In the past, this required the application to be filed by holders of at least 10% in aggregate of the share capital or a nominal amount of €1,000,000 of the share capital, but under the UMAG holders of 1% in aggregate of the share capital or a nominal amount of €100,000 of the share capital can apply. As shareholders can use the shareholders’ forum on the internet to rally support for an application, the new threshold will hardly be an effective way of restricting special examinations.

The court will allow an application to appoint a special examiner if:

  • the applicants held their shares for at least three months before the date of the meeting at which the application to appoint the special examiner was defeated, and
  • there are circumstances that suggest with some justification that the directors have acted without integrity or are in gross breach of the law or the articles of association.

There is likely to be a sharp increase in the number of special examinations, at least in cases of serious breach of duty. The results of the examination, published in the special examiner’s report, may form the basis for subsequent liability claims against the directors or officers.

Test cases

Until recently there has been no German equivalent to the US-style class action. If a large number of investors suffered losses as a result, say, of a company’s failure to disclose information to the market, the German courts were flooded with individual claims, each of which had to be processed and decided on its own merits at a great cost of time and money to the claimants and the courts.

The new Capital Investor’s Test Case Act (Kapitalanleger-Musterverfahrensgesetz) (KapMuG) has introduced the concept of a test case into German securities law and civil procedure. The Act will run for a five-year trial period, and is already being applied in a prospectus liability case against the German telecommunications company, Telekom AG, on the grounds of alleged manipulation during the 1996 IPO. A total of 14,447 shareholders, represented by 754 lawyers, have filed claims.

The purpose of the new procedure is to bring about a “test case decision”. This sets out the individual factual elements or legal issues, which are then legally binding in relation to all the claimants whose cases are linked to the test case. The individual proceedings are then continued on the basis of the factual elements or legal issues and decided independently.

The test case is initiated by an application filed by a claimant, and the application is published in a special claim register. If a further nine claimants file an application in the same matter, this sets the actual test case proceedings rolling. These are conducted by the higher regional court, which chooses one of the claimants as the test claimant. Until a decision – the test case decision – has been reached in the test case proceedings, other claims can be bound to the test case decision.

Once the test case decision has become final and absolute the courts will continue to process and take decisions on the individual cases. The German procedure differs from US class action suits in that, under the German system, the court pronounces an individual decision for each claimant. In contrast to the US, in Germany a claimant cannot opt out of test case proceedings.

Remuneration disclosure

Under the new Board Remuneration Disclosure Act (Gesetz über die Offenlegung der Vorstandsvergütungen) (VorstOG) there is for the first time a duty in Germany to publish the remuneration paid to the individual directors of listed companies. Formerly, companies were only required to disclose the aggregate remuneration paid to all directors, although the German Corporate Governance Code recommended voluntary disclosure of individual directors’ salaries.

The revised law requires listed companies to state, against the name of each director, the entire remuneration paid to him. The amount must be broken down into fixed and performance-related components and components that provide a long-term incentive, such as stock options. The individual benefits promised to the director should he leave the company - in particular, pension and settlement payments, which in practice form a substantial component of board remuneration – must also be disclosed. The VorstOG does not go as far as the UK Directors’ Remuneration Report Regulations, however: for example, there is no requirement to put the directors’ remuneration to an advisory vote.

The shareholders can opt out of the VorstOG by a majority of three-quarters of the share capital represented in the vote. If so, the previous provisions apply, and the aggregate remuneration paid to the entire board of directors must be published in the annual financial statement.

This article first appeared in our Clearly Corporate Bullitin April 2006. To view this publication, please click here to open it as a pdf in a new window.