Ashurst Governance and Compliance Update - Issue 25

1. FCA fines former chair for unlawful disclosure

The Financial Conduct Authority has published a Final Notice imposing a financial penalty of £80,000 on Sir Christopher Gent (CG), the former non-executive chair of ConvaTec Group Plc, for unlawfully disclosing inside information to two of ConvaTec's major shareholders in breach of Article 14(c) of (what was) the EU Market Abuse Regulation (EU MAR). The inside information related to the revision of ConvaTec's financial guidance and the retirement of ConvaTec's CEO.

Facts

Revised financial guidance

At a ConvaTec board meeting on 25 September 2018: (i) the latest financial information presented to the board indicated that ConvaTec's forecast revenue growth was at the lowest end of its published market guidance, leading the board to request a further interrogation of the financial data; and (ii) the board discussed a situation concerning a major customer potentially reducing its orders, which would significantly affect ConvaTec's forecast revenue growth.

Over the coming days, ConvaTec sought to clarify the position regarding the customer's plans for a depleted inventory and the potential impact on full year guidance. During the investigative process, a number of calls were held, and e-mails sent, between senior ConvaTec executives and ConvaTec's brokers. During a call on 9 October 2018, ConvaTec was advised by its brokers that, at that point, the information relating to the customer's intentions and the potential impact on ConvaTec’s financial guidance was not precise enough to necessitate an RNS announcement. During a further call that day, which was attended by the CEO, other senior ConvaTec executives and CG, the brokers' view was shared and it was noted that the work to update revenue growth guidance was ongoing.

CEO retirement

During a conversation on 10 October 2018, ConvaTec's CEO told CG that he wanted to explore retirement, subject to reaching agreement on remuneration and exit arrangements. CG subsequently informed a ConvaTec executive, whose responsibilities included giving legal advice to ConvaTec and overseeing ConvaTec's compliance with EU MAR (Executive A), about the CEO's intentions. CG noted that he would need to clarify timings as to the CEO's retirement. CG asked Executive A to inform ConvaTec's brokers and mentioned his intention to call three of ConvaTec's major shareholders.

Disclosures

During the afternoon of 10 October 2018, CG had separate telephone conversations with two major shareholders (Companies A and B) during which he disclosed that ConvaTec expected to make an RNS announcement on 15 October 2018, depending on the board's analysis, which was expected to announce the revised financial guidance and the CEO's retirement. Prior to the second disclosure, CG informed one of ConvaTec's brokers that he was in the process of calling the board, including Company A (which had a board appointee), and also discussed with the broker whether he should inform Company B (together with another major shareholder) of the impending RNS announcements relating to the revised guidance and the CEO's resignation. The broker agreed that he should do.

Inside information

A ConvaTec board meeting took place on 12 October 2018, during which the board resolved that the information regarding the revised guidance to revenue growth and the CEO's retirement was now inside information.

Release of RNS announcements

On 15 October 2018, ConvaTec released two separate RNS announcements addressing (i)the revised financial guidance and (ii) the CEO's intention to step down. By market close on 15 October 2018, ConvaTec's share price had fallen from 224.2 to 150 pence.

FCA findings

Set out below are some key points from the FCA's findings.

Test for inside information

The FCA found that the relevant inside information CG disclosed was that, depending on the board's analysis, ConvaTec expected to make an RNS announcement on 15 October 2018, which was expected to announce that ConvaTec was revising its financial guidance and the retirement of its CEO. By way of reminder, Article 7(1)(a) of EU MAR provides that, for the purposes of EU MAR, inside information comprises 'information of a precise nature, which has not been made public, relating, directly or indirectly, to one or more issuers or to one or more financial instruments, and which, if it were made public, would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments'.

The FCA rejected CG's representations that the information which he possessed and disclosed was 'fundamentally unsuitable' for announcement and was not inside information. The fact that, as at 10 October 2018, the information was not in a form to be announced did not prevent it from being inside information. The FCA noted that the test for whether information is inside information does not include whether the information is currently suitable for announcement. Whilst the fact that both matters were 'depending on the board's analysis' clarified that the relevant events were not certain, they did not have to be certain for the information disclosed to be sufficiently precise to constitute inside information. Instead, they needed to be reasonably expected to occur. The FCA cited Hannam v FCA, in which it was found that this meant that there needed to be a realistic prospect of the events occurring. In the FCA's view, at the time of the disclosures, this test was met as there was a realistic prospect that the financial guidance would be revised and that the CEO would retire, despite the fact that ConvaTec needed to clarify the financial position and the CEO had not yet confirmed he would be retiring. Further, the FCA found that the information was also specific enough to enable a conclusion to be drawn as to its possible effect on the price of ConvaTec's shares. Again, the FCA referred to Hannam v FCA where it was held that there is no need to know the extent to which a company's share price would be affected.

