The European Commission Publishes its Action Plan on Modernizing European Company Law & Enhancing Corporate Governance in Response to Enron, Ahold, and the Sarbanes-Oxley Act

Article by Jean Paul Poitras, Phillip von Randow, Christophe von Teichman, Chuck Nathan and Gunar Wolf.

On May 21, 2003 the European Commission provided a major element of the European response to Enron, Ahold, and the Sarbanes-Oxely Act by presenting an Action Plan for "Modernising Company Law and Enhancing Corporate Governance in the EU." The Action Plan is based on a comprehensive set of legislative and nonlegislative proposals extending over three phases through 2009. The issues covered by the Action Plan include corporate governance, capital maintenance, groups/pyramids, as well as corporate restructuring and mobility.

The Action Plan is the Commission’s response to the "Winter Group" report presented last November. The Commission’s Action Plan follows the Winter Group’s recommendation to establish a broad framework at the EU level that allows for Member State flexibility, while striving for improved coordination of Member State initiatives (in contrast to adopting a comprehensive EU Corporate Governance Code).

While the Commission has pushed for a reform of company law and corporate governance for some time, recent corporate collapses such as Enron, WorldCom and Ahold, as well as the actions taken by US legislators/regulators, have brought these issues to "the heart of the political agenda" according to the Commission. Related to its Corporate Governance Action Plan, the Commission on May 21, 2003 also published a list of 10 priorities for modifying Statutory Audit Rules, which are also briefly summarized below.

Provided below is an overview of the key elements of the Action Plan. The list is divided chronologically, indicating the timeframe in which the Commission intends to realize each element: short term (2003-2005), medium term (2006-2008) and long term (2009 onwards). Although most of the initiatives would need to be implemented by new or amended legislation requiring action by the European Parliament and the European Council, in some cases the Action Plan proposes that the Commission act more quickly and adopt recommendations, which are identified below.

Overall the main emphasis of the Action Plan is on corporate governance issues. The following short-term initiatives are proposed:

• Annual Corporate Governance Statement. Listed companies will be required in their annual reports to explain the key elements of their corporate governance structure, including: a description of shareholder rights and how they can be exercised; the composition and operation of the board; major shareholders and their voting/control rights; and any material transactions with related parties/major shareholders.

• Facilitation of the Exercise of Shareholders Rights. A framework will be developed for enhancing shareholder rights in listed companies (e.g., rights to ask questions, table resolutions, vote in absentia, participate in general meetings via electronic means) and for resolving cross-border voting problems.

• Promotion of the Role of Non-executive/Supervisory Directors (Recommended, but on a "comply or explain" basis). The Action Plan provides for a strong and effective role for non-executive (independent) or supervisory directors, particularly in areas where executive directors have conflicts of interests, such as remuneration of directors and supervision of the audit of the company’s accounts.

• Collective Responsibility of Board Members. Board members will be made collectively responsible for financial statements and key non-financial statements.

• Directors’ Remuneration (Recommended). The Commission suggests disclosure of the company’s remuneration policy and individual directors’ remuneration. The Commission will also recommend prior shareholder approval of share and share option schemes in which directors participate as well as proper recognition of the costs of such schemes in the annual accounts. The potential medium-term actions include: (i) enhancing disclosure by institutional investors of their investment and voting policies; (ii) offering a choice for all listed companies between the two types of board structures now available in some EU countries (monistic/dualistic); and (iii) enhancing directors’ responsibilities by giving certain shareholders a special investigation right, developing wrongful trading rules and giving EU-wide effect to a director’s disqualification.

In the field of capital maintenance, the Commission’s Action Plan contemplates short-term simplification of the relevant Company Law Directive on the formation of public limited liability companies and the maintenance and alteration of their capital. The proposals include:

• a partial relaxation of certain rules, including those concerning contributions in kind, acquisition of own shares or limitation/withdrawal of preemption rights; and

• an introduction of "squeeze-out rights" and "sell-out rights" going beyond the proposed Directive on Takeover Bids (which offers those rights only to listed companies and only in the case of a takeover bid).

A potential long-term action is the introduction of an alternative capital maintenance regime that is not based on the concept of legal capital but rather on the requirement that a solvency test be satisfied before any payment of dividends or other distribution can be made.

• The Action Plan proposes to introduce expanded financial and non-financial disclosure obligations for groups where the parent company is not listed (short term).

• The Commission is also considering the prohibition of stock exchange listings for abusive pyramids, which are defined as chains of holding companies with the ultimate control based on a small total investment (e.g., multi-tiered holding structures in which ultimate control is exercised through small majorities at each level; medium term, pending further research).

New proposals are planned for company law directives: (i) for facilitating crossborder mergers in cases where there is no reciprocal national legislation allowing a merger; and (ii) for transfers of a company’s center of activity and/ or registered office, which is currently impossible or at least conditional on complex legal arrangements (short term).

Simultaneously with the Corporate Governance Action Plan, the Commission has published a list of 10 priorities for improving and harmonizing the quality of statutory audits throughout the EU. Underlying these priorities is the concern for avoiding the extra-territorial effects of the Sarbanes-Oxley Act. The main goals of the Commission are to ensure the accuracy of audited accounts, prevent conflicts of interest for auditors and enhance the EU’s protection against Enron-type collapses.

Interested parties are invited to provide the Commission with comments on the Action Plan by August 31, 2003. The Council, which originally invited the Commission to produce the Action Plan has declared its intent to deal with these corporate law issues as a priority. However, as the drawn-out saga of the EU Takeover Directive demonstrates, it may be difficult on a number of points to reach an EU-wide consensus and transform the Commission’s plans into concrete actions.

Latham & Watkins operates as a limited liability partnership worldwide with an affiliate in the United Kingdom and Italy, where the practice is conducted through an affiliated multinational partnership. ^© Copyright 2003 Latham & Watkins. All Rights Reserved.

Latham & Watkins is an international law firm of more than 1,500 attorneys in 21 offices worldwide, including Boston, Brussels, Chicago, Frankfurt, Hamburg, Hong Kong, London, Los Angeles, Milan, Moscow, New Jersey, New York, Northern Virginia, Orange County, Paris, San Diego, San Francisco, Silicon Valley, Singapore, Tokyo, and Washington, D.C.

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.