Corporate Governance 2023 - Trends And Developments

Introduction

In recent years, activist shareholders have been increasingly active in Japan. During the annual general shareholders' meeting season in June 2022, shareholders made 330 proposals against 97 companies (in the previous year, there were 187 proposals against 65 companies). The number of companies that had to deal with shareholder proposals was at an all-time high, with a particularly large increase in shareholder proposals from institutional investors, including activists. Since these shareholder proposals cover a wide range of topics, including, among others, those related to corporate governance such as appointment and dismissal of directors, those seeking shareholder return, and those seeking ESG-related responses, and different types of activists (such as whether they are long-term investors or event-driven investors), responding to these shareholder proposals is not a straightforward process. Japanese listed companies are being challenged on how to respond to such proposals and how to improve their corporate value over the medium to long term through constructive dialogues.

On the other hand, the number of tender offer transactions announced in 2022 was only 59 (on a reported basis, excluding tender offers purported to buy back shares), showing a decline for the first time in four years. In addition, there was no hostile tender offer transaction in 2022 for the first time in six years, down from five in the previous year. However, there was still movement of hostile acquisitions, mainly by activist investors, including behind-the-scenes movements. There are many types of hostile acquisitions in Japan. Acquisitions by corporations are often conducted with the bona fide aim of managing the target company. Acquisitions by mainstream western-style activists who aim to reorganise their business portfolios often lead to higher corporate value of the target company. These hostile acquisitions can be considered "good" acquisitions from the viewpoint of increasing corporate value. On the other hand, in recent years a concerning acquisition tactic known as the "stock speculator wolf pack" has emerged in Japan. This tactic involves attempting to seize control of the management of the target company by gaining 30-40% of the voting rights by buying up in the market and requesting convocation of an extraordinary general meeting of shareholders. Those who initiate such acquisitions aim to make the target company a "shell company" for the purpose of stealing profits after the acquisition. This situation requires attention. It has been pointed out that in many cases of "stock speculator wolf pack" - since the leaders of such wolf pack have a low sense of compliance awareness and have internal control issues - they often fail to submit large shareholding reports in a timely manner or makes false statements in their process of purchasing on the market.

Based on these trends, the Ministry of Economy, Trade and Industry (METI) launched the Fair Acquisition Study Group (chaired by Hideki Kanda, Professor, Graduate School of Law, Gakushuin University; the "Study Group") in November 2022 to promote discussions for the improvement of predictability and best practices of the concerned parties of the acquisition and capital market parties to facilitate desirable acquisitions that enhance corporate value in a fair M&A market.

In this article we would like to review recent trends in activist shareholders and examples of hostile takeovers, and to present the current state of discussions in the Study Group.

Trends in Shareholder Proposals by Activists

As mentioned above, although shareholder proposals by activists in Japan are on an increasing trend, such shareholder proposals rarely pass in practice. In the recent years, however, there have been two cases which drew attention from the perspective of corporate governance, where proposals by activist investors to appoint or dismiss executives were passed. In both cases, the activist requested the target company to convene an extraordinary general meeting of shareholders instead of making a shareholder proposal at an ordinary general meeting of shareholders. The two cases are outlined below.

One of those cases involves Oasis Management Incorporated ("Oasis"), a Hong Kong investor famous for its activist movements against Japanese companies. Oasis requested Fujitec to hold an extraordinary general meeting of shareholders and made its shareholder proposal. Oasis called for the removal of all then-current outside directors and proposed appointment of six directors nominated by Oasis. As a result, four Oasis candidates were elected at an extraordinary general meeting of shareholders held on 24 February 2023, while three then-current directors were dismissed. Oasis launched its campaign against Fujitec much earlier than the extraordinary general meeting request. They claimed that they were particularly concerned about Fujitec's inappropriate related-party transactions between Fujitec and a company controlled by the chairperson of Fujitec and their relatives. As a result of these campaigns, Fujitec withdrew the proposal to nominate the chairperson as a candidate for the director of Fujitec at the annual general meeting of shareholders held on 23 June 2022. However, after the general meeting, it was announced that the chairperson would be appointed as chairperson of the board (although not a director). In response, Oasis continued its campaign, which led to the request for holding an extraordinary general meeting of shareholders.