In support of its finding that information can constitute inside information whilst still being subject to clarification or further investigation, the FCA referenced the obligation under Article 17(1) of EU MAR which requires an issuer to inform the public of inside information 'as soon as possible'. The FCA highlighted that a short delay between the inside information coming into existence and an announcement having to be released is acceptable for announcement preparations to be made and where the situation needs to be clarified.

Selective disclosure

Whilst EU MAR recognises that the disclosure of inside information on a selective basis may be justified in certain circumstances if undertaken in the normal exercise of employment, profession or duties, the disclosures in this case were found not to fall within the parameters of the exception to the rule against non-disclosure of inside information. The FCA agreed with the decision of the European Court of Justice in Grǿngaard and Bang where it was held that the exception to the rule against non-disclosure of inside information must be interpreted strictly, such that the disclosure of such information is justified only if it is 'strictly necessary for the exercise of an employment, profession or duties and complies with the principle of proportionality'. The FCA found that the disclosures were made otherwise than in the normal exercise of CG's employment, profession or duties in his role as chair of ConvaTec, because (among other things):

• The disclosures were not reasonable nor was it necessary for them to be made in order for CG to perform his proper functions. Further, the imposition of confidentiality and no-dealing requirements by CG did not make the disclosures part of the normal exercise of CG's employment, profession or duties. Interestingly, in concluding that the disclosures were neither reasonable nor necessary, the FCA highlighted that the main reason for the disclosures was to provide the shareholders with a 'heads-up' rather than to consult.
• CG's explanation that he did not want to 'surprise shareholders of scale with announcements' did not justify making the disclosures. While shareholder engagement formed part of CG's duties, disclosing inside information for this reason ran contrary to the objectives of EU MAR which aims to protect against 'unfair advantage being obtained from inside information to the detriment of third parties who are unaware of such information and, consequently, the undermining of the integrity of financial markets and investor confidence'. Additionally, CG did not make similar disclosures to other larger shareholders.
• Although Recital 19 to EU MAR provides that discussions of a general nature relating to the business and market developments are permissible between shareholders and management, CG's disclosures of inside information fell outside the scope of this type of discussion.
• There were more appropriate ways in which the shareholders' support could have been encouraged; for example, other major shareholders were given access to ConvaTec's senior management team in calls following the RNS announcements.

Negligent disclosure

The FCA found that, having received relevant training on EU MAR, and in light of his wealth of experience and position, CG should have realised that the information he disclosed was, or may have been, inside information and that it was not in the normal exercise of his employment, profession or duties selectively to disclose it. According to the FCA, CG 'failed properly to apply his mind to the specific question of what information, if any, he might properly disclose, as well as when, in what manner and to whom;' further, he failed to obtain clear, formal advice on this question prior to making the disclosures.

CG was found to have acted negligently notwithstanding the following:

• At the time of the disclosures, ConvaTec had not yet formally classified the information regarding the expected financial guidance revision and the expected retirement of the CEO as inside information. Additionally, CG had been informed of the view of ConvaTec's brokers that ConvaTec needed to obtain further information on the guidance revision and should not make an announcement until it had sufficiently precise information.
• Both Executive A and one of ConvaTec's brokers were informed by CG that he was intending to call, and/or had called, the major shareholders.
• ConvaTec had a relationship agreement with Company A which imposed confidentiality and no-dealing obligations, and CG imposed such obligations himself on the relevant individuals at Companies A and B to whom the disclosures were made.

2. PIE Auditor Register comes a step closer

The Financial Reporting Council has published the Public Interest Entity Auditor Registration Regulations, which create the FRC's new registration regime for statutory auditors of public interest entities (PIEs). The Regulations form part of the government's audit and corporate governance reform package and follow through on its aim to make the FRC, and its successor body, the Audit, Reporting and Governance Authority, directly responsible for approving and monitoring the auditors of PIEs, thereby taking over from the ICAEW and the Association of Chartered Certified Accountants.