The other case involves 3D Investment ("3D"), a Singaporean investor also known for its activist movements against Japanese companies. 3D requested Fujisoft to hold an extraordinary general meeting of shareholders and made its shareholder proposal. 3D proposed appointing four director nominees of its choice at the extraordinary general meeting. At the extraordinary general meeting held on 4 December 2022, two directors nominated by 3D were successfully elected. Similar to the Oasis and Fujitec case, the conflict between 3D and Fujisoft had been ongoing prior to the meeting in which 3D highlighted concerns regarding Fujisoft's capital efficiency and business efficiency, primarily attributing them to excessive real estate investments. At Fujisoft's annual general meeting of shareholders held in March 2022, 3D proposed the appointment of two director candidates, but the proposal was rejected while receiving just under 40% of the votes (a majority vote is required to appoint or dismiss a director at a shareholders' meeting under Japanese laws). Consequently, the above-mentioned extraordinary general meeting was convened following further share acquisitions and submission of the proposal.

In Japanese companies, which traditionally have a strong shareholder base composed of (among others) clients and banks that are favourably inclined towards the company, claims made by activist investors have not always been highly appealing to shareholders. Against this background, the above two cases attracted attention as the activists' proposals concerning the appointment and dismissal of executives, which form the cornerstone of corporate governance, have passed (even though not all appointments and dismissals were passed). The circumstances surrounding these cases can be attributed to the presence of corporate governance issues, as in the case of Fujitec. However, it is also worth noting that a series of governance reforms, including the establishment of the Japan Corporate Governance Code and the Stewardship Code by the Financial Services Agency (FSA) and the Tokyo Stock Exchange, have brought about major changes in the shareholder structure of Japanese companies, as well as changes in investor awareness, making it easier for activists' claims to be heard if they are found to be legitimate. Furthermore, listed companies have also experienced a shift in mindset. In some cases, the company did not simply oppose the activist proposal, but also engaged in dialogues with the activist, leading to the withdrawal of the proposal when the company and the activist reached a mutually agreeable solution, such as the company accepting a portion of the proposal.

Hostile Takeover Trends

As mentioned above, although the number of hostile tender offer transactions that actually commenced in 2022 recorded zero, it does not mean that there was no movement of such transactions.

For example, Yamauchi No. 10 Family Office ("Yamauchi"), a fund established by the founding family of Nintendo Co, which is one of Japan's leading game companies, announced on 18 May 2022 that it planned to launch a tender offer against Toyo Kensetsu. According to Yamauchi's announcement, the tender offer has not yet been implemented because Toyo Kensetsu's management has not agreed to discuss Yamauchi's acquisition proposal. This acquisition proposal remains effective, and on 17 April 2023 Yamauchi further announced that it had made a shareholder proposal regarding the election of directors at the Toyo Kensetsu's annual general shareholders' meeting.

Operating companies also made attempt to conduct hostile acquisitions in 2022 which eventually turned out to be not hostile. On 30 August 2022, Oisix Ra Daichi Inc ("Oisix") launched a tender offer against SHiDAX CORPORATION ("Shidax"). The tender offer started as an agreement between Oisix and the founder of Shidax, but due to Shidax's management's opposition to such transaction, the tender offer was then launched as a hostile takeover. During the tender offer period, a third party, COLOWIDE Co, Ltd ("Colowide") made an acquisition proposal to Shidax, which was withdrawn later on. Ultimately, Shidax changed its position regarding this tender offer from opposing to being neutral and the tender offer commenced upon ceasing to be a hostile acquisition.

In recent years, hostile takeovers, which had long been considered taboo in Japan, have become an option for those seeking to acquire attractive target companies and thus remain to be actively pursued. Nevertheless, there have been questionable cases of acquisitions that lack good faith, such as takeover employing the "stock speculator

pack" tactic described at the beginning of this article. There have been calls for the establishment of rules governing hostile takeovers and takeover defence measures, giving rise to the discussions led by the METI as outlined in the following Section and discussion led by the FSA to reform the relevant rules of large shareholding reports and, possibly, tender offers.

Discussion in the Study Group on Fair Takeover

The Study Group, established in November 2022, has been examining ways to improve the predictability of takeovers of the parties involved and related parties in the capital market and to present best practices, with the aim of facilitating desirable takeovers through the sound exercise of market functions in a fair M&A market. The Study Group is also analysing the behaviour of parties involved in takeovers from the perspective of further developing M&A practices in Japan, taking into consideration the legal systems and practices in other countries as well as opinions provided by domestic and foreign parties. The Study Group aims to revise the "Guidelines Regarding Takeover Defense for the Purpose of Protection and Enhancement of Corporate Value and Shareholders' Common Interests" published by the METI and the Ministry of Justice in 2005 (the "Current Guidelines").

The first session of the Study Group was held on 18 November 2022, and following sessions continue to be held on a monthly basis. A public consultation period of about one month was also set up to solicit opinions from the public. At the sixth study group session held on 28 March 2023, draft guidelines based on the results of the previous discussions and public consultation were presented. Further discussions will continue to be held based on the content of the draft guidelines, and ultimately be formally published (as of the date of this article, the final version of the guidelines has not yet been published; the new guidelines shall hereinafter be referred to as the "New Guidelines").

New Guidelines

An outline of the draft New Guidelines is as follows:

The New Guidelines primarily focus on the act of an acquirer gaining management control by acquiring shares of a listed company. The New Guidelines cover unsolicited offers and bids where an acquisition proposal is made without any request or offer from the target company's management and the relationship of trust between the potential buyer and the target company has not yet been established.

The three principles that should be respected in acquisitions that aim to gain control of listed companies are:

Corporate value and ordinary shareholders' interests

The desirability of an acquisition should be assessed on Proposal A: whether it enhances corporate value and secures benefits that should be enjoyed by ordinary shareholders; or Proposal B: whether it secures or improves corporate value and, in turn, shareholders' common interests.

It should be noted that whether to adopt Proposal A or B in the New Guidelines is still under discussion.

Shareholders' intentions

Matters involving management control of the company should be decided based on the reasonable intentions of shareholders.

Transparency

Information necessary for shareholders' judgement should be properly made available by the acquirer and the target company, who shall ensure transparency of the acquisition through compliance with laws and regulations relating to the acquisition.

Code of Conduct for Directors and Board of Directors in Relation to Acquisition Proposals

Generally, in an acquisition which seeks to gain control over management of a company, directors and the board of directors of the target company (including, if applicable, the special committee established by the target company) should determine whether the acquisition proposal will increase the company's corporate value. Furthermore, they should make reasonable efforts to ensure that the acquisition is conducted under terms and conditions which benefit ordinary shareholders.

Below are some basic examples of how directors and the board of directors should act in various situations after receiving an acquisition proposal seeking management control.

• Upon receiving a proposal containing a specific acquisition offer, it should be submitted to the board of directors for deliberation.
• The board of directors should examine the proposal while considering whether the proposed acquisition is a "bona fide acquisition proposal" (an acquisition proposal that is concrete, legitimate and feasible).
• The board of directors should take a substantial role in the analysis and evaluation of the acquisition proposal. It shall also maintain a supervisory role to ensure the fairness of the review process to address conflict of interest risks.
• To foster mutual trust it is also reasonable to consider securing appropriate negotiation time and opportunities through provisions in a confidentiality agreement so that the acquirer will not publicly disclose the acquisition proposal, commence a tender offer, or purchase additional shares without agreement with the company (a standstill clause).
• When deciding whether or not to agree to implementation of due diligence, it is necessary to consider the specific details of the proposal identified during examinations and negotiation with the acquirer, the acquirer's business environment, track record, and other factors. In cases where there are competing proposals, consideration should also be given to fair treatment towards such other proposers.