The Regulations will come into force on 5 December 2022 and, from that date, all PIE auditors will need to be approved by the FRC before they can be included on the register.

3. LSE publishes Dividend Procedure Timetable for 2023

The London Stock Exchange has published its Dividend Procedure Timetable for 2023. By way of reminder, the timetable is published on an annual basis as a guide for companies with shares listed on the Official List or admitted to trading on AIM to be used when setting the timetable for their interim and final dividend programmes.

4. UKJT consultation relating to legal statement on digital securities

The UK Jurisdiction Taskforce (UKJT) has announced its intention to issue a legal statement on issuing and transferring equity and debt securities on blockchain and distributed ledger technology (DLT) systems and has published a consultation paper to ensure that the statement addresses the issues about which key stakeholders are most concerned.

The broad question the UKJT will seek to address through the legal statement is whether English law supports issuing and transferring equity and debt securities using blockchain or DLT. The focus is on equity or debt securities constituted or evidenced by reference to a blockchain or distributed ledger and not conventional securities whose performance is linked to, or which are collateralised by, digital assets.

The consultation closes on 23 September 2022. It is expected that the legal statement will be published by the end of the year.

5. FRC publishes recommendations to improve digital security disclosure

The FRC Lab has published a report on digital security risk disclosure to help companies improve the disclosure of digital security strategies, risks and governance. In producing the report, the Lab was supported by technical experts from the Department of Culture, Media and Sport, the National Cyber Security Centre and the Department of Business, Energy and Industrial Strategy.

With the continued digitisation of the economy, digital security risk is increasingly becoming fundamental for an investor's understanding of a business. However, the Lab's research evidenced that disclosures are not meeting investor needs effectively. Companies often provide limited useful information on digital security and do not connect to the wider strategic direction of the business or respond sufficiently to geo-political or cyber events.

The Lab's report states that while many FTSE 350 companies reported at least one digital-related principal risk (mainly cyber risk), disclosures are often 'boilerplate' and overly 'static'. The report suggests that corporate reporting teams and audit committees that want to enhance disclosures might consider disclosure which:

• Explains how digital security and strategy are important to the company's current and future business model, strategy and environment.
• Details the company's governance structures, culture and processes to support digital security and strategy.
• Identifies both the current and future digital security and strategy risks and opportunities faced by the company.
• Highlights the impact of internal and external events and the actions and activities that respond to these.

The report is supported by a separate detailed example bank which provides a number of practical examples to help companies improve their disclosures. It also provides potential questions for boards and audit committees to consider.

6. FRC publishes review of judgments and estimates

The FRC has also published an updated Thematic Review focused on Judgements and Estimates.

Companies are required to disclose their more complex accounting judgments, as well as the most significant sources of estimation uncertainty. These disclosures allow readers of annual financial reports to assess how the accounting policies applied have been affected by the judgments taken by management. They facilitate a better understanding of assumptions made about the future and the extent to which changes to those assumptions may affect a company’s future position.

The FRC states that better examples of these disclosures are tailored to a company's circumstances and explain the specific judgments and assumptions made. Sources of estimation uncertainty should be quantified and other relevant information such as sensitivities or ranges of potential outcomes should be provided where these help readers understand management's judgments about the future. The requirements for IFRS reporting in this area are provided in IAS 11. To the extent that topics such as climate change or the ongoing effects of the Covid-19 pandemic affect significant judgements or sources of estimation uncertainty, the FRC expects these to be discussed.

The FRC's first thematic review on the topic of judgement and estimation uncertainty disclosures was published in November 2017. This latest report identifies some improvement in the overall quality of judgment and estimate disclosures over that period.

The FRC has, however, identified the following as areas where there is room for further improvement:

• Companies should explicitly state whether estimates have a significant risk of a material adjustment to the carrying amounts of assets and liabilities within the next financial year.
• Sensitivity disclosures should be provided more frequently and in the way that is most meaningful to readers.
• As sources of estimation uncertainty may vary from year to year, companies should reassess whether disclosures made in a previous year need to be revised.
• Companies should assess whether disclosure of climate-related significant judgements or assumptions and sources of estimation uncertainty are required by IAS 1 and consider whether information about assumptions with a longer-term effect is required.
• Where additional estimate disclosures are provided, such as those carrying lower risk, having smaller impact or crystallising over a longer timeframe, they should be clearly distinguished from those with a short-term effect.

The review includes examples of good practice, including: quantified assumptions and amounts at risk of material adjustment; detailed explanations of management's judgments and the nature of the uncertainties relating to significant estimates; and discussion of the effects of climate change on estimates.

7. FCA publishes policy statement on financial promotions

The Financial Conduct Authority has published a policy statement on its proposals to amend its financial promotion rules and guidance, along with a final handbook instrument and final non-handbook guidance on approving financial promotions.

The FCA confirms that it is proceeding with its proposals to:

• Require firms that have approved a financial promotion to take reasonable steps to monitor the continuing compliance of the financial promotion with the financial promotion rules for the lifetime of the promotion.
• Require section 21 approvers to collect attestations of 'no material change' from clients with approved promotions every three months, and for the lifetime of the promotion.

The relevant provisions of the final handbook instrument and the final guidance on these provisions are in substantially the same form as the drafts published in January. The new rules will come into force on 1 February 2023.

For more information, please see Item 3 in our Financial Services Team's update. The background to the proposals can be found in Ashurst Governance and Compliance update, Issue 12.

8. UK Secondary Capital Raising Review: a new start?

As reported in Ashurst Governance and Compliance update, Issue 23, HM Treasury published the UK Secondary Capital Raising Review in July 2022. Set out below is an Ashurst news brief item on this development which first appeared in the September 2022 issue of PLC Magazine.

Following on from Lord Hill’s review of the UK listings regime, on 19 July 2022, HM Treasury published its UK Secondary Capital Raising Review, which seeks to modernise and streamline the secondary fundraising process for listed companies in the UK through a package of reforms.

The recommendations in the Review form part of a broader move for UK capital markets reform in a post-Brexit world, including HM Treasury's review of the prospectus regime and the FCA's primary markets effectiveness review. The overarching aim of this wider push for reform is to ensure that the UK capital markets regime is efficient, dynamic, modernised and competitive from an international perspective, which will bolster the UK's position as a global financial centre.

The government, the FCA and the Pre-Emption Group, each of which has a critical role in the implementation of the reforms, have been quick to welcome the findings of the Review. In terms of timing, it is envisaged that some reforms are to be implemented immediately, whereas others will take more time to be realised.

Enhancing pre-emption

The Review recommends that the principle of pre-emption, which it cites as a hallmark of the UK market, should be maintained and enhanced. In line with this, the Pre-Emption Group's role should be further centralised and formalised, including through revised terms of reference, a dedicated and easily accessible website and a review of the Pre- Emption Group's membership to ensure that it is representative of UK capital markets.

Smaller fundraisings

The Review recommends increasing flexibility for companies so that they can undertake smaller fundraisings quickly and cheaply. In particular, it considers that the Pre-Emption Group should restate its statement of principles to provide that shareholders should consider supporting disapplication resolutions of up to 20 per cent of issued share capital, rather than the current 10 per cent, with the first 10 per cent being available for any purpose and the second 10 per cent to be used for an acquisition or specified investment. This would make permanent the temporary relaxation introduced in response to the COVID-19 pandemic. Use of the 20 per cent authority would be subject to conditions such as consultation with the company's major shareholders, soft pre-emptive issuances, and a new post-transaction reporting requirement. Granting companies additional flexibility to address their capital requirements, while imposing appropriate safeguards through the various conditions, is likely to be welcomed by market participants. In addition, the Review proposes that the Pre-Emption Group's guidance should be reformulated to support consideration of higher disapplication authorities for capital-hungry companies, potentially to an upper limit of 75 per cent, in light of the particular requirements of companies operating in sectors such as technology and life sciences.

Involvement of retail investors

Building on the recent market trajectory, the Review recommends increasing the involvement of retail investors and other existing shareholders in all capital raisings. In respect of non-pre-emptive offerings, the Review considers two possible approaches to achieve this:

• Follow-on offers, comprising an institutional-only placing followed by a subsequent offer aimed at retail shareholders.
• Retail investor platforms, allowing for retail investor participation alongside the institutional offering.

The Review recommends that the Pre-Emption Group's statement of principles is updated to incorporate guidance on the use of follow-on offers, including in respect of the offer period, which would allow existing shareholders sufficient time to become aware of the offer and make an informed investment decision.

Reduced regulatory involvement

The Review notes that the majority of a prospectus issued for a secondary fundraising merely duplicates information that is already available to investors through continuous disclosure requirements and stresses that the prospectus drafting process, which is both costly and lengthy, is further delayed by the FCA review and approval process. The Review goes on to recommend that the threshold at which a secondary issue requires an admission to trading prospectus should be increased from 20 per cent to 75 per cent of existing share capital. It will be interesting to see whether the FCA takes forward this proposal which, if implemented, together with the recasting of the public offerings of securities regime under HM Treasury's UK prospectus regime review, would significantly reduce the use of prospectuses on secondary fundraises.

In a bid to align the UK more closely with other major jurisdictions, the Review recommends that the appointment of a sponsor should not be required for a secondary issue except in certain cases, such as a significant acquisition. The removal of the sponsor seeks to reduce the pre-launch timetable by eliminating the need for lengthy diligence that is currently required for a sponsor declaration.

In respect of working capital, with a view to enhancing the utility of the issuer's confirmation to investors, the Review proposes a move away from the current prescriptive approach to working capital statements, which provides that clean working capital statements cannot be accompanied by assumptions. This follows-on from the FCA's temporary COVID-19 measures, under which the FCA allowed assumptions in an otherwise clean working capital statement, and brings the treatment of working capital statements closer to that of profit forecasts. In addition, the Review proposes that the more focused working capital diligence process that is undertaken on undocumented placings should be replicated for all secondary fundraises.

Existing fundraising structures

The Review suggests making existing fundraising structures quicker and cheaper. Highlighting the current lengthy timetables for pre-emptive offers, which lead to increased market risk and price volatility, the Review proposes that the process is streamlined by:

• Reducing the minimum offer period for rights issues and open offers from 10 to seven business days.
• Reducing the situations which require a general meeting by:

- broadening the scope of the two-thirds allotment authority, currently limited to fully pre-emptive rights issues, to include any pre-emptive offering; and

- updating the Companies Act 2006 pre-emption provisions to remove deficiencies relating to the treatment of overseas shareholders, fractions and convertible securities to align the provisions more closely with the process that is followed where statutory pre-emption rights are disapplied. Companies would then be more inclined to comply with the statutory requirements for a pre-emptive offer, removing the need to hold a general meeting.

• Where shareholder approval is required, reducing the minimum notice period for non-AGM shareholder meetings from 14 to seven clear days.

In the cases where a prospectus is not required under the proposed regime, the Review suggests the use of a non-duplicative offer document, the content of which would not be mandated by any content requirements but instead be driven by market practice and tailored to the circumstances of the issue, which would allow issuers to come to market more quickly. To address the expectations of investors in the US and other international markets under this streamlined disclosure framework, the Review recommends that companies should be able to opt in to an enhanced disclosure regime that would bolster their disclosure in areas that are particularly relevant to a fundraising, including risk factors and a business overview. Together with a shorter form offer document and efficient diligence, the Review believes that this would allow US and other international comfort to be delivered while removing the need to make duplicative and unnecessary lengthy disclosures. Alternatively, all the supplemental offer disclosure could be published in an extended press release at the time of the offer.

The Review proposes that offer documents published where no prospectus is required should be subject to a lower non-prospectus recklessness standard of liability, rather than the current higher prospectus negligence standard. It also proposes that consideration be given to clarifying that investment banks and financial advisers, acting in any capacity, are not liable for a prospectus or any other offer documents of an issuer, or any information incorporated by reference into it.

While the flexibility of the enhanced disclosure regime is welcome, it remains to be seen whether it will significantly affect market practice in offerings which incorporate a US element, given that US standards have traditionally dictated that a full prospectus be published. In addition, it will be interesting to see what recourse will be available to shareholders under the repositioned documentary landscape if things do go wrong.

Increasing range of choice

The Review also proposes an increase in the range of choice of fundraising structures for companies. In particular, it suggests that aspects of the Australian accelerated fundraising structures, which balance the need to respect pre-emption rights against the need to raise capital quickly, could be reflected in the UK system, including the use of short-form documents and cleansing notices.

Drive to digitisation

The Review proposes prioritising the so-called 'drive to digitisation', under which all shareholders hold their shares in fully digitised form. This would not only enable the Review's recommendations to make fundraisings quicker and cheaper to be implemented more effectively but, more broadly, it would also help to position the UK as a leading jurisdiction in this area. The Review recommends the launch of a digitisation task force with an independent chair to drive the modernisation of the UK shareholding framework. This has already been actioned by the government and it has already appointed Sir Douglas Flint as chair of the digitisation taskforce.