In particular, in a company whose board of directors is not primarily composed of outside directors (meaning the outside directors do not constitute the majority), it is beneficial to establish a special committee that is independent from the parties to the acquisition (meaning the acquirer and the management of the target company) and to respect the judgement of such committee in order to complement the independence of the board of directors and ensure the fairness of transactions.

Increasing the Transparency of Acquisitions

Disclosure and provision of information by the acquirer

At each step, the acquirer shall comply with the large shareholding report rules and the tender offer rules to enhance transparency and provide shareholders with sufficient information and time to make appropriate decisions (informed judgement).

Disclosure by the target company

Enhancing the disclosure of information by the target company should enable informed judgement by ordinary shareholders.

In addition, the ex-post disclosure of information on how the target company reviewed the acquisition proposal and how it led to the acquisition can enhance the transparency of the process of forming the terms and conditions of the transaction.

Prevention of actions that may distort shareholders' decision-making

The acquirer should not, among others: (i) conduct a structurally coercive acquisition tactic, such as a coercive two-step acquisition; (ii) disclose inaccurate information or provide misleading information to shareholders; or (iii) pursue a takeover while concealing the intention to do so.

Policies and Countermeasures for Responding to Acquisitions

The ideal approach, before employing countermeasures to acquisitions, is for the parties involved in an acquisition to conduct appropriate actions to seriously consider and negotiate, have both the target company and the acquirer provide necessary information, ensure transparency and fairness, and then let the shareholders decide whether or not to accept the proposed acquisition.

The following points should be considered in relation to the countermeasures to acquisitions.

• The implementation of countermeasures should, in principle, be based on the reasonable intention of the shareholders as it involves a change of control over the company.
• The countermeasures should be carried out in a necessary and appropriate manner, taking into consideration the prvinciple of the equality among shareholders, protection of property rights, and the prevention of abuse of management power for self-preservation.
• The introduction and disclosure of countermeasure policies during normal times (such as before receiving a hostile offer) are desirable as they will improve the foreseeability for the acquirer. However, before considering the introduction of such policies, companies should make reasonable efforts to enhance the intrinsic value of the company in day-to-day operations and work towards ensuring that it is reflected in the market capitalisation.

While the Current Guidelines focus on how companies should act upon enacting countermeasures to acquisitions, the New Guidelines currently under discussion within the Study Group focus on facilitating serious considerations and negotiations between the acquirer and the target company, as well as comprehensive information disclosure to ensure transparency. By facilitating such actions, the New Guidelines expect that shareholders will be able to take informed judgements regarding the acquisition proposal.

The New Guidelines, once officially published, will significantly influence M&A practices in Japan. Traditionally, unsolicited acquisition offer or bid tends to be unsuccessful in the Japanese market as the Japanese society tends to be reluctant to support hostile transactions. Nevertheless, the publication of the New Guidelines will encourage Japanese companies to take such offer or bid more seriously, assess the effect of such offer or bid from a corporate value perspective, and engage in in-depth discussions and negotiations with the acquirer, which may, as a result, lead to an increase of unsolicited acquisition offer or bid against Japanese companies.

It should be noted, however, that the New Guidelines aim to facilitate only "good" acquisitions which enhance corporate value of a company. Hence, the New Guidelines provide certain guidance on the countermeasures to acquisition proposals that are not bona fide or "not good" (such as acquisitions for short-term profit or acquisitions employing the "stock speculator wolf pack" tactic). In any event, the Japanese market and policy makers are engaging in major discussions on how to deal with hostile or unsolicited acquisition offer or bid on listed companies, and close attention should be paid to such discussions.

Originally published by Chambers and Partners.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